Carbon tax compensation: too complex, too costly, or both?

Adjustments may be needed for government transfer payments to various beneficiaries, although those with indexation provisions will automatically be adjusted as CPI effects are reflected in benefit increases.

Given the multiplicity of different benefits and thresholds for them, including different low-income tax-free thresholds, low-income Medicare Levy exemptions, and the like, further adjustments to a large number of concessions will be needed to deliver compensation precisely.

Others may miss out. Those with taxable incomes below the increased tax-free thresholds in Table 1 won't be fully compensated. Self-funded retirees in the superannuation pension phase cannot be compensated via tax cuts because they pay no tax. For those with superannuation investments in the accumulation phase, will contributions and earnings tax rates be reduced?

What about compensation for loss of purchasing power of existing savings? This was largely ignored in 1985, similarly in 1991-93, and only partly covered in 1998-2000. Compensation for savings' loss of purchasing power could be expensive.

The only way to avoid this 'savings compensation' morass is to have a net carbon tax impact on the CPI of zero. One way of doing that would be to use all carbon tax revenue to cut the rate of GST. (I'm not holding my breath.)

Carbon tax revenue can't finance comprehensive household compensation, especially if it reduces emissions – its primary purpose. Budget savings from elsewhere will be needed to do the job.

What about 'compensation' for 'trade exposed' industries as well? We can't even precisely define 'trade exposed' industries (and how much they are exposed) under the CPRS-type policy the Government seems to be pursuing. We can't afford industry compensation as well, without truly swingeing Budget cuts (and forget cuts to company taxes or any other taxes for that matter).

Defining 'trade-exposed' industries with any sort of principle, precision, consistency and equity is only possible if the carbon tax applies to Australian consumption, including imports, and excludes our exports.

This consumption model eliminates the need for messy, expensive and discriminatory 'special deals', demands for which are already increasing apace. It also broadens the carbon tax base, by 'carving-in' imports rather than 'carving out' import-competing industries, in a WTO compliant way. This helps finance household compensation, but only in part.

Carbon tax compensation is complex, but we've done this before. If we stick to household compensation, and design the policy to obviate the need for 'special deals' industry compensation, we'll be closer to a Budget-viable approach.

Even then, 'compensation' won't be cheap. It will leave gaps – notably savings and super compensation – and it will collide with the Government's policy to return the Budget to surplus by 2012-13. We'll need more Budget savings, above those already needed, to finance comprehensive household compensation for any carbon tax.

The Government will have to choose existing Budget commitments that have a lower priority than getting a carbon tax across the line. This will be quite difficult.