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Apr 14, 2011

Carbon price compo for business v households: not the same thing

Labor would like us to think businesses will act just like households when it comes to carbon price compensation. Experience suggests otherwise.

Another speech, another step closer to the policy that will not die: Greg Combet yesterday gave a couple of further clues as to why Labor’s preferred carbon price scheme will be the CPRS under another name.

Remember, Labor did its best to kill the CPRS. First they never sold it properly. Then they dumped it … sorry, delayed it. Then, just to make sure, they dumped the prime minister who oversaw it. Then, as if that wasn’t enough, they swore black and blue there wouldn’t be a tax on carbon after the election.

But that was 2010. This is now. In a Press Club speech primarily designed to provide a justification for injecting the unlikely phrase “millions will be better off under a carbon price” into public debate, Combet dropped more hints that the carbon price is just Mark V of the CPRS.

First, Combet said compensation will be more than 50% of revenue, and it will be permanent. That it will apply “for the first year and over a period of years”.

The 50% threshold is, I suspect, considered psychologically important in selling the carbon price scheme, in a way it wasn’t in 2009 when no one ever mentioned household compensation. It enables the government to say most of the revenue raised will go to households.

And strangely enough, Combet’s statements match the second-last iteration of the CPRS from the 2009-10 MYEFO documents in which, once the scheme was up and running, just over half the revenue went on compensating low and middle-income households. However, revenue grew faster than compensation over the out-years, so household compensation dropped to 45% of revenue by 2020.

Combet also used as his example for the steel and aluminium industries the 94.5% free permit compensation levels from the CPRS. It will look very odd, then, if the government’s carbon price model doesn’t include exactly that compensation level.

Combet did so as part of an argument that compensation to polluters doesn’t reduce their incentive to reduce carbon emissions.

“I should also make the point that by providing this assistance the government does not reduce the signal for these industries to reduce their carbon pollution. If the assistance is in the form of free permits, these permits are an asset. These businesses have an opportunity to reduce their carbon emissions and sell surplus permits. If they cannot there is a very substantial level of shielding against carbon leakage.”

Wrong, minister.

It’s not just Combet, of course — he was merely articulating the approach favoured by Labor and the Liberal moderates who backed Malcolm Turnbull’s ETS amendments, which was even more generous to polluters than the CPRS.

Combet is making the implicit comparison of households to business: we’re compensating households through tax cuts and transfer payments, but economics says (correctly) that they’ll still change their behaviour in response to changed prices. So too, he wants us to think, will business change its behaviour.

The first problem with that is that under any of the models advanced for a carbon price by Labor, businesses would be compensated differently to households. They wouldn’t get a tax cut or a grant, they’d get free permits. That is, they would see virtually no price signal, whereas consumers would see the full signal. It’s like giving householders a “no carbon tax” card they could wave every time they had to make a purchase.

If the carbon price revenue was being directed into a corporate tax cut, it might make more sense to argue businesses would respond to carbon price signals, but not when the price signal is almost entirely neutered.

But experience also suggests Combet is wrong on his principal point, that business will be motivated to reduce emissions by the prospect of selling surplus permits.

You’d never know it from the shock jocks and people like Greg Hunt, but a European emissions trading scheme has been in operation for five years. So there’s plenty of what the consultants call “learnings” to be had from it. The biggest “learning” of all of course is that the impact of a carbon price is far, far less than that alleged by business before its introduction, but we knew that already. Another relates to how businesses react when they’re given free permits, which was also the basis of the European scheme. A US economist, Daniel Matisoff, has looked at how business is supposed to respond in theory, and how they have in reality.

Matisoff identified a number of problems, and found that “companies exhibit a strong preference for business-as-usual operations, especially under conditions of high uncertainty”. Some are problems that turned up were relatively minor and would be addressed as businesses adjust to a scheme. For example, some smaller European businesses initially couldn’t find buyers and sellers of the small number of permits they needed, or wanted to sell — a problem that would presumably be addressed by brokering services.

Businesses can also attempt to pass on what carbon price cost they do face to consumers. At the beginning of the European ETS, power companies notoriously passed on the cost of their permits — despite the fact they had got them for free. The overallocation of permits that led to that has since been fixed.

But Matisoff found more fundamental problems. It’s big utilities that are most likely to operate as economic theory would suggest, and trade their permits after cutting energy use. But they adopted a short-term approach because of regulatory uncertainty around issues like the future regulation of coal-fired power, and put off long-term investment decisions because of uncertainty about the long-term carbon price.

However, those issues are endemic to a trading system, and can’t be fixed no matter what compensation model you use.

Large non-utility companies, however, are much more likely to opt for “business as usual” — as one quote used by Matisoff shows: “Many large industrial firms … have no desire to change behavior, regardless of possible profits from selling carbon permits.” Part of this is because they want to stick to their core business. As one says in the paper: “I’m a brick producer, I want to produce bricks.” The study also found internal issues about which areas of a business are charged with selling permits, which are charged with managing sustainability issues, and “shopfloor”, where the most practical energy efficiency measures are likely to be identified.

And small and medium firms simply don’t have the resources to invest in properly understanding the operation of the carbon permit market. For those business, the ETS is simply a compliance issue, not an opportunity to make money from selling permits. That, at least, is a problem obviated by targeting the carbon pricing scheme at the biggest polluters, something both the CPRS and the new carbon price scheme will do.

The problem of long-term certainty recurs in Matisoff’s findings. Such a problem is likely to be even greater in Australia if the Coalition remains in the grip of climate denialists and opportunists, who may be able to cruel the effectiveness of a carbon price simply by keeping businesses uncertain about whether there’ll still be a carbon pricing scheme of any kind in, say, 2020.

But it’s also an issue for Labor. The final version of its CPRS extended free permits well into the 2020s, meaning businesses could safely put off the need to plan for the full impact of a carbon price for several years. That’s why Ross Garnaut’s proposal to limit CPRS-style compensation to just three years until the PC develops a new set of compensation guidelines makes more sense than the original CPRS model — businesses will still be uncertain, but they’ll know that whatever the PC comes up with, it won’t be as generous as the CPRS compensation model.

Better still to abandon compensation altogether, and concentrate on providing transitional assistance that business will know expires after a limited period, say three or five years. And if provided via grants or tax cuts, it’s likely to maximise the chances of business acting in accord with how economic theory says they will.

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39 comments

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39 thoughts on “Carbon price compo for business v households: not the same thing

  1. John

    Greg Combet will compensate households through tax cuts and transfer payments:
    “Millions will be better off under a carbon price.”

    You can thank Tony Abbott’s scare campaign for this permanent redistribution of income from the rich to the poor.
    Who would have thought that the Liberal Party under Tony Abbott would become responsible for socialist welfare policies?
    Neocons will be turning in their graves.

  2. JamesH

    Excellent comparative analysis Bernard; this sort of thing is why I subscribe.

  3. Captain Planet

    Outright compensation or transitional assistance will only result in our corporate “citizens” taking everything that is given to them, and then crying like babies in however many years, that they are unable to cope with the expiration of the compensation / assistance, and holding the country to ransom, demanding permanent special treatment.

    Free permits clearly don’t work as they eliminate the price signal, despite what some might think.

    All money raised from the Carbon Tax, and the longer term sale of permits, must go towards subsidising the only industry which is deserving of help and will actually play a role in decreasing the impact of a Carbon Price on all other industries.

    Renewable Energy.

    To say that a carbon price will “change behaviour” in terms of energy consumption sounds great. It is very difficult to choose to buy your energy from renewable sources when the industry does not yet have sufficient infrastructure on the ground to provide that energy.

    We need to create this change in two ways:
    1. Make CO2 emitting activities more expensive. A Carbon Tax will do this.
    2. Make non – CO2 emitting alternatives available. The prevailing orthodoxy places faith in market forces to do this – In theory, private industry will rush out and build windfarms and electric car infrastructure all over the place to supply zero carbon energy. IN practice this will take an unacceptably long time unless direct assistance is given to these industries – and the blindingly obvious source of funding is the carbon tax itself.

  4. Jimmy

    I find it hard to believe that the top 1000 emitters in the country will choose “business as usual” rather than spend say $20 a tonne reducing emmissions they can sell permits for for $25 a tonne and be able to market themselves as “green”, especially when the compensation will eventually be removed and they will be forced to make the investment anyway. I would of thought not doing this would be acting against the best interests of the shareholders.

    Captain Planet – Transistional Assistance is necessary to avoid a massive shock to the economy, big emitters can’t just flick a switch and start emitting less they need time to adapt.

  5. Scott

    The price signal to business is only one aspect of the ETS.

    The major aims of an ETS here is to reduce emissions and compensate for carbon’s externality effects. The fact that only a limited number of permits get distributed every year (and the number of permits reduce every year to a Government decided limit), means that a reduction in emissions will occur if an ETS is implemented correctly. It is better if these permits get auctioned off (to provide compensation to the government for the externalities as well as to accurately price carbon), but initially free permits are acceptable as a means of enticing business into the program. The problem with the European model was that initially, these free permits were overallocated (so emissions actually increased for the first couple of years). However, as long as this does not occur with the Australia model, reduction of emissions is assured.

    After that, it is up to business to decide whether they will reap the profits of trading or not. Some businesses will decide it’s all too hard and ignore the trading aspects of the ETS to focus on it’s core business. Others will use carbon trading strategies as a competitive advantage. But like everything in business, let the directors and shareholders decide what is good for their own companies.

  6. david

    Abbott is being cornered like the rat he is.

  7. D. John Hunwick

    As Bernard Keane has well-argued – the most sensible approach is NOT to have free permits. The real reason for this is that the decline in CO2 emissions is now more urgent than ever. The climate scientists that really know what they are talking about (and feaured on Crikey) are saying the 2 degrees of warming (or 450ppm of CO2) is a dangerous level not a possible safe one. To be slow in responding to this only increases our chances of passing some irreversible tipping point that will make life on earth hell for all our descendants

  8. kuke

    Yes, excellent post thanks.

    How much will the carbon rise each year by? This is the key. And if it changes into an ETS, how do we keep rising the minimum price?

  9. Frank Campbell

    “the unlikely phrase ‘millions will be better off under a carbon price'”

    When a caahbun price cheerleader like Bernard Keane realises there’s a rancid smell emanating from this govt. policy, you know the game is up. It’s no longer a tax, it’s a bonus! The magic pudding has become steadily more supernatural since the cooks announced it, matching the ALPs slide in the polls rather neatly. If this goes on, everyone will end up with an enormous cheque and their own coalmine. Result: Labour landslide, mostly mullock heap.

    But Darth Combet-I worry about him. He exudes more anxiety than a family of Freuds. That fixed, obsessive stare. The thin censorious mouth. The endless chain of engineering similes: market “mechanisms”, policy “settings” , price “signals”, “adjustments”…the Controller’s technocratic dream….

    Maybe it’s just ALP desperation. After all, they’ve staked the lot on this idiotic tax. It’s a carbon referendum. In effect a referendum on anthropogenic global warming, or rather belief in it. The polls don’t look good there either. Declining belief since 2006.

    As even Keane is aware, the tax will not change corporate behaviour. Too small for a start. And now Gillard’s giving away all the revenue to bribe voters. Fuel will be excluded next. Farmers and their farting stock are already exempt. That leaves thermal coal. Killing that will drive up power prices even faster than now. The alternatives are laughable: not a baseload renewable technology in sight- and no money for the essential R and D. More wind turbines, useless unreliable power at 3 times the cost? Or Solar the Unready? A billion dollars spent on domestic solar managed just 0.1% of power production. A sickening subsidy to the the middle class: you pay for their carbon guilt.

    In a decade we’ll look back on this collective mania with disbelief.

    2020: in the long dark corridors of The Lodge, the Prime Minister pedals remorselessly, the lino worn thin. Now permanently naked except for his Tour de France helmet, he’s no longer allowed out, but is always voted in.

  10. Jimmy

    Kuke – rising the minimum price under an ETS is easy you just cut the amount of permits available.

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