National, Labour, Greens: You all get this, please help clear it up!

Ok, first off, I’m sorry I haven’t done a post-budget thing for a Green’s alternative budget yet – it will come, I’ve just been really really busy.

Second, this talk on the ETS is irritating me.  And it isn’t because of the description of what it will do to prices – this is true, the price of stuff that uses carbon will go up when you put a price on carbon.  The problem is the “frame” its being put into, which ignores trade-offs.  Here is the frame:

What is it?: A market-based approach to reducing greenhouse gas emissions. Emissions units, or carbon credits, are traded between participants.

People see this and then they say “global warming isn’t real” or “we are too small to impact on global warming” and then they say “NO ETS!”.  However, this isn’t the point of the ETS.

The ETS is a scheme to raise the funds to pay for our Kyoto Liability.  Even if you don’t believe in global warming, we have a liability that is based on carbon emissions.  As a nation, either people who produce the carbon pay for it – or everyone pays for it through higher taxes.

So here in lies the question – do we want higher prices for carbon goods or lower incomes because of higher taxes?  Given that the liability is a function of the amount of carbon we produce, it follows that pricing carbon on the basis of this will lead to the “best” solution – no matter what political party you support.  I know that National, Labour, and the Greens all understand this – so if you guys could like, explain it to the ACT party, and then like, explain it to the public, I’ll be very happy :D

Update:  Fuller points discussing the arguments around this in more detail in this comment.  Amazed at the strength of feeling around the ETS when all the impact studies suggest that the costs aren’t nearly as substantial as many other policies that are out and about …

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  • http://www.tvhe.co.nz rauparaha

    If few others plan to meet their Kyoto obligations then why should we? It’s not like there’s an international police force that’ll fine us and jail us if we don’t pay.

    I’m not saying the ETS is a bad idea, but I don’t think an argument centred wholly on unenforceable, international legal obligations is a particularly strong one.

  • http://www.tvhe.co.nz Matt Nolan

    @rauparaha

    If that is the key, then the debate should be regarding whether we meet our obligation or not.

    If we are going to renege, do it – then don’t have an ETS.

    If we still have the intention to follow through, use the ETS.

    Again, this comes down to facing the trade-off instead of looking only at one side.

  • http://www.tvhe.co.nz goonix

    @Matt Nolan
    That is the first step that must be taken, before determining the optimal approach to meeting the liability (which otherwise wouldn’t be necessary).

    ACT are saying scrap the ETS – they are not saying this because they don’t understand the optimal way to meet a liability (although I understand they prefer a tax to an ETS). They are saying this as they want to forgo meeting the liability through withdrawing from the Kyoto Protocol (two very different things, given the distinctions we’ve discussed above).

  • http://www.tvhe.co.nz goonix

    Matt Nolan :
    Ok, first off, I’m sorry I haven’t done a post-budget thing for a Green’s alternative budget yet – it will come, I’ve just been really really busy.

    Oh and I’m sure they can’t wait for another savaging. :P

  • http://www.tvhe.co.nz Matt Nolan

    @goonix

    IF that is the case – they should say “leave Kyoto, then we don’t have to do the ETS” not “hey, lets not do the ETS”.

    @goonix

    It won’t be savage – it will be mild like the other “alternative budget” posts. However, I am sure people will still get annoyed, as no-one likes to have trade-offs pointed out ;)

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  • http://www.tvhe.co.nz goonix

    @Matt Nolan

    That is exactly what they are saying, as far as I can tell. From their policies page:

    “ACT will repeal the Emissions Trading Scheme and withdraw from the Kyoto Protocol”

  • http://www.tvhe.co.nz Matt Nolan

    @goonix

    When they discuss policy they should say that the first bit is conditional on the second bit.

    And the media still needs to know the difference as well…

  • StephenR

    They are saying this as they want to forgo meeting the liability through withdrawing from the Kyoto Protocol

    This, I think, has the effect of raising the future bill by even more if the effect is simply to delay action. Surely they should be saying ‘renege’.

  • http://www.tvhe.co.nz rauparaha

    Yeah, I think the distinction is that everyone wants to SEEM like they care without paying anything. Most countries who listen to their citizenry deal with the dilemma by signing up and then failing to pay up. Who’s going to point it out when they’ll just be drawing attention to their own failure to meet their Kyoto target?

    So, really, opposing an ETS and remaining vague on the Kyoto obligations is a fairly good political strategy ;)

  • http://www.tvhe.co.nz Matt Nolan

    @StephenR

    @rauparaha

    “So, really, opposing an ETS and remaining vague on the Kyoto obligations is a fairly good political strategy”

    I hate politics. That is all.

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  • http://offsettingbehaviour.blogspot.com/ Eric Crampton

    @rauparaha has nailed it. Signing on, then ignoring it, seems politically optimal.

  • Rachel

    From my (under-researched, mostly based on hear-say) understanding
    -Our Kyoto liability is up to 2012
    -the ETS is set to last indefinitely and is not focused specifically on short term reductions
    If that is correct than assuming a position of believing global warming isn’t happening, then the damage from the ETS in the long term will surely outweigh the benefit of a more efficient approach of meeting the kyoto liability (assuming we do) for the next year and a bit?

  • http://jtcontracelsum.blogspot.com John Tertullian

    Kyoto obligations expire in 2012. NZ is currently in credit, and we are waiting for huge amounts of money to be paid to us to buy our credits, but so far no-one has been forthcoming. Wonder why. The ETS is a joke and a rort. It cannot be justified by our so-called Kyoto obligations.

  • peteremcc

    1) We’re in credit for Kyoto.

    2) We’re never going to see any of that money because come 2012 no-one is going to actually pay.

  • http://www.tvhe.co.nz Matt Nolan

    @Eric Crampton

    I am not a fan of political optimality – I see it as descriptively accurate, but given that these sorts of posts are meant to discuss optimal social policy I find it inappropriate ;)

    @Rachel

    @John Tertullian

    Rene has also made that point, and I can see definite value in it.

    I was under the impression that the government was basing policy on the scheme continuing – so given that working assumption the ETS is the way to go. We can definitely debate whether that is a fair assumption for policy, but the discussion in parliament should first be around that THEN the ETS – at the moment it is the wrong way around IMO :)

    @peteremcc

    1) Whether we are in credit or not is actually irrelevant for an ETS – as it is about relative prices. If you want me to clarify this ask and I will :)

    2) I don’t believe that is the current working assumption for policy – if ACT believes that is a better assumption, then they should be making the case for that, and canceling the ETS would then be a logical outcome. Saying we should cancel the ETS when it is the best policy given current working policy seems a touch inappropriate.

  • peteremcc

    Not sure what you mean by relative prices, but I get that not reducing emissions might mean we only get a few hundred million in credit instead of lots of hundreds of millions.

    But I think that’s taken care of by point two.

    Either point takes care of your argument that we need the ETS to pay for our liability though.

  • http://www.tvhe.co.nz Matt Nolan

    @peteremcc

    Hi Peter,

    In essence, the Kyoto protocal and any future agreement implies that the price on emission markets for a “unit” of emissions is part of the opportunity cost of producing a “emission unit”.

    At the moment, the market faces a cost less than this – so individuals produce too many units relative to what is optimal. By either introducing an ETS or (preferably IMO) taxing emissions we can make this cost equate to the opportunity cost. We then use the funds to pay for the emissions/reduce income taxes (which are more distortionary).

    Now, if we are a net creditor country, we are saying that we are producing fewer emissions than we have been provided credits for. This does not changes the “opportunity cost” associated with each emission – it just implies that we are net beneficiaries from the scheme, and so either the credit allocation given to businesses will make them better off or income taxes will be lower than they would hvae been.

    That is point 1 – the actual size of the liability/credit is irrelevant, it is the opportunity cost associated with carbon emissions that matters, once the market faces this it will allocate resources efficiently.

    With point 2, the working assumption in government is that they will pay and that there will be another scheme. IF this isn’t the best assumption then we should tell policy makers to change that – and then an ETS will be irrelevant.

    But at the moment it is seen as the most likely case. Now if (and according to Rene ACT does say this on occasion) people say that they don’t believe this assumption that is fine – but if we admit that the government is making policy on this basis there is a perfectly good economic rationale for the ETS.

    So any economic argument against having an ETS per see must rely on two things:

    1) The Kyoto liability is not binding/will not remain binding
    2) The ETS is poorly designed in efficiency terms.

    The first one, which you have raised, is not an attack on the ETS but an attack on a working assumption – so instead of complaining about the increase in costs based on the ETS the complaint SHOULD be about the government acting like it will take on a liability it won’t!

    The second argument (which I have raised in the past) is unlikely to be sufficient – as the current scheme is still probably an improvement on paying out of income taxes ACCEPTING the liability as given.

    Hopefully this clarifies what I am saying :)

  • peteremcc

    Yeah, that’s pretty much what my understanding was.

    “Instead of complaining about the increase in costs based on the ETS the complaint SHOULD be about the government acting like it will take on a liability it won’t!”

    That’s a fair point, but this is where politics steps in.

    It’s much easier to explain to people that the government is putting a cost on them through the emissions trading scheme, than to explain that actually the cost is being put on them by the government’s decision to adopt the Kyoto Protocol and therefore the ETS is an indirect way of paying for that.

    People don’t see the result of the Kyoto adoption, they see the result of the tax.

    Overall, what i’m trying to say is that it’s a bit unfair to say that Greens/Labour/National understand this issue and that ACT doesn’t – I’d suggest you speak to John Boscawen, he certainly understands everything you’re discussing here (I know as I’ve discussed it with him as well, and actually questioned him on the opportunity cost directly).

    The disagreement is simply on whether it’s right or not, not the understanding.

  • peteremcc

    Also, it’s important to note that you’re “likely” analysis is a bit disingenuous as it suggests that whether payments for Kyoto credits take place is actually just some random chance that will take place elsewhere.

    That may be true for whether other countries pay, but it’s up to our government whether we pay.

  • http://www.tvhe.co.nz Matt Nolan

    @peteremcc

    @peteremcc

    Hi Peter,

    I agree with you that the post can be construed as a touch harsh – and I only wrote it in this manner because it felt like ACT was using political marketing to slightly misrepresent the issue. Now I realise parties do this – but I do tend to attack all parties when they do, not just ACT. I have had similar comment streams with the Green party and Libs during this very same week …

    In my opinion, focusing solely on the ETS is highly misleading. In principal I would view it as appropriate to agrue against Kyoto – but once we have Kyoto in place and a significant liability (as in liability per unit, even if not an aggregate liabilty) I see the purpose of policy as trying to sort out the best way putting this into account rather than acting as if the cost doesn’t exist (which is what attacking the ETS on the grounds of higher prices does).

  • PaulL

    I agree on the opportunity cost argument – essentially though that boils down to one of two things:

    1. If we optimally priced carbon, our credit might be bigger than it is now, so we should get on and do it. This only works if we actually think anyone will pay us – which they probably won’t

    2. In global terms, it is important to optimally price carbon so that people make appropriate decisions for the good of the world. This is a reasonably argument, I personally don’t think that an ETS is going to get to that result though – too much politics, insider trading, and sub-optimal legislation so as to protect special interests. I suspect that the ETS is actually worse than the status quo.

    My view on the overall problem is that it would be nice to have a price on carbon, and it would be nice to have lower overall carbon emissions so long as it had a relatively small impact on cost of living. A tax is far more efficient than a trading scheme as soon as you include the assumption that there is no realistic potential for international trading. It also has the substantial benefit that it is largely a progressive tax (those more wealthy tend to emit more carbon), and it is an entirely avoidable tax (changing your behaviour can reduce the amount of tax you pay). Both of those are very desirable from my viewpoint. If we also assume a compensating reduction in income tax, then a carbon tax hits the political high points of:
    – soak the rich – so the lefties are happy
    – the rich can avoid it by using products that are less carbon intensive – and they got income tax cuts so they’re happy too
    – the greenies love it (Greens official policy is for a carbon tax)
    – ACT would tolerate it (their official policy is for a carbon tax)
    – it has no impact on exports, and increases the cost of imports – good for balance of trade

  • http://www.tvhe.co.nz Matt Nolan

    @PaulL

    I prefer a carbon tax as well. However, in essence a tax and an ETS are very very similar:

    http://www.tvhe.co.nz/2008/11/19/a-carbon-tax/

    An optimal ETS gives us “quantity certainty” a tax gives us “price certainty”. Our current ETS gets confused and just passes some of the cost to society more generally ;)

  • PaulL

    An optimal ETS is very similar to a tax. Nobody has an optimal ETS. The main areas of sub-optimality appear to be:
    – carve outs for protected/special industries
    – free granting of permits, creating windfall gains
    – not uniformly implemented across the globe – so major trading impacts

    A tax would avoid all these problems. If we had an optimal ETS then I would agree, but really that isn’t a useful discussion, we don’t have and won’t have an optimal ETS.

    Reminds me vaguely of a young lady I knew with a degree in statistics, who assured me that you could make money betting on red/black on roulette. Logic was that you bet $1, if you lose you bet $2, if you lose you bet $4 and so on. You eventually win, and end up ahead. Intuitively that must be wrong, it took me about an hour to work through why. The problem is constraints – as soon as I put a limit on how much money someone has to bet, no matter how high that limit, the strategy will deliver a net loss.

    The other major flaw with that betting strategy is that you’ve turned a pass-time in which you probably lose small amounts of money in the hope of a very large payoff (therefore = fun) into a pass-time in which you probably make a small amount of money with a possibility of massive loss (not = fun). Anyway, off topic.

  • http://www.tvhe.co.nz Matt Nolan

    @PaulL

    I completely agree. I thought that is what I said in the comment, just to make it clear I do agree ;)

    I would prefer a tax, and optimal ETS will be similar – our ETS is a bit funky.

    One thing I will say though is:

    “free granting of permits, creating windfall gains”

    Given we are provided a free allocation under Kyoto, this allocation is an income boost. We could say that it would be fair to give this allocation directly too industry.

    The Labour ETS didn’t, the National ETS does in a really funny way :P