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Dr Harry Clarke - The Carbon Tax

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Matt Smith

Welcome to a La Trobe University podcast.  I'd be your host Matt Smith and today we'll be discussing the carbon tax with Professor Harry Clarke from the School of Economics at La Trobe University.  The carbon tax comes into effect in Australia on July 1st, 2012 and is already in effect in many countries in the world, most notably in Europe.  A lot of people are worried about the changes it will bring.  But what exactly does it mean to put a price on carbon?

Harry Clarke

Essentially, carbon emissions are the major greenhouse gas and human generated greenhouse gas emissions are generating climate change.  This is potentially very damaging for Australia, it's damaging for all countries, so the idea of a carbon tax is basically to put a price on that damage, so that you're signalling to people who are generating emissions that they are creating a cost.  So essentially it's an externality and you're trying to attach a price so that you internalise that externality.

Matt Smith

So it's a bit of a slap on the wrist to get industry that is polluting the atmosphere to try and curb that a bit.

Harry Clarke

It's a slap on the wrist, it's trying to reduce carbon emissions, that's for sure.  It's also trying to get industry to think about alternative ways of producing, for example, producing energy that become economic if you have a carbon price.  So there are no incentives to move towards alternative technologies if there's no price on carbon, but when you attach a price on carbon, you create incentives for producers to think about different technologies, for consumers to be a bit more careful about their emissions, and generally to try to reduce the impact of carbon emissions on the environment.

Matt Smith

OK, so the tax will take the money from the industry and what is the proposal to be done with that money?

Harry Clarke

The point of the tax is not to generate money at all, in fact it will generate a substantial amount of money for the few years that the tax is going to operate before we switch to an emissions trading scheme, some of that money can be used for investment in renewable, into research and development into alternative technologies, and some of the money can be used to assist industries that are facing problems, to help them adjust to the new kind of energy environment.

Matt Smith

Should this sort of tax be levied on consumers or producers?

Harry Clarke

It's a well known proposition in economics that it doesn't matter who you nominally levy a tax on, the effective incidence of the tax is going to depend on what economists call elasticities of demand, and elasticities of supply.  And that's going to determine pretty much the incidence of the tax.  In the short run, consumers are going to bear a fair amount of the tax, producers will bear some of the incidence of the tax.  In the longer term, producers have got opportunities to evade the impact of the tax by making switches in their technologies, and so to some extent are consumers.  They also have the ability for example to install solar cells on their rooftops, and so on, and evade the impacts of the tax.

Matt Smith

There's a lot of fear amongst consumers that they're going to bear the brunt of the carbon tax.  What sort of effects do you think realistically they'll notice?

Harry Clarke

There'll be small increases in electricity prices, that will be the major kind of effect.  In fact, we've had very strong increases in electricity prices in recent years that have got nothing to do with the carbon tax, just related to the extra costs of providing that type of infrastructure.  So in the short run people will face higher electricity prices.  They'll also be compensated using the revenue from the tax.  My guess is the impact on almost all Australians will be quite marginal.  The main thing that people will notice is that the use of carbon-based fuels increases, and so they'll be given that signal, but overall in welfare terms they won't be that much worse off, because they'll be compensated with extra income, using the proceeds of the tax.

Matt Smith

So doesn't that just make the money go around in a bit of a circle?  Will it actually achieve anything then?

Harry Clarke

When you alter a price in economics, you have substitution effects and income effects.  The effect of the tax is focussing on the substitution effect, so if you are faced with a higher price, you'll tend to switch away from the good that has become relatively more expensive.  The fact that you're given some income compensation won't affect those substitution effects.  You'll get the extra income but you'll still face those incentives to make the switches away from carbon-based fuels and from activities that generate greenhouse gas emissions.  No, it's still a viable and sensible policy.

Matt Smith

A lot of industry is saying that this is going to affect the way they operate and also affect things like their ability to be competitive.   Is that founded?

Harry Clarke

There's a lot of concern about the effect of carbon taxes on the traded goods sector of the economy, on our import competing industries and on our export industries.  And in fact I've done a study using a general equilibrium model of the traded goods sector in Australia, and we've looked at those effects.   We find that outside of the alumina sector, the non-ferrous metals sector generally, the effects are very small.  The reason is that things like coal exports are not taxed directly.  What are taxed are the fugitive emissions that occur when you mine coal.  For example, coal producers in Australia will sell less coal to Australian power stations if power stations switch to more carbon efficient fuels, but that coal will, by and large, just be exported to overseas markets.  There won't be a significant impact on that industry.  And that's true for most sectors of the economy as I say, with the exception of the aluminium sector, where there are significant costs.  And the government has addressed the issue of those costs by handing out generous free emissions entitlements to those trade-affected sectors of the economy, and the Productivity Commission has been set up to monitor how effective those kinds of assistance arrangements are, as the carbon tax and the emissions trading scheme is implemented.  So I don't think they are major concerns.  I think those sectors of the economy are making a lot of noise, but I think they're making a lot of noise out of self-interest.  I don't think the concerns are as substantial as those sections of the industry are suggesting.

Matt Smith

Now you said that there's exemptions being applied.  The worry with a tax like this is that it's actually not going to be applied effectively to the big polluters, because of exemptions, because of the politics that are tied up with it.  Is that sort of concern unfounded?  Is the people that are making the big pollution going to be bearing their fair amount of the carbon tax?

Harry Clarke

I really want to be careful about making remarks about this issue, because I do see things that are not quite right about the current pricing scheme, but I'm a big supporter of carbon pricing, so I don't want to cast general doubts about this policy.  It's really important that we've got carbon pricing in place and I don't want to nitpick over the scheme.  But I do think there are areas where assistance has been given where it should not be given.  I don't favour giving assistance to the non-traded goods sector, to electricity producers for example.  I think that what you want to provide incentives for these types of producers to make switches to non-carbon based fuels, and we should do this as quickly as possible.  I think assistance should only be given to the traded goods sector, and there the basis for assistance is that this sector is competing with industries overseas that are not subject to a carbon tax.  So, there does seem to be some equity case for giving them that kind of assistance.  It seems to me there's no case for giving local power stations assistance because they can pass on prices for increased electricity to consumers, and that's what you want.  You want consumers to react to higher electricity prices by being careful about their electricity demands, and you want incentives for power stations to make switches towards carbon friendly ways of generating electricity.  As I say, I think there are wrinkles, yes, I'm not a hundred percent happy with assistance to the power sector, but I don't want to cast doubts about the package as a whole.  It's a very good package and it's a decisively good step in the right direction.

Matt Smith

You say a step in the right direction.  Has it not gone far enough?  Is it maybe a good starting point that we'll hopefully build on?

Harry Clarke

Well, I think what's going to happen to carbon prices in the future, really depends on what's going to happen in a few years time when we do switch to an emissions trading scheme.  The most likely forecast is that unless a number of overseas countries become more active in controlling their emissions, that carbon prices are going to fall, in fact, in the future, and that is not something that would be a good trend.  So I think we've still got to work towards getting some kind of international consensus to price carbon, to encourage the big emitters, the United States and China to price carbon.  I think Australia is setting a good example by joining European countries and pricing carbon, but in the long term we want the carbon price to increase.  We want to, in the long term, fade out and eliminate the use of carbon-based fuels and to not add net to the stock of carbon emissions in the atmosphere.  The potential cost longer term of not addressing climate change are huge.  They are huge for a country like Australia that has still got a substantial agricultural sector, a substantial dependence on the troubled Murray-Darling Basin.  It's really important from the viewpoint of national prosperity that we address carbon emission issues.  So longer term we want higher carbon prices but Australia can't generate that alone.  We do need the participation of countries like the United States and China in addressing their emissions.

Matt Smith

Europe are quite advanced in addressing their emissions.  How do we compare?  I know we've got different factors here and different industry here as well.  Broadly speaking, how are we addressing carbon compared to how Europe's addressing it?

Harry Clarke

Well, current carbon prices in Europe are lower than the planned prices in Australia, because Europe's going through a severe recession.  Australia's not, Australia's booming away as an economy.  We're probably the only developed country in the world to do so well, through the global financial crisis.  But my judgment is that Europe will eventually recover from the crisis and there will be eventually upward pressure on carbon prices.  Currently the prices that are set in Australia are higher than European prices but I don't expect that situation to persist.

Matt Smith

You've said a couple of times that the emissions trading scheme will  replace the carbon tax in a few years time and indeed it was initially proposed that we have an emissions trading scheme.  How will things change when that scheme comes into play?

Harry Clarke

Most economists prefer an emissions trading scheme because economists are not interested just in trying to punish polluters – we want to clean up the pollution at lowest cost, in this case, to the international community.  So, if we can purchase carbon permits on the international market and achieve mitigation at a lower cost, that's to Australia's advantage.  We're still achieving emissions reduction but we're just doing it more efficiently.  So I think that the issue of switching to an emissions trading scheme offers advantages to Australia.  There are still limitations on the number of permits that you can buy overseas.  You don't have unlimited access to the market.  So we'll still be compelled to reduce our emissions, but basically an emissions trading scheme enables emissions targets to be met more cheaply, so that's to Australia's advantage.  I emphasise when I make these comments about the advantages of an emissions trading scheme that these are second order issues to the general issue of addressing carbon emissions.  So there are arguments for a carbon tax, there are arguments for an emissions trading scheme.  Generally I prefer an emissions trading scheme and most economists prefer this type of scheme.  That's not an implied criticism of the carbon tax proposal.  Again, it's really good that we're taking action to address our carbon emissions.  It's a second order issue, the exact way we go about doing that.

Matt Smith

The whole thing reminds me of, like in the Middle Ages, the Catholic Church had this thing where you pay, you get your sins forgiven for paying that money.

Harry Clarke

That's a criticism of the international trading.  So that's kind of saying well, we can sustain higher emissions by getting the rest of the world to cut its emissions, so we're kind of buying an indulgence.

Matt Smith

That's it, indulgence.

Harry Clarke

So I don't think that's a completely fair way of looking at it.  It's just this idea that economics has, that environmental economists have, that you want to achieve environmental objectives at lowest cost, so if you've got inexpensive reforestation options in other countries, why not take advantage of these options?  Why penalise local producers unnecessarily?  We want to clean up the environment, we want to have lower emissions, but we also want a good economy.  We all benefit from having a good economy.  So I think international trade in emissions permits is a good idea.  I guess the difficulty is that in the past some of this trade has been corrupted and sometimes the clean development mechanism has been wrongly exploited by some countries as a way of getting revenue without achieving real emissions reductions.  I'm talking about an in principle kind of scheme, a scheme that does work rather than a scheme that's being rorted,  but still I think emissions trading does enable a country like Australia to achieve a good control of its carbon emissions at low cost and I think that's a nice thing for the economy.

Matt Smith

Professor Harry Clarke there, from the School of Economics at La Trobe University.  And you can read more on his website, harryclarke.com.  That's Clarke with an "e".  That's all the time we have for the La Trobe University podcast.  If you have any questions, comments or feedback about this podcast, or any other, then send us an email at podcast@latrobe.edu.au.