Are carbon taxes (another) Australian 'magic pudding' policy?

The Government's proposed carbon tax is being asked to do a lot. It's supposed to (i) reduce greenhouse gas emissions, (ii) include 'compensation' for (some) trade-exposed industries, and (iii) finance (some?) compensation for households. Ross Garnaut also wants it, potentially, to finance (iv) other tax reforms included in the Henry Review, and (v) $3 billion a year for low emissions technology innovations.

A cash-strapped Government promising to get the Budget back into surplus shouldn't promise too much for its carbon tax. Its Budget credibility will suffer.

Consider some scenarios.

Assume a modest carbon tax from 1 July 2012, with no initial effect on greenhouse gas emissions, raising $X million per annum. Assume this tax costs nothing to collect. Assume all carbon tax costs, one way or another, feed through to higher consumer prices. Assume all tax revenue is used to finance a cut in the rate of GST.

This revenue-neutral tax change should produce roughly zero change in the Consumer Price Index (CPI) on average. Emissions-heavy product prices rise, others fall.

On average, consumers' incomes (whether earned income or government benefits) and accumulated savings will retain roughly the same real purchasing power, even if consumer behaviour does not change.

All carbon tax revenue is expended providing consumer compensation via a lower GST rate. None is available for the second, fourth and fifth objectives listed above, unless they exactly coincide with the household compensation objective. They don't.

Now progressively remove the assumptions in this scenario.

Administering a carbon tax requires significant additional Budget resources – significantly more than a single-rate GST. These reduce carbon tax revenue available for consumer compensation and other purposes. Now carbon tax revenue can't even pay for 100% consumer compensation without new Budget savings. Other tax reforms are, of course, beyond this carbon tax budget.

Now suppose consumers are compensated for the carbon tax by income tax cuts and increased welfare benefits rather than GST cuts (as seems likely). The carbon tax still delivers just $X million per annum.

Now the CPI increases. All prices increase due to the tax on emissions embedded in all products.

This CPI increase means total compensation costing more than $X million per year is required, to maintain consumers' real purchasing power from accumulated super and other savings, beyond that required to maintain the real value of incomes. More new Budget savings are needed to deliver household compensation plus other reforms.