Carbon tax will stoke inflation and hurt productivity

A second use will be to overcompensate "battlers" who may just be encouraged to maintain old consumption habits in the face of higher prices for the products of Australia's 500 "greatest polluters".

If the government is really serious about changing behaviour, it must rely on income effects as well as relative price effects yet, with the proposed policy, income effects will be fighting relative-price effects. This is a severely compromised "price mechanism", whatever economic theorists might say.

The third use of the additional tax is a fund to support research into alternative-energy generation mechanisms. This government gave us the pink batts debacle, the education revolution spending (in reality highly inefficient handouts to construction companies), and has made a massive bet on current best-in-class broadband technology.

Can the voters of Australia have any real confidence that the Gillard government will pick winners from a bunch of technologies, all of which are currently far less efficient than coal or gas-fired electricity generating plants? Even if sensible choices of new technologies are made, it is extremely unlikely that the relatively small investments Australia can afford will create the necessary breakthroughs.

This policy is a remnant of Kevin Rudd's misplaced aspiration to lead the world in solving what he called the "greatest moral challenge of our times". Australians became suspicious when he was left alone and friendless in Copenhagen and his closest cabinet colleagues told him to abandon his ETS plan. The same colleagues then called time on his prime ministership.

There are various aspects of the government's financial arrangements that suggest there is a growing budget hole in the overall carbon tax-and-spend plan, and this issue will eventually become a serious embarrassment.

We can also be certain that there will be fraud and mismanagement in any carbon trading scheme, as already alleged to be the case in the only two such schemes currently running, in Europe and the United Nations.

Abbott's alternative direct-action plan has been widely criticised, despite its promise to provide "incentives rather than penalties; to rewarding positive action rather than punishing Australian families, households and businesses". Its costs to the budget would be far lower than the government's plan. Equally important, it avoids all the major costs to productivity and competitiveness of the Gillard plan, as enumerated above.

There is one very important final point, which was made by the head of the Productivity Commission, Gary Banks, in a speech in March. "It will not be efficient from a global perspective (let alone a domestic one) for a carbon-intensive economy, such as ours, to abate as much as countries that are less reliant on cheap, high-emission energy sources . . . Modelling aside, it's commonsense that achieving any given level of abatement is likely to be costlier in a country with a comparative advantage in fossil fuels."

A carbon tax, starting at $23 a tonne and (according to Treasury modelling) rising quickly to $37 a tonne by 2020 will do nothing to help the global or Australian environment. Instead, it will send jobs and emissions offshore; it will produce a large and growing fiscal hole; it will be rorted; and it turns companies into supplicants to the government, having to beg for relief from the impact of the carbon tax.

Rather than creating certainty, all this has added hugely to uncertainty for business and, coming on top of the government's actions over other issues such as the mining tax and live cattle exports, has turned sovereign risk into a serious issue for business for the first time in many decades.

This is not the work of Adam Smith's famous invisible hand. Instead, it is quite obviously the work of politicians and bureaucrats who desire to strut the world stage, be seen to be doing something and resort to the very visible hand of a new tax and a new money churn whenever confronted with what they perceive to be a problem.

Australia cannot afford the frolic of a carbon tax. We should be improving productivity, not weakening the competitive position of Australian firms.

The world is too competitive for us to burden our industry with a tax no other country has embraced. The government's carbon tax will strengthen both the terrible twins of inflation and productivity.

The Reserve Bank will be forced to respond by raising interest rates higher than with no carbon tax, causing great and unnecessary pain to Australian businesses and households.