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News.com.au
16 July 2013
Carbon tax to go by July 2014.
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From a
global perspective, carbon taxation is economically justified as greenhouse
emissions constitute negative externalities. The market prices of goods and
services that create such externalities do not reflect their true societal
cost, resulting in their overutilisation and ensuing deadweight loss. To
prevent a tragedy of the commons, Pigovian taxation is needed to correct for
this market failure.
Compared
to a simple carbon tax, an emissions trading scheme offers several advantages.
A mandated carbon quantity rather than price allows for better control towards
emission targets. The ability to trade emission permits allows reduction
efforts to be redistributed to where their marginal cost is lowest, resulting
in improved efficiency. However, depending on the execution, an emissions
trading scheme is also more vulnerable to loopholes that undermine reduction
efforts and even potentially lead to worsening of greenhouse emissions.
The first issue concerns the primary market for emission
permits. Under the present implementation of the Kyoto Protocol, the
predominant primary market is free allocation rather than auction. This
practice carries the same disdvantages that lead to the failure of Marxism, for
the practices of command economies cannot feasibly approach the allocative
efficiency of free markets. Inevitable mismatches in allocations have resulted
in windfall profits to some carbon emitters. This constitutes a subsidy for carbon
emitters, an "anti-Pigovian" measure that exacerbates pre-existing
negative externalities, leading to potential increased emissions.
The
second issue concerns the Clean Development Mechanism of the Kyoto Protocol,
where parties can offset their permitted carbon emissions by investing in
emission reduction projects. This offers added flexibility and also corrects
for positive externalities but carries numerous flaws:
- It is difficult to determine the suitable number of offset credits to award. For example, as carbon sinks, forests vary unpredictably in carbon capacity and are insecure as long-term storage. Meanwhile, forest planting itself releases emissions, and the presence of forests in some cases can actually worsen global warming due to increased solar absorption¹.
- It is difficult to determine the additionality of projects. Awarding offset credits for measures that would have been economically indicated anyway without the Kyoto Protocol consitutes a second anti-Pigovian subsidy for carbon emitters and leads to oversupply of carbon credits.
- Perverse incentives arise. Awarding offset credits for removing potent greenhouse emissions incentivises companies to produce more of those emissions in order to be paid to remove them. For example, the use of credits derived from fluoroform and nitrous oxide removal projects are now banned in the European Union and New Zealand due to systematic abuse.
Even
with an auction-only primary market and the removal of carbon offset
mechanisms, there remains a third issue concerning the inherent price
volatility of an emissions trading scheme. This invites secondary market
agiotage, raising the carbon price and resulting in "inefficient
taxation", where portion of revenue is paid to private speculators instead
of the state. Furthermore, it is conceivable that the largest carbon emitters
will hold an advantage on the secondary market due to information asymmetry.
This effectively constitutes a third anti-Pigovian subsidy for carbon emitters.
An
Australian transition to an emissions trading scheme offers potential
advantages at the cost of potential disadvantages that may attentuate and even
reverse any gains. The Opposition's Direct Action Plan is no
palatable alternative to a carbon tax due to the inherent weakness in a command
rather than market economy approach. An Australian emissions trading scheme
should have an auction-only primary market. While I am not against limited use
of temporary protectionism for easing economic transitions, I do not believe
this is indicated here as we are transitioning from an existing fixed-price
carbon tax rather than free carbon. A carbon offset mechanism should be
avoided, as this has the largest potential for unfruitful complexity and
counter-productive loopholes. The European Union trading scheme thus far has
attracted criticism for being ineffective² and Australia must be wary of inheriting its failures.
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