Making sense of the carbon tax in Australia
There has been a lot of talk about the Gillard government’s proposed carbon tax. Much of it has been heated, coloured by the wider debate around global warming. This was to be expected given that the issue of man-made climate change remains both complex and controversial, not to say confusing to many of the public at large.
While it is agreed by all that the burning of fossil fuels such as coal for the production of electricity releases carbon emissions, it remains a matter of opinion whether this contributes to global climate change. For a vocal minority, this assertion is perceived as dubious and unproven, and they have naturally found it hard to sanction a carbon tax on energy producers. Others are hesitant to endorse the carbon tax due to its high potential cost relative to the benefit.
We’ll address the particulars of that larger dissension in another forum. Our aim here is narrower, namely to distinguish the carbon tax levied on energy producers from the as yet unspecified tax compensation that would devolve to a majority of taxpayers following its implementation.
The attention in the media has understandably been focused on the details, however vague they remain, of this medium term tax benefit to the public. The prospect of an unexpected boon in cash always makes for good news fodder. But, a deeper grasp of how the carbon tax would be advantageous in the long run has been somewhat lacking as a result.
So, what is the carbon tax and how does it work? First, a carbon tax is a goods and services tax (GST). It is explicitly not a direct tax on income. Rather, it is an indirect tax whereby a government imposes a fee on the cost to produce a certain good, in this case electricity derived from coal or other fossil fuels. Specifically, the carbon tax is levied on the carbon content of fuels. With a carbon tax, fuels like coal, petroleum, or natural gas are taxed in proportion to their carbon content measured by the tonne.
As it turns out, coal, the cheapest of all fossil fuels, holds the highest proportion of carbon atoms. These are released into the atmosphere as carbon dioxide when coal is burnt to produce energy. Clean energy sources that are not linked to combustion, such as wind or sunlight, do not discharge carbon dioxide. The purpose of the carbon tax then is to coax power companies into transitioning to alternative forms of energy that have less or no carbon content in order to maintain their profit margins.
This is easier said than done. As we’ll see, for the carbon tax to be truly effective, certain preconditions must be in place. But beforehand, it is important to consider the moral premises on which the carbon tax is based. A carbon tax is a fee upon a market activity that is perceived to produce a negative environmental outcome. It assumes that the actions of the companies involved in such an activity, namely energy production from polluting fossil fuels, have a social cost. The pernicious effects on the environment that follows from climate change are examples of such a negative outcome.
Pollution is understood to have a social cost because of its negative impact on parties not involved in the market transaction. As such, the carbon tax is similar to the tax levied on tobacco products in the sense that the non-smoker both suffers directly from the harmful effects of second hand smoke and indirectly bears the health care costs of treating the diseases caused by cigarette smoking. Accordingly, the tax is meant to make energy producers responsible the social burden of their actions while incentivizing them to reduce their carbon emissions by shifting to cleaner fuels.
Second, a tax on carbon emissions, like a tax on tobacco or at the petrol bowser, is a regressive tax. It is so because energy producers pass on their tax liability to all consumers, regardless of income, in the form of higher energy prices. The extra amount paid as a result of the tax is the same for everyone. For instance, under its current formulation, the carbon tax is expected to increase a household’s energy cost by about $500 a year. The only way to reduce your contribution to a regressive tax is by using less of the good, for example by exchanging your petrol thirsty car for one that will net you more kilometres per litre or dumping your energy guzzling appliances for more efficient ones.
Since this is not always possible, a regressive tax like the carbon tax has the greatest impact on lower income groups as these end up paying a larger proportion of their limited income towards their energy needs. This is why talk of a tax on energy is always accompanied by a discussion of tax benefits for taxpayers based on income. Consequently, in addition to being regressive, the carbon tax is also revenue neutral because a substantial share of the money it raises goes to subsidize the consumer’s increased energy tab. We’ll discuss the Government’s proposals for compensation to help consumers with their higher power bills separately. Fully half of the revenue from the carbon tax would go towards such a subsidy.
The rest would presumably be returned to the energy industry in the shape of funds earmarked for research and investment into clean energy sources. The Government is quick to stress that the carbon tax, unlike a blanket tax on tobacco, is a market based solution to the problem of pollution. The goal of a cigarette tax is to bring about the simple eradication of a damaging habit. No compensation is offered to offset the tax. The carbon tax, on the other hand, is a price instrument whose aim is to render polluting energy sources like coal less competitive in the marketplace than their cleaner alternatives.
Here’s how the carbon tax would ideally work. In the first place, the government imposes a tax on the carbon content of the polluting fuel so that the cost to the producer for each unit of energy output is increased. Next, the energy producer translates this higher cost into higher prices at the metre for the consumer. The Government then returns a portion of the funds collected from the tax to the consumers who fall below a chosen income threshold. The remainder of the tax revenue goes back to the energy industry for research and refinement of non-polluting alternatives.
This is both relevant and controversial because those taxpayers whose income is higher, which is to say the better off, receive little or no compensation for their increased energy tabs and, evidently, end up footing a large chunk of the bill for the development of cleaner fuels. Eventually, thanks to the revenue from the carbon tax, new, clean energy sources are established at costs that allow them to be competitive in the marketplace against the older, dirty sources such as coal or petroleum at their still taxed price. The consumer is then given a choice somewhat analogous to that of purchasing marginally more expensive organic foods as opposed to the industrial, environmentally challenged kind.
Evidently, the right price is crucial. For the transition to occur, the price of the new energy source must be competitive. If it remains too expensive, the switch to cleaner fuel would be unlikely and the carbon tax would be deemed a failure by most. The Gillard Government seems to be remarkably optimistic when it comes to the capacity of industry to come up with alternatives to carbon that would be cost effective. It clearly understands that for the carbon tax to work as intended the revenues obtained from it must be both sufficient and carefully targeted.
Still, a shift to cleaner but potentially more expensive sources of energy would have ramifications throughout the Australian economy, not least on businesses which the Government has already said it would not subsidize. Higher energy costs would have an impact on the materials used in home construction for example. In the end, we return to the moral argument behind the shift to clean energy. If you believe that pollution is a net loss to the planet, you should be prepared to pay more for the electricity you use, at least in the medium term. In time, you may be rewarded when technological advances, as they often do, bring costs down.
