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EU linkage shows where carbon pricing scheme really creaks

Is the government’s decision to link its carbon pricing scheme to the EU short-term gain for long-term pain? That’s the tenor of much of the commentary today in relation to the fiscal impact in 2015-16 of removing the floor price in the first year of a floating price. Henry Ergas conjured up a $25 billion black hole using the old trick of going out a few years. In this case, entirely arbitrarily, Ergas used five years. Forward estimates cover four years, Henry.

In fact, yesterday’s announcement has only minimal impact on revenue forecast for 2015-16, because that forecast was always dodgy: the government, courtesy of Treasury, had forecast that in the first year of an ETS the floating price would be $29 a tonne, and so earn it $9.4 billion before free permits were handed out. But few people expected it to be $29, particularly with any sort of international linkage.

That’s why the Greens insisted on a floor price of $15 a tonne once the floating price started. The government’s forecast revenue was always going to be optimistic, although in July last year we were still assuming that the global economy was going to continue to recover, which proved to be another form of optimism.

So now the post-2015 price will track the EU price, which, for all that European governments might be keen to see it rise, is unlikely to get near $29 and probably not even reach $15, any time soon, not with the European depression continuing.

As for what that does to the 2015-16 surplus, well, it’s not just politicians that can leave that until closer to the time; there are any number of fiscal challenges to deal with before then. To say nothing of fretting, as poor Henry Ergas is, of what will happen in 2020.

And that’s not the only implication for the government, assuming it is still around in 2015-16. Treasury’s modelling, in assuming the rise of a floating price to $29 from $25.40 in the last year of the fixed period, included an assumption of a CPI impact of a further 0.2% in 2015-16 from that $3.60 rise. That CPI impact is unlikely to ever materialise; indeed, a significant fall in the carbon price in 2015-16 may send a deflationary surge through the economy that might, depending on the level of inflation at the time, be a welcome arrival or a dangerous addition to a slow economy.

And don’t forget that the government has built in compensation for that price rise, with further tax cuts due in 2015-16. So households will be even more over-compensated than they are now.

That’s where the scheme truly creaks, and why it would, regardless of linkages with the EU, have always ended up costing money once the fixed period ended. This is the “great big new tax” that won’t provide much revenue if any; indeed, after yesterday, is likely to simply be a vehicle for household payments that are unjustified and unnecessary.

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