Climate policy: it’s the (emissions) price, stupid!

The Coalition and Labor want climate “direct action”, but won’t consider a carbon price now. This bipartisan recipe for high-cost greenhouse gas reductions, at worst, may deliver none.

We’ve learned nothing from history. We’re bad at “direct action”. Look at the home insulation, “green” loans, etc, debacles. We should set an emissions price and let the market sort it out. How?

From Rio (1992) to Copenhagen (2009) negotiations have failed. But they provide two lessons:

• countries won’t apply the same mitigation policies at the same time; and
• they keep haggling based on failed emissions production-origin policy models.

These lessons tell us what not to do, and suggest a way forwards.

Putting a price on carbon, whether via an ETS or a tax, is the same as applying a broad-based indirect tax. Countries have introduced these at different times and different rates. Our GST is an example.

Why are GST-type taxes successful when a carbon tax is not? They’re consumption-destination taxes. They exclude exports and tax imports the same as locally produced substitutes. They don’t undermine competitiveness. Production-origin emissions taxes hit exports and exclude imports.

Governments unilaterally proposing a production-origin GST would be ridiculed. Production-based carbon taxes are similarly treated. Quelle surprise!

Those countries introducing production-based carbon taxes try to reduce adverse competitive effects by building-in crudely devised trade-exposed sector “carve outs”, emasculating them.  Others take no action.

Australia is not just trying to cut indigenous emissions. We need the rest of the world to act over time to reduce global emissions. If it doesn’t, nothing we do (at 1.4 per cent of global emissions, and falling) makes much difference. This reality should drive our policy approach.

Nationally, we could devise, unilaterally adopt, and sell by example to other countries, a climate policy model that (i) reduces indigenous emissions; and (ii) does not undermine our trade competitiveness. Any country can adopt this “no regrets” model unilaterally.

Globally, production-origin emissions, by definition, equal consumption-destination emissions. In national accounting jargon, global GDP equals global GNE. The emissions embodied in both are the same.

We know production-origin models won’t work when countries act at different times. But there’s an alternative path to the same result. This tracks the consumption-destination GST model.

There’s no “free lunch”. There’s a trade-off. Getting the trade-off right is essential.

Governments applying production-origin emission abatement models can more precisely target indigenous emissions - if their carbon accounting systems are up to scratch. But they undermine international competitiveness. So they won’t be applied properly, if at all.

Consumption-destination models are less precise, as explained below, but don’t undermine international competitiveness. They exclude exports and tax imports the same as locally produced substitutes.

The choice is between more precise models that won’t work globally, and less precise models that will.

With a failed production model, the global emissions reduction outcome is uncertain, at best. The local activity, investment and jobs outcome is clear and adverse.

If we adopt a consumption-based model, the global emissions reduction is small (our emissions are small in relative terms), and job losses are avoided. More importantly, the chances of others adopting this model are much better than the production-origin model, because in doing so they don’t lose international competitiveness, either. That improves chances of a global emissions reduction outcome.

The consumption-destination approach has two key practical advantages:

• It’s World Trade Organisation (WTO) compliant. As long as the carbon tax applied to imports is the same as that applied to locally produced substitutes, WTO rules are not breached. This is why Australia’s GST and some other taxes get a WTO “tick”.
• It’s data-efficient. A country applying this model does not need to know the emissions embedded in imports of product “X”. The carbon tax on imports is the same as the tax on locally produced products. It’s based on the average emissions embedded in production of the indigenous product.

Sure, this is “rough justice”. Imports produced using hydropower are penalised compared with local products using LNG or coal. Imports using brown coal get off lightly compared with local products using black coal or diesel. But that’s what the current WTO rules require.

Which is “rougher justice” from an emissions reduction perspective? Applying a production-origin model that we know doesn’t work, or a consumption-destination model that gradually spreads globally, putting in place a comprehensive emissions price driving production adjustments that reduce emissions?

One final observation is crucial.

The apparent emissions reduction precision of a national ETS is a dishonest charade. An Australian emissions target under an ETS will be white-anted if activity shifts to non-ETS countries. Importing emissions permits (often of doubtful provenance - but allowed under the CPRS) escapes an Australian emissions cap. The global emissions effects of ETS are suspect. At best, the “trading” bit of ETS systems doesn’t reduce emissions by one gram, anyway. It just shuffles them.

Whether we use an ETS or a carbon tax, the lever driving emissions reductions is price. So why don’t we focus on getting a globally applied, predictably rising price on emissions in place? That delivers greater investment certainly, drives changes in technology and, globally applied, cuts emissions.

Climate policy is intended to raise prices of emissions-heavy products compared with greener products. But it’s not intended to cut real incomes. Using most revenue from a carbon price to cut other distorting taxes and increase welfare payments can achieve the first effect and avoid the second.

The lesson is clear: mitigation policy is all about the emissions price. “Direct action” will cost us much more for a lot less.