Do climate policies have a budget 'black hole'?

If we cut GST revenue by an amount exactly offsetting revenue raised from the carbon tax, average consumer prices might change little. Real incomes and consumer spending might be unaffected in total.

But this policy isn't costless. It requires more revenue to cover administration plus compliance costs.

Only some carbon tax revenue (ie, net of administration costs) could be used to finance 'compensation' for consumers. Real after-tax incomes will be reduced a bit, even if prices on average don't change. Revenue-neutral income tax cuts puts average consumers further behind because average prices rise.

Climate policy (and other tax reforms?) can't be 'purchased' in this case either.

Real-world policies will probably be partly effective, partly ineffective:

• Partly ineffective ETS or carbon price policies collect some revenues, but not enough to maintain real after tax incomes or consumption (Panels A plus B in Figure 1).
• Partly ineffective 'direct action' initiatives add more to Budget costs. No revenues are collected at all (Panels A plus C in Figure 1).

Can politicians sell an effective policy without 'purchasing' its acceptance by massaging the hip pocket nerve? Can they sell an ineffective policy that just 'churns' resources through the Tax Office with no environmental benefit, no scope to increase real after-tax incomes, and increased administration and compliance costs? Either way, I doubt it.

What to do?

First, choose the most cost-effective way to reduce greenhouse gas emissions. This requires independent assessment, currently off the agenda.

Second, secure more Budget savings to 'purchase' an effective climate policy. Is this even being considered? These savings are additional to those already needed to 'make room' for skilled labour demand, etc., expected from the mining boom and natural disaster reconstruction.

Ross Garnaut's proposal to finance other tax reforms as well just adds to the savings needed.