Fair shares in climate burden

There is a consensus that, in order to avoid the problems caused by climate change, the economic costs of carbon emissions need to be internalised by establishing a carbon price.

But for all the discussion about the challenge of addressing climate change, there has been little consideration about the equity impacts of policy responses to climate change.

There are two ways to establish a carbon price: by setting a carbon tax or by having a cap and trade system.

A carbon tax would be a government mandated tax, levied on every tonne of carbon that is emitted into the atmosphere by a business. The level of carbon emissions by every business would be monitored, and they would be required to pay the appropriate amount of tax which corresponds to the amount of carbon they emit.

A cap trade system would differ from a carbon tax because it would use market mechanisms to establish a carbon price, the level of carbon emissions would be capped and permits to emit carbon would either be handed out to businesses or, preferably, auctioned.

A business would be allowed to emit carbon up to the amount of their permits. If they wanted to emit more carbon they would need to purchase permits from another business that is emitting less carbon than the amount of their permits and is willing to sell their excess permits. The price of these permits, determined by supply and demand, would in effect be a carbon price.

By establishing a carbon price, both these methods would add to the costs of businesses, especially those which emit a lot of carbon. And, depending on the structure of markets in which particular businesses operate, these additional costs would often be passed on to consumers through higher prices for goods and services.

And this is where the equity impacts of policy responses to climate change become relevant. Higher prices for goods and services, even if slight, would disproportionately affect persons on lower incomes, which would be an inequitable outcome. Without policies to offset these equity impacts, establishing a carbon price would represent a form of regressive taxation similar to a consumption tax like the GST.

But there are a number of policies that can be implemented to offset these equity impacts.

In the case of a carbon tax, it is quite a simple task to offset equity impacts because revenues from a carbon tax would accrue to the government and could therefore be used to reduce income tax rates, particularly those at the lower end of the income scale. However, in the case of cap and trade systems it is a more complicated matter, because revenues from trading permits would accrue to the owners of those permits and not to the government. But, given the prospect that cap and trade systems will be the primary method used to establish a carbon price, it is very important.

There are two possible methods that could be used to offset the equity impacts of a cap and trade system. The first method would involve the government setting aside the revenue obtained from the initial auction of permits (assuming they are auctioned and not just handed out) and investing it in a "Climate Change Equity Fund", similar to the Future Fund and University Endowment Fund set up by the Federal Government. This fund would be managed by independent trustees and dividends from its investments would provide revenue for the government to enable it to reduce income tax rates.

The second method would involve the government retaining a certain number of permits for itself. For example, if the government were auctioning permits, it would retain 20 or 30 per cent of the total number of permits available, given the level of the cap on carbon emissions. The government would then lease out these permits, for a fixed period of time and at the market rate, to businesses who need to emit carbon but are unwilling or unable to purchase permits outright from another business. The revenue that would accrue to government from leasing these permits could be used to reduce income tax rates.

Addressing climate change is one of the major policy challenges facing government, and it requires decisive action. And in developing policy responses to climate change, the need to address the equity impacts of policy responses to climate change should be high on the agenda.

It is likely that, in addition to the two methods outlined above, there are additional methods that address the equity impacts of policy responses to climate change.

There needs to be a comprehensive examination of these methods by government, to ensure that Australia and the world have both a sustainable and an equitable future.