Climate change

February 25, 2009

Carbon tax or cap-and-trade? The debate we never had

Filed under: Carbon Pollution Reduction Scheme — Barry Brook @ 1:46 pm

Guest Post by Tim Kelly. Tim is works as a Principal Climate Change Advisor in the Water Industry.

The Federal Government has now released its Carbon Pollution Reduction Scheme White Paper and as expected the mechanism it has chosen is that of a pollution permit and trade system (cap and trade).  The cap and trade approach has been widely accepted by many businesses, green groups and Australia’s major political parties including the Australian Greens, and yet I am continuously witnessing surprise by individuals and groups when they learn more about the impact of such an approach on eliminating the economy wide benefits of voluntary behaviour.

At the outset, when State and Federal Governments were considering which approach would best deliver National emissions reductions, they should have explained the basic advantages and disadvantages of the two likely contenders, being a carbon emissions tax (carbon tax) or the cap and trade approach, in an open and transparent manner.  At the end of this post I provide a ‘pros and cons’ table comparing these two alternatives. In particular, I note that in the disadvantages column of a cap and trade scheme, stakeholders should have been advised of the following critical points:

1. A cap and trade scheme, by its nature, extinguishes the impact of voluntary efforts from reducing aggregated economy wide emissions as any greenhouse reduction or avoided emission by an individual or entity, because it merely results in freeing up permits to pollute in another part of the economy (i.e., it makes no difference whether I ride my bicycle to work or buy the biggest worst performing V8 petrol vehicle — national emissions will be the same!).

2. A cap and trade system, by its nature, does not drive innovation in voluntary markets, and greatly reduces diversity in voluntary markets.

3. A cap and trade scheme that uses the voluntary surrender of permits as a greenhouse reduction mechanism, ties the cost of voluntary abatement with the cost of pollution, thereby diminishing prospects of continued voluntary action.

This is not to suggest that the cap and trade approach might not drive actions to reduce emissions by permit holders.  But it leaves out vast numbers of individuals and small to medium businesses in the economy from being able to contribute to reduce national emissions in a meaningful way.  A cap and trade approach largely alienates non-permit holding businesses and individuals from taking a meaningful role in reducing the nation’s emissions.  So there is a question as to whether there is any value in the Department of Climate Change slogan “Think climate. Think change. We can’t afford not to”.

Anyway, below is a comparison of the two main approaches focussing on the mechanisms, their effectiveness and flexibility to reduce emissions for a given target.  Naturally, this appears superficial in the table, so if you don’t agree, please consider my full discussion and reasoning (PDF document) which led to my conclusions.

[Barry Brook: This post from Tim is particularly timely, because the Federal Government has just announced an inquiry into the merits of their cap-and-trape model. For instance, a Canberra Times article says:

The Federal Government’s plan to reduce Australia’s carbon emissions will be re-examined after Treasurer Wayne Swan referred the emissions trading scheme to the House economics committee. It will examine whether carbon trading is the best way to reduce emissions, while maintaining low economic costs, putting in place long-term incentives for clean energy and contributing to a solution for climate change“.

So we may yet have a chance to fix this deeply flawed approach before its gets locked into legislation].

Aspect Cap and trade Carbon tax Winner
Cost on business and community For a given price on emissions the cost on carbon is has no influence for change in the broader economy (beyond businesses covered by the scheme), other than to become more efficient. The cost on emissions has a wider impact than just the covered emitters as the tax drives the broader community and smaller businesses to seek alternative low emission electricity, products and services that can reduce National emissions Tax
Economy wide and community wide involvement Destroys the ability for an individual or business entity from reducing economy wide impacts. Drives action directly through emitters and in secondary voluntary markets as people use their choices to avoid the cost and contribute to national emissions reduction Tax
Simplicity and bureaucracy cost Terrible, complex documents, complex schemes, complex shifting of funds and compensation for little value, legal risks MinimalCan be managed to charge only what is required to cause change, letting the market decide where the change would occur without the merry go round. Tax
Encouraging innovation in the market Rules out many offset products and as proposed, destroys the integrity of voluntary purchases of renewable energy Drives innovation and a full suite of low emissions solutions and renewable energy solutions that can be led by market choice for genuine renewable energy Tax
Need for non tangible offset frameworks. Creates perverse outcomes and the need for intangible concepts such as using permits as carbon offsets which do not directly link to low emissions solutions and may not indirectly drive low emission solutions and may not even cause economy wide reductions. No need for weird reverse logic intangible offset concepts using permits to pollute as tangible market offset products and renewable energy choices would work to lower economy wide emissions. Tax
Price certainty Requires massive free permit allocations to indirectly manage the permit price. Falls back on a carbon tax to ensure the price stays below $40 even with many emitters paying nothing like this when grandfathered permits are factored in Easily assigned and controlled by Government.Easily adjusted with new science and negotiations at regular intervals at markets transition. Tax
Need for full information Requires complex assessment of current emissions and forecasting of future emissions in five year blocks to seek to minimise over-allocation that would constrain progress or under-allocation that would cause mechanism failure and the need for review and intervention Not required as the price becomes a constant driver in the economy throughout economic cycles Tax
Certainty in achieving the greenhouse reduction objective Unclear as to whether the CPRS could achieve certainty due to its compromises, measurement methodologies and the ability for Government to issue unlimited permits in a given year Reduces emissions without direct control and necessarily requires reviews as the economy transitions to lower emissions and updates with science and negotiation. Neither approach provides absolute certainty
Creating a difference between pollution costs and abatement for customers to decide on what products and services they would buy. Buying and surrendering CPRS permits to reduce emissions causes Siamese twinning, locking the cost of abatement with the cost of pollution.
(ultimately all other offsets form national and international sources would cease where all nations adopt
cap and trade)
Increases the cost of polluting technologies and provides a relative benefit for other technologies to compete more fairly, letting the market decide what type of electricity, offsets and efficiencies they buy, knowing that these will reduce National emissions Tax
International linking Reduces options for trading offsets and low emission products Increases opportunities to trade in offsets and low emission products Tax
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