Carbon taxes and trade-exposed industries

Minister for Climate Change, Penny Wong, recently accused the Opposition and its supporters of diversionary tactics in raising the option of a carbon tax as Australia’s means of addressing carbon emissions (The Australian, 23 February 2009). The Minister’s dismissive approach is premised on the assertion that this debate has come and gone and that “It is time now to stop talking and start doing.”

With all due respect, this debate certainly has not been held properly, at least in the public domain. It is not hard to see the political reasons behind avoiding the awkward questions posed by a superior alternative to the one that suits the present political agenda, but these issues can be dealt with another time. Suffice to say that most of Minister Wong’s assertions regarding the benefits of an ETS and the disadvantages of a carbon tax are either misleading or just plain wrong.

The one aspect that I will deal with here is that around the treatment of trade-exposed industries. The Minister claims that “the hard policy questions regarding the treatment of emissions intensive trade exposed industries … remain” under a carbon tax. This is incorrect.

The short answer to this issue is that a carbon tax with an appropriately designed border tax adjustment (BTA) (as exists with the GST) will effectively resolve this issue conclusively. And it will do so in a much less costly fashion than the ill-designed Government’s proposed emissions trading scheme (the CPRS).

In short, a BTA works by charging imports as they enter Australia and rebating the charge as exports leave the country. This is how the GST BTA works. The net effect of this design feature is that it does not matter whether Australia goes it alone on the matter of carbon pricing, at least in terms of our international competitiveness. Domestic producers do not have to compete at home against imports unencumbered by the impost, nor are exports expected to compete in countries that do not tax their own domestic producers.

The major concern around a BTA is its consistency with the provisions in the World Trade Organisation (WTO). Certain BTAs, such as that for the GST, are well established as being consistent.

A charge for carbon emissions, or any other form of energy tax, though, has proven problematic on a number of grounds. Under the CPRS, a BTA is unlikely to be allowed since provision is only made to adjust taxes. The permits issued under the CPRS, though, are a form of property, a fact noted on several occasions in the Green and White Papers. While a tradeable permits scheme has the same economic effect as a tax, these problems arise due to the different legal form of the charge.

With respect to a carbon tax, the property issue does not arise since this form of carbon pricing is recognised as a tax and, therefore, potentially qualifying for adjustment.

Energy taxes have been known to be problematic under the WTO (and its forerunner, the General Agreement on Tariffs and Trade (GATT)), at least since 1970. Things came to a head, though, in 1991 with the handing down of the GATT’s dispute-settling Panel’s decision in Dolphin-Tuna. That decision has often been interpreted as identifying competing products by reference to the product’s physical characteristics and not the manufacturing process. Using the facts of that dispute, since the final consumer could not distinguish dolphin-friendly from dolphin-unfriendly tuna only by looking at the product, these were competing products. The United States, therefore, could not single out dolphin-unfriendly tuna for special treatment.

Extending this reasoning to carbon taxes (indeed, all energy taxes), a carbon tax could not be imposed at the border as there may be variations in the amount charged if the respective production processes vary in terms of the amount of carbon emitted.

A number of circumstances, though, suggest that this interpretation of Dolphin-Tuna is not entirely accurate. The Panel’s primary concern was evidently about protectionist regulations masquerading as environmental protection. For example, there was evidence that that specific regulation was just the latest in a long history of the United States attempting to protect its domestic tuna fisheries.

Subsequent Working Party reports continue to regard the matter as unresolved, suggesting that the common interpretation of Dolphin-Tuna has not been settled as correct. In particular, the Working Party noted the earlier GATT decision in Superfund, which allowed a special charge on certain imports produced using certain chemicals. It was not clear whether those substances were still physically present in the final product. The charge was allowed as it was designed to be equivalent to a different charge imposed on domestically-produced products that utilised the same chemicals. This suggests that there is room in the WTO for charges to be imposed on imports for aspects of the production process not apparent in the final product, such as carbon emissions.

A similar reasoning applies to adjusting the tax on exports. The main issue there is whether a rebate upon export constitutes an illegal subsidy. While the matter is not completely clear, as for imports, a literal reading of the WTO text may result in absurd outcomes, suggesting that rebating energy taxes upon export is legitimate. In any event, similar reasoning as for imports applies to adjusting for exports.

There are exceptions within the WTO for legitimate environmental protection ends that otherwise contravene the substantive provisions. These apply equally to tradeable permit schemes, allowing measures to stand notwithstanding the breach. Consequently, it may be possible, on this basis, for a BTA mechanism to be belatedly incorporated into the CPRS. However, it is far preferable to avoid the uncertainty around relying on breach exception provisions.

The Government should reconsider its needlessly obsessive commitment to pricing carbon through an emissions trading scheme. Establishing a carbon tax with a properly designed BTA will resolve the international competitiveness concerns that domestic industry have without the need for hand-outs (such as subsidies under a tax or free permits under the CPRS). Complexity will be reduced, resulting in a less costly system to administer. While some difficult issues with the CPRS are common to a carbon tax, many are resolved through such a switch in policy.

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