Australia: Carbon Tax

Wealth Management Winter 2011 Newsletter
Last Updated: 2 June 2011

It is clear from the media that the most contentious political issue at the moment is the Carbon Tax debate. It has been said that arguably the two most important issues the world currently faces are:

  1. The prevention of nuclear weapons falling in to the hands of rogue states or terrorist organisations; and
  2. Human induced climate change.

In that context the importance of the climate change issue cannot be understated and so there is little wonder that the carbon tax issue has generated such passionate, and sometimes hysterical, debate. The purpose of this article is to discuss, from an economic and pragmatic perspective, some of the key concerns, which are broadly as follows;

  • Is there sufficient evidence to support action on climate change?
  • Why should Australia act if some key polluters including the United States, Japan and Russia have not priced carbon?
  • Will a price on carbon make a difference?
  • Is a Carbon Tax a better option than the Coalition's Direct Action policy?
  • We will deal with each issue in turn below.

Is there sufficient evidence to support action on climate change?

We do not pretend to be an expert on this subject and indeed we are not. Our limited knowledge has come from reading a number of articles written by Dr James Hansen and a number of books on this subject including:

  • The Weathermakers, by Tim Flannery
  • Heaven and Earth – Global Warming: The Missing Science (2009) by Ian Plimer
  • Censoring Science: Inside the Political Attack on Dr. James Hansen and the Truth of Global Warming, by Mark Bowen.

Weathermakers has been painstakingly researched and referenced by Tim Flannery and presents a clear argument for human induced climate change. Ian Plimer's book presents the opposite view and, to his credit, is meticulously well reasoned and certainly leaves you in some doubt about the veracity of the climate change argument. Indeed, Plimer has been the champion for the view that climate change is a furphy and has been interviewed countless times. What is perhaps not well known is that Plimer has very much a conflict of interest. As at 2009, he was listed as a director of a number of Australian mining companies including: Ivanhoe, CBH Resources and Kefi Minerals. He was also listed as a director of Australia-based coal gas company Ormil Energy. Of course, a conflict of interest alone does not mean his views are wrong.

What is clear about the science behind global warming is that it is incredibly complex. The only true experts in the field are climatologists (Plimer is a geologist). Arguably, the world's leading climatologist, Dr Jim Hansen, is employed by NASA and has devoted his life to this field. He has been fortunate enough to draw upon the skills of leading atmospheric chemists, physicists and paleoclimatologists to prove beyond any reasonable doubt that human induced climate change is real. Furthermore, his scientific rigor has debunked the main theory espoused by Plimer and others. The sceptics key argument is that 1) climate change is a natural cyclical event not impacted by humans and 2) the build up of carbon dioxide is a natural reaction to warming.

There are two key limbs to this argument, the first being:

"that climate change is a natural cyclical event"

This argument is not disputed. Historical records confirm this to be the case. Climate change has been occurring ever since the earth came into being some 4.6 billion years ago. The issue is whether human interference is increasing the rate of change.

Let's look at the second limb of the argument:

"the build up of carbon dioxide is a natural reaction to warming"

Bear with us on this as this is critical. What the sceptics are suggesting is that carbon dioxide is a result of warming (the build up in carbon dioxide lags warming). This differs from the human induced climate change argument that carbon dioxide is causing the warming. A subtle but very important difference.

The science shows that the sceptics argument is partially correct when viewed in terms of preindustrial emissions. Carbon dioxide emissions didn't initiate warming from past ice ages. Where the sceptics are wrong however is that the studies show that carbon dioxide did amplify the warming. Further, the argument that carbon dioxide in the post industrial age is not causing the warming and so human activity isn't having any impact has been proven to be patently false. This does not mean Plimer and other sceptics should be lambasted for their efforts because they have, perhaps inadvertently, helped push the science to new levels - levels where climatologists are now comfortable to say that the science is beyond any reasonable doubt.

We do not want to get bogged down on this area but it is important for sceptics to be sceptical because that promotes more scientific rigour and improves our understanding. But it is also important for individuals to recognise that the science is incredibly complex and so best left to the experts. We would encourage anyone who remains in doubt (of which there are still many) to read James Hansen's books and articles as his knowledge on the subject is unsurpassed.

Why should Australia act if some key polluters including the United States, Japan and Russia have not priced carbon?

We do not pretend that there is a definitive answer to this question but we will make some observations. Firstly the economies of Japan and the United States are suffering from enormous public debt burdens that are placing extreme stresses on their finances. Russia is still recovering from the sovereign debt bailout in 1998. The inference here is that the above countries have not enacted good public policy in recent times and so should not be held out as good examples to follow.

Will a price on carbon make a difference?

Australia's emissions per capita are of course very high but, due to our relatively small population, our efforts alone are unlikely to make a material difference. This cannot be denied. We can understand why some sections of the business community hold onto this view as being critical.

If we act first then there is a logical basis to the argument that some businesses will be at a competitive disadvantage as against overseas counterparts who have not imposed a price on carbon. We do not disagree with this line of thinking. It is not incorrect. What it is though, is incredibly short sighted. If we do nothing then we cannot persuade others to take action. If we do nothing we cannot expect the problem to go away. Of course, we could do nothing and hope that other countries do the hard work for us and reduce global emissions. We could also hope that another country finds a groundbreaking new technology or method that results in a low cost clean energy solution that can be rolled out globally.

But sitting back and doing nothing is akin to being on a leaky boat and refusing to bail out water while others around you are trying desperately. It is not the right thing to do. It is both selfish and irresponsible. We need to ask ourselves are we willing to make small sacrifices for the potential of long term gain. Science suggests we have little choice. According to NASA, about one-third of the carbon dioxide emitted today will still be in the air 100 years from now. This means even if we stopped global emissions today completely, the planet would continue to warm for more than a century. If we do nothing the potential damage to our economy in 20-50 years time (let alone the planet) is likely to be far worse.

Is a Carbon Tax a better option than the Coalition's Direct Action policy ?

The respective political parties have put forward two options for consideration, the Carbon Tax and the Direct Action Plan. Let's make this clear, we do not think either policy is perfect. Absolutely not. But it is also true that the longer we delay action, the more difficult the task becomes. In other words, we are better off accepting an imperfect solution than delaying or doing nothing at all. In that context then, let's consider the only two options before us;

  • Carbon Tax – a tax on polluters that theoretically will impose an incentive upon business to reduce emissions to reduce the tax burden. The goal is to reduce emissions by 5% by 2020
  • Direct Action - taxpayer funded clean energy initiatives with a view of reducing emissions by 5% by 2020.

Both policies profess to work towards the same outcome, albeit via vastly different methods. Let's consider each policy in turn:

A. Carbon Tax

From an economic perspective, the tax on polluters is technically appealing as pollution is really only another cost of production which has not been priced in by the market before. Just as there is a cost for labour, there is also a cost to the environment from pollution. A tax on carbon goes some way to capturing this cost.

When any cost is imposed on business they have one of two choices;
- pass on the cost to consumers in part or in full; or
- absorb the cost

Typically business will try and pass on the cost where they think consumers will pay. This is referred to as the elasticity of demand. Demand is said to be inelastic when prices rise but demand falls away by a smaller percentage. Essential goods tend to have a stable or inelastic demand profile. Businesses that sell such goods where competition is limited tend to be able to pass on costs to consumers more readily. Electricity is one such example.

In contrast, demand is said to be elastic when prices rise and demand falls away by the same or a greater percentage. Import competing products typically display elastic demand curves and are less able to pass on costs. It follows that businesses that can pass on costs to consumers should not receive any compensation and those that can't should receivedue consideration.

Businesses most exposed to a decline in profitability will be those that 1) have high emissions, and 2) are not in a position to pass on the extra costs to consumers and 3) receive little or no compensation. Based on a $30 per tonne starting price, modeling indicates that the overall impact is not expected to be significant but industry compensation details have yet to be finalised. Fears of mass job losses appear to be ill-founded but some restructuring is inevitable in high pollution industries. The policy would not work if this was not the case.

In terms of living costs, it is true that a carbon tax will put upward pressure on some products more than others. Treasury modeling suggests that the price rises will, on average, be minor and offset by compensation to low to middle income earners. There is no free ride. A carbon tax will impose a cost but in turn there will be a clear incentive to reduce emissions. It is hoped that clear incentives will also promote research and development into clean energy alternatives that have otherwise been too expensive to consider.

B. Direct Action

What about Direct Action? If direct action can achieve the same emission reductions then it could also be said to be sound public policy. The difference in achieving the overall outcome however could not be more stark. Direct Action does not capture the true cost of production and so does not reduce the incentive for polluters to reduce emissions. Instead of relying on polluters to pay the price, it relies on taxpayer funds. Economists estimate that this will end up being a significantly more expensive measure to implement. Again, there is no free ride. The Coalition would have to maintain the program by either reducing funding to areas such as health or educator increasing taxes. This may be possible when the emissions target is only 5% but when it is necessarily increased in future years (it is generally accepted that emissions need to be reduced drastically, certainly much more than the 5% so far targeted), the Coalition scheme over the long term would become a significant drain on public finances.

This publication is issued by Moore Stephens Australia Pty Limited ACN 062 181 846 (Moore Stephens Australia) exclusively for the general information of clients and staff of Moore Stephens Australia and the clients and staff of all affiliated independent accounting firms (and their related service entities) licensed to operate under the name Moore Stephens within Australia (Australian Member). The material contained in this publication is in the nature of general comment and information only and is not advice. The material should not be relied upon. Moore Stephens Australia, any Australian Member, any related entity of those persons, or any of their officers employees or representatives, will not be liable for any loss or damage arising out of or in connection with the material contained in this publication. Copyright © 2011 Moore Stephens Australia Pty Limited. All rights reserved.

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