Call A Tax A Tax


Wayne Swan is still trying to convince us that the federal government’s proposed carbon tax is not a tax.

Whether Swan’s comments are deliberately obfuscatory or simply reflect a latent wish that Treasury had dreamt up a decent euphemism for the policy is anyone’s guess — but there’s no squirming out of this one: a carbon tax is most definitely a tax.

In this respect, Opposition Leader, Tony Abbott is correct. A tax is a tax is a tax, even when it is levied on business rather than collected from consumers at the checkout or deducted from employees’ pay-packets.

Here’s the rub. The carbon tax will undoubtedly be passed on to Australian consumers. If this weren’t the case, then the carbon tax would fail the first test of an economic policy designed to address climate change. The purpose of the tax, after all, is to influence production and consumption patterns away from perpetuating carbon-intensive industries and toward supporting cleaner, greener manufacturing processes and service delivery.

The more pertinent questions are whether or not a tax is the best policy instrument to achieve this goal and the extent to which it will affect our standard of living.

The net "costs" of a carbon tax will depend on the flexibility of production in the Australian economy, in particular, the ease with which we are able to find substitutes for carbon and develop methods for using carbon more efficiently. The process of reducing our reliance on carbon (or changing any production method for that matter) is what economists refer to as "innovation" and comprises developments in both technology and production know-how.

If innovation holds the promise of delivering good substitutes for carbon then a tax on carbon will encourage business to invest in these new technologies. This is because businesses will be able to maintain their profit margins while replacing their carbon inputs with alternatives. In this case, the costs of a carbon tax may be quite negligible. There is some evidence to suggest that it is possible that our standard of living may in fact increase as investment in research and a new technology stimulates economic growth.

On the other hand, if innovation can at best only deliver poor substitutes for carbon, then a tax may reduce incentives for business to invest in these new technologies. In other words, if business can’t find a good substitute for carbon, a carbon tax will be costly for consumers because the most efficient production methods will remain carbon-heavy ones and the tax will have merely ramped up their cost.

So which will it be? Innovation is a stochastic beast and while its trajectory may be roughly discernible, its end points tomorrow are, almost by definition, unknown today. However, even economic models adopting conservative assumptions about new technologies suggest that a carbon tax to ensure a less than 1.5 degree rise in global temperatures will only shave 1.6 per cent off global economic output.

The assumption underlying this analysis is, of course, that there is no inherent value in moving toward a less carbon-intensive production and consumption cycle. As a society we may decide that climate change poses such a big threat to our standard of living and therefore that any costs associated with reducing carbon emissions are worth it as we re-envisage how we live and work.

But it’s not good enough to implement a carbon tax that is merely likely to promote a reduction in carbon consumption while enabling us to maintain our standard of living at or close to present levels. We need to be reasonably certain that the tax will be better at achieving this outcome than other mechanisms.

Economists support a price on carbon because it creates a clear incentive to reduce emissions. Failing to price carbon while simultaneously subsiding energy-saving technologies may actually lead to increased emissions. This is because energy efficiency doesn’t replace carbon, it merely makes it cheaper to use. Unless subsidised research and development yields a complete substitute for carbon and it is cheaper than existing carbon-intensive production methods, a tax on carbon will still be necessary to reduce emissions. 

In the public debate, the most competitive economic policy alternative to the carbon tax is an emissions trading scheme (ETS). While a tax merely puts a price on pollution and theoretically creates an incentive to reduce polluting, an ETS caps the amount that businesses are collectively sanctioned to pollute by issuing "pollution permits" that can be traded between individual businesses and on financial markets.

Even if we put aside the environmental justice critiques of emissions trading schemes, the economic arguments against ETSs and in favour of pollution taxes are compelling. Firstly, an ETS creates extreme volatility in the price of permits (and thus in the price of pollution), generating uncertainty for businesses and making investment decisions more precarious. The US sulphur dioxide trading scheme is a case in point.

Secondly, while an ETS establishes a market with the potential for attendant trading bubbles, a carbon tax allows the government to raise revenue by taxing a so-called market failure — otherwise known as a social "bad". This provides the government the opportunity to reduce taxes on income or profits, thereby increasing overall efficiency in the economy.

Thirdly, taxes are easier to administer than trading schemes. A smaller bureaucracy means less risk of government philandering, market manipulation or cronyism in permit distribution.

Finally, setting a discernible price on carbon by way of a tax improves efficiency of production both within Australia and relative to the rest of the world. An ETS is predicated on quotas. It is a difficult political process to allocate initial quotas across regions and industries in a way that is fair, efficient and environmentally sustainable. A tax, however, creates a common price for polluting, promoting maximum reductions in industries and regions where it is most efficient to do so.

No economic policy on its own can ensure a shift to less carbon-intensive society. Given that the vast majority of Australians support doing something to mitigate climate change, the Treasurer would be well advised to abandon false semantics and to defend the carbon tax for what is: the most effective economic policy instrument we have to promote the reduction of emissions.


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