To cut emissions start by capping windy economists

Age
Saturday 14/3/2009 Page: 2

The contrarian push for i It's a delusion to imagine a carbon tax smacks of one approach is politically greenhouse scepticism.

ACCORDING to a growing band of economists, we'd be better off using a carbon tax to reduce greenhouse gas emissions, not the emissions trading scheme the Rudd Government introduced to Parliament this week.

My opinion? Don't believe it. It may be a case of the grass being greener on the other side of the fence. But what worries many, I suspect, is the knowledge we're dealing with reform that limits economic growth rather than promoting it. Though economic modelling tells us growth forgone would be minor, their instincts tell them the disruption would be huge.

The "cap-and-trade" system embodied in the Government's carbon pollution reduction scheme involves a government setting a (slowly reducing) cap on the carbon dioxide emissions it allows each year, then issuing permits equal to the cap. Businesses that have more permits than they need are able to sell them to businesses that don't have enough.

By contrast, a government introducing a carbon tax imposes a charge per tonne of carbon. By raising their price, the tax discourages consumption of emissions-intensive goods and services goods and services, while providing producers with an incentive to reduce emissions. The tax would be raised until it brought about the desired emissions reduction.

The cap-and-trade system works in a similar fashion. By limiting the emissions allowed, it raises the scarcity value and thus the price of emissions intensive goods and services. The emission permits also gain a scarcity value which, provided it sells the permits rather than giving them away, ends up in the Government's coffers. The cost of permits gives businesses an incentive to reduce emissions and buy fewer permits.

The two systems are different ways of achieving the same objective. Cap-and-trade controls the quantity of emissions permitted and lets the market set the price, whereas a carbon tax controls the price of emissions and allows the market to determine the quantity. In theory, cap-and-trade is slightly more sophisticated because it creates a new market for permit trading, which shifts the cost of reducing emissions to businesses most able to bear it (that is, the ones that can reduce their emissions most cheaply).

In practice, however, some economists fear cap-and-trade is harder to administer than a tax, and the market price of permits could be unstable. Some economists support a carbon tax because they believe pollies don't face the temptation to give out free permits, they just raise a tax rate, which is simple. But most economists don't have much feel for politics and I think it's a delusion to imagine one approach is politically superior to the other. Neither system gives the pollies courage they don't possess.

A government that doesn't have the courage to charge for permits wouldn't have the courage to raise a pollution tax until it brought about the desired emissions reduction. One good reason for preferring a trading scheme is that it fits better with what other countries are doing and allows permit trading. Where countries can reduce emissions more cheaply than we can, we effectively pay them to do it for us.

But if there's a reason for economists preferring one system, I think it's which objective they give higher priority: minimising economic cost or maximising environmental certainty. If your concern is emissions reduction you control emissions quantity; if your concern is minimising economic loss then you control emissions price.

Economists are always talking about the need for governments to have the courage to implement unpopular reforms that will leave us better off. Right now the Government is trying to introduce a controversial reform, under fire from all directions. So where are the economists? With a few exceptions they are attending a seminar entitled "Maybe another way would have been better?".