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HG Alert: The future of an Australian carbon tax - 16 Nov 2010

With the ongoing focus on climate change globally, it seems inevitable that the Australian government will move to introduce legislation to regulate greenhouse gas emissions. The question now is what form that regulation will take.

The generally-accepted options are an emissions trading scheme (ETS), a carbon tax, or potentially a hybrid of both.

Emissions trading is now old news. It came onto the agenda when Kevin Rudd entered Australia's political consciousness. Now that an ETS has been shelved (at least for now), the new remedy being touted is a carbon tax.

Key points

  • A carbon tax will put a price on each unit of carbon emitted, rather than restricting the amount of carbon emitted.
  • A carbon tax could be implemented at a number of stages throughout the supply chain as a tax on mining companies, power suppliers or consumers.
  • A carbon tax could be introduced quickly and be in place by mid-2011.
  • Businesses should be ready to make submissions to government on the design of any carbon tax.

What is a carbon tax?

A carbon tax puts a price on each unit of carbon emitted, rather than imposing a limit on the quantity of carbon emitted.

The theory behind a carbon tax is that as it becomes more expensive to emit a unit of carbon, emitters would invest in emission-reducing (green) technology, up to the point where it is cheaper to adopt these technologies rather than to pay the carbon tax.

A carbon tax is also intended to be neutral between different sources of energy, in that the tax would be levied on units of carbon emitted, as opposed to units of energy produced. This means that the most efficient sources of energy (those with low amounts of carbon emitted per unit of energy produced) should be less costly, and so favoured, over less efficient sources.

Part of the economic appeal of a carbon tax is that the 'efficient market' decides how much carbon is emitted rather than a government authority (as under an ETS).

Prime Minister Gillard's position

On the eve of the election, Julia Gillard famously made a promise to rule out implementing a carbon tax. Following this, on 15 September 2010, Dr Marius Kloppers, the Chief Executive of BHP Billiton, gave support to a gradual transition to a carbon price, involving tax, land use actions and limited carbon trading.

Fast forward to the weeks after the election, and Prime Minister Gillard found herself in a minority government, having to enter into agreements with both the Greens and the Independents in order to hold power. Unsurprisingly, due to the 'hung parliament effect', Prime Minister Gillard is now open to imposing a price on carbon by way of a carbon tax.

Internalising the cost of carbon dioxide

When coal is oxidised (burned), carbon dioxide is released into the atmosphere, effectively for free. Neither power stations nor we as consumers pay for the release of that carbon dioxide. Economist Arthur Pigou would say that carbon dioxide is external to the price paid for electricity. In order to reflect the true cost of producing that electricity - that is, the cost to both society and the environment - the price of emitting carbon dioxide into the atmosphere needs to be internalised.

A carbon tax will internalise that cost. The problem, however, is that a tax is often seen as a blunt instrument, which is difficult to adapt to changes in the economy. A perfect example is that if a price is instigated on the entire coal industry, then there will be no encouragement for clean coal technology to be developed if both clean and dirty coal are taxed at the same rate. Further, by focusing on a tax instead of an emissions trading scheme, Australia may miss out on profiting from trade in carbon permits, particularly on the international stage. The Northern hemisphere has already proven hungry for carbon permits, and New Zealand industry (particularly those involved in forest sequestration) is already profiting from selling their carbon permits overseas.

If a price on carbon is to be introduced by way of a carbon tax, the question is what stage that tax will be implemented. If we examine a basic supply chain, such as for coal, there are three possibilities:

  1. The first option is that a tax is placed on every tonne of coal that is mined, and our mining industry bears the brunt of a carbon tax. The problem with this approach is that much of our coal is exported, meaning that a domestic tax will hinder our international trade, on which we are so reliant. This is even more relevant given the recent increase in the value of the Australian dollar. In addition, about 30 percent of our export coal is coking coal, used in the production of steel. Because we're not going to find an alternative to steel quickly, a tax levied on miners will affect more people and companies than just the emitters of carbon dioxide.
  2. Another option for a price on carbon is to tax emitters - that is, the power stations that purchase the coal from the miners and burn it, releasing carbon dioxide to provide electricity. The argument here is that a tax at this point in the supply chain will be far more effective than a broad tax on coal mining. Jim Mitchell, outgoing Managing Director of Western Australia's main electricity retailer Synergy, argues for a tax that targets a smaller portion of polluting industry, rather than broadly taxing the entire industry. The intended effect of this type of tax would be that the worst emitters would either reduce their emissions or change their approach, without necessarily causing the entire industry, and so the economy, to pay for the new tax.
  3. The final option is to introduce a tax at the end of the supply chain, on consumers. It would take a bold government to directly tax the entire voting electorate, and it is unlikely that such an approach will be adopted.

When will a carbon price be introduced?

After John Howard said 'never ever' to GST, he then introduced GST well in advance of the 2001 election. The voting public had time to adjust and get used to the new tax, which took much of the sting out of the Beazley-led Opposition's rollback GST election policy.

Similarly, a carbon price has been slated for introduction in 2011, to be put in place before the next election, so that we can adjust to having a price on carbon in our economy. In the current hung Parliament, this may well be an impossible task. However, there will certainly be much debate over the coming year.

What price on carbon?

New Zealand has already begun pricing carbon, and New Zealand's Prime Minister John Key has urged Prime Minister Gillard to put a price on carbon in order to avoid a mismatch between our two integrated economies.

The Vice President of Santos, James Baulderstone, has suggested that a carbon price of at least $20 a tonne is needed, so that new base load gas power stations can compete with the existing brown coal stations in Victoria.

Because of the hung Parliament, Prime Minister Gillard needs the support of both the Independents and the Greens to pass any legislation. On top of this, as of 1 July 2011, the Greens will control the Senate, making it even more difficult to get legislation through both houses of Parliament. The Greens have already stated that nothing less than $23 of tax per tonne on carbon emissions will be acceptable. The government has previously suggested that a tax of about half that amount would be preferred, as it will have a smaller impact on the economy.

A carbon tax that is not ambitious may not get through parliament, and may share the fate of Kevin Rudd's Carbon Pollution Reduction Scheme (CPRS). Climate Change Minister Greg Combet has urged the Greens to be realistic, and to avoid adopting the same approach as used in blocking the CPRS.

It seems that negotiations will take place between Labour, the Greens and business for a price on carbon somewhere between $12 -$23 per tonne.

Business' influence on the price on carbon

The appeal of a carbon tax is that an efficient market can determine what an appropriate level of total carbon emissions in the economy should be.

Given that the market is not always efficient, it is critical that business plays a role in the design of any carbon tax that the government imposes. Although economic theory may suggest that the point in the supply chain where the tax is imposed should not impact on who ultimately bears the tax, the reality is that producers may not always have the ability to push the costs down to consumers of energy, whether retail or wholesale customers.

Accordingly, businesses should be prepared to make submissions to government on the design of any carbon tax, and be in a position to readily quantify what the impact of a particular emissions reduction policy - whether a carbon tax or ETS or otherwise - would be.

For more information about how your business may be affected by, or benefit from, the proposed emissions reduction schemes being discussed, please contact HopgoodGanim's Climate Change practice.