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The Australian Government's proposals for a carbon pricing policy

Cameron Hepburn, Senior Research Fellow at the Grantham Research Institute on Climate Change and the Environment

Frank Jotzo, Director of the Centre for Climate Economics and Policy at the Australian National University's Crawford School of Economics and Government

2 August 2011

Australia's Government has put forward a carbon pricing package| which is, in some respects, as significant as the European Union's Emissions Trading Scheme (EU ETS). The scheme promises to be a cost-effective way for Australia to meet its national target for reducing greenhouse gas emissions by 2020, which is an unconditional five per cent reduction compared with the level in 2000 (i.e. five per cent lower than in 1990, when emissions from land-use change are taken into account). It also puts Australia in a position to ratchet up its ambition to a 25 per cent reduction compared with 2000, depending on a future international agreement and other countries' actions and commitments.

The policy was negotiated between the minority Labor Government, the Green Party, as well as independent MPs who support the government, in Australia's Multi-Party Climate Change Committee.

Under the proposed new scheme, the carbon price is scheduled to start in mid-2012 as a fixed price permit scheme. It will make the transition to an emissions trading scheme in mid-2015. For the three years from mid-2012, the Government will sell an unlimited number of permits at a specified price, starting at A$23 per tonne of carbon dioxide, rising at 2.5% above inflation annually. The A$23 starting price equates to €17 (or £15), broadly in line with the average price in the EU ETS over the last few years, but above the price in July 2011 of about €13 per tonne of carbon dioxide. In the proposed trading phase from mid-2015, caps in the scheme would be set with reference to the national target for reducing emissions. An independent Climate Change Authority, modelled on the UK Committee on Climate Change|, would provide formal advice. According to Greg Combet, the Australian Minister for Climate Change and Energy Efficiency|, the fixed price was calibrated to avoid a big price shock when the transition to emissions trading takes place. For the first three years of the trading phase, there will be a floor price of A$15, as well as a ceiling price that will be set A$20 above the market price on introduction (and which will thus be unlikely to apply). The aim is greater price predictability, and the floor price gives reassurance for investors in low-carbon assets that the price will not slump to very low levels, irrespective of market conditions. The floor price|  will be implemented by way of a reserve price at permit auctions, coupled with a fee on imported emissions units to bring their cost up to the floor price.

The new Australian scheme will cover around 60 per cent of Australia's domestic emissions of greenhouse gases, which is a greater share than is covered by the EU ETS. The Australian scheme will include emissions from stationary energy (power plants), industrial processes and activities, and waste. In contrast, heavy road transport, aviation and synthetic greenhouse gases (such as hydrofluorocarbons and sulphur hexafluoride) are to be covered through an equivalent carbon price introduced through the tax system. Agriculture and forestry will be excluded, but are already subject to a domestic offset credit scheme.

Emissions-intensive industries that are most exposed to international trade competition will be allocated free permits. For the most emissions-intensive activities, the permits will cover 95 per cent of the emissions that would occur based on levels of output and the industry average for emissions intensity, while 66 per cent of the emissions from intermediate emissions-intensive activities will also be covered. Rates of assistance to these industries are scheduled to shrink by 1.3 per cent a year, and will be subject to review by Australia's Productivity Commission, with the possibility of moving to allocations based on the global uplift of product prices, as proposed by the Garnaut Climate Change Review Update 2011|. The most emissions-intensive coal-fired power plants will also be eligible for financial assistance, but other emitters will have to buy permits. Industry assistance has been heavily criticised by many observers in Australia, but appears to have bought tentative support from some key business constituencies.

Price impacts on households have been a central part of the public debate in Australia, and they are due to be addressed by the proposed new scheme through changes in the income tax system, family payments and welfare. Benefits will heavily skewed towards households on lower and middle incomes. Most individuals below an annual income of A$65,000 will pay $300 less tax, and a two-child family will gain up to $1,200 per year from tax savings and government payments. The Government estimates that two-thirds of households will be fully compensated, or over-compensated, for the rise in their cost of living, even before taking into account changes in consumption because of higher prices for electricity and gas.

The carbon pricing package is flanked by a range of other new policy initiatives to support investment in renewable energy (including a A$10 billion financing facility), energy efficiency, and land-based carbon sequestration.

By most yardsticks, the new Australian Government package on the whole is sound economic, social and environmental policy, but this has not yet translated into public support. Following previous policy reversals on climate change, there is widespread cynicism within the Australian electorate. Scare campaigns about the economic impact of the 'carbon tax' are falling on fertile ground. Despite studies by Vivid Economics|, Australia's Productivity Commission|and others|  showing that many other countries have in place comparable or more ambitious policies, the argument that Australia should not "get ahead of other countries" remains prominent in the debate.

Will the carbon price become and remain law? The current Government has sufficient support in both houses of Parliament, and passage of the legislation is likely before the end of the year. But the opposition under Liberal Party leader Tony Abbott is fundamentally opposed, after bipartisanship on climate policy collapsed at the end of 2009. A future Government led by the Liberal Party could repeal the legislation if it took the trouble to go to a special 'double dissolution' election over the issue. This, however, may be politically difficult. An alternative scenario is that carbon pricing will simply cease to be such a political football once it has come into force without causing an economic meltdown.

Here are some key questions and answers about the proposal for a new carbon tax:

What is the rationale for limiting to 500 the number of companies to which the carbon tax will apply?

Emitters of more than 25,000 tonnes of carbon-dioxide-equivalent per year need to acquire permits. Others are indirectly covered, especially through increases in the cost of using gas (distributors need to buy permits) and electricity (generators need to buy permits). This will minimise transaction and compliance costs.

Is the 'jobs and competitiveness' programme, to be launched as part of the scheme, adequate and based on sound economics (it looks like the scheme proposed in the Garnaut Climate Change Review Update 2011)?

The 'jobs and competitiveness' programme is likely to be effective in avoiding inefficient relocation of emissions-intensive companies from Australia. However one can argue that too much money will be spent on it, especially in the form of free permits to emissions-intensive companies. An economically better model would be based on the market conditions in individual industries and take account of carbon policies in other countries, rather than allocating free permits by formula. The Garnaut Climate Change Review Update 2011 called for a model based on these principles, and the Productivity Commission is to assess whether and when a shift to such an approach would be advisable.

Is the additional package to support the steel industry - the Steel Transformation Plan - adequate and based on sound economics?

Australia's steel industry is under particular pressure right now because of the high exchange rate. The extra money has, to some extent, alleviated steel industry concerns about the carbon pricing package.

What are the implications for low-carbon innovation - are the proposals to support innovation good enough?

There will be major extensions of government support, especially through the Clean Energy Finance Corporation. There is the chance of more effective administration of existing subsidy programmes by way of bundling under the Australian Renewable Energy Agency (ARENA). And there are new initiatives for carbon sequestration on the land.

Are the various revenue-recycling mechanisms - pension increases and tax breaks, etc - well conceived?

They are a significant reform, in line with what Australian economists have called for. In particular, the changes in income tax are designed to preserve participation incentives (to offer work in the marketplace if prices go up but wages stay the same, so counteracting the disincentives for low-income earners).

          
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Photograph of Cameron Hepburn

Photograph of Frank Jotzo