Greens carbon tax

I see that the Greens have announced a carbon tax to replace the emissions trading scheme (with details and analysis by BERL here).  The authors of TVHE have long been a fan of  this type of switch when discussing the issue (eg here and here).  And the idea of pricing an externality and using it to lower other tax burdens is a good one.  Note:  John Small also discusses here, with specific discussion about dairy.  Aaron Schiff discusses here.

So it should be unsurprising that I broadly agree with the aim Green party policy here, and this should be kept in mind while reading my post.

However, TVHE isn’t about saying what policies I think are good or bad – it is about considering trade-offs and thinking about the details of policy when we can.  In that context, there are a few points I must raise.

Households, consumers, firms

The use of households by the Greens is a touch, disingenuous.  We need to be very clear about what the externality is before we make claims like this – an issue we will get to at the end (in fact, the most important question I have regarding the Green party policy).

Assume for now that there is a type of externality, which requires taxpayer funding to clean up, and is due to the decisions of producers.  In that case, pricing the externality is a way to get us towards “user pays” for pollution – excellent.

Now the ETS already does this in a form, so the question is how the relative burden is being shifted.  What forms of household/consumer/firm are currently being subsidised, and which forms are paying more in tax for the pollution?

This is a complex question, and doesn’t actually lend itself to points like this:

“The Green Party’s plan will future-proof our economy and put New Zealand firmly back in the global green race, all while leaving households better off.

From what I can tell, the main difference will be including agriculture in the tax – thereby switching burden from general taxpayers towards agriculture.  Whether that is fair (I think it is) and the impact on aggregate income (which is unclear) are two hard questions to ask, but important ones.  As always there is some type of trade-off here.

Let me give an example.  There is a lot of talk about “rural communities” struggling, and yet they are implicitly subsidised at present.  This scheme involves removing this subsidy for those regions, making whatever issues we are inherently concerned about there worse.  This isn’t to say we shouldn’t do it, just that we also need to consider side-effects in this manner – even IF the average household was better off, there are distributional consequences 😉

The nature of the tax rebate

By giving everyone except the poorest a lump sum payment, the tax rebate involved from the ETS has its own distributional consequences – consequences we can argue about regarding both fairness and efficiency.

We shouldn’t just “throw” some type of tax rebate in the scheme, we need to ask about what the best type of tax rebate is to meet a given policy objective.

I am not going into detail here – but a tax-free threshold isn’t what economists usually consider when discussing this type of policy.  Instead this is a targeted form of progressivity – and so needs to be justified on that basis as well.

The ETS, Kyoto, and the externality

The externality is an interesting one.  To quote myself from Keith Ng’s facebook wall.  [Note:  At the start of this comment I talk about whether the costings are reasonable – I’m not covering that in this post, so take that as my comment 😉 ]:

Hmmm the report does cover it – but it decides to work with partial equilibrium discussions of the price change in a few categories, rather than doing a CGE model of the full impact. So by default the benefits will be exaggerated – but not as badly as if costs had been completely ignored.

I also didn’t see reference to payments due to Kyoto liabilities, which was the justification for an ETS initially. I wonder what happens there? Without the justification of Kyoto payments this becomes a very different question.

Essentially, we face a prisoner’s dilemma in the world for dealing with climate change – but the actions of NZ are inconsequential (due to our small size). We joined Kyoto to try to solve the PD – but if that is out of the question we have to ask what our “best response is” given what the rest of the world will do. In this case, investing in ways to mitigate the costs to NZ becomes the most sensible way forward – rather than targeting a non-existent externality (due to NZ’s small size once again).

John touches on the small size argument here, but I don’t find his reasons sufficient to undermine the small size argument in this scenario (eg demand is irrelevant if we are in a world with no agreement, and taxing industries for a “technological” dividend isn’t a compelling argument).

If we are discussing a world where Kyoto liabilities disappear, where is the externality from our production of carbon emissions?  Whether NZ cuts emissions to zero, keeps emissions unchanged, or doubles emissions, the probability of a GWE (global warming event) and the intensity of said event will be unchanged.  Just like with most of our commodity prices, the chance of global warming is outside the hands of our policy makers.

In this case, producers arguably AREN’T creating an externality.  We are just taxing them for kicks.  Now there are arguments for a tax (showing the rest of the world we are serious about climate change, having the moral high ground on an incredibly important and scary issue), but it isn’t the externality argument.  Kyoto, by putting in a liability for nations, creating the externality regime we justified the NZ ETS/tax argument on – if that is gone, the argument is different.

I have no doubt these words are incredibly unpopular, but I couldn’t really care less – instead, if we are accepting a policy framework where Kyoto has failed and a GWE is very likely we need to change tack in terms of our concern.  Namely, the role of policy is now about investigating the risks NZ faces in light of such an event, and helping us co-ordinate preparation.  It becomes one of insurance and civil defence.

Now, if we do believe in a central agreement about global warming – and that we need an ETS/tax in place to pay for this and give firms/households certainty, that is cool.  But then the tax is used to fund these liabilities NOT to cut taxes – something that I haven’t been able to find reference too so far in the report!  To me, this is an extremely important issue to get clarity on!

  • JC

    The first thing I see is we create inequality for those on fixed incomes like benefits and Super, so there’s going to have to an adjustment made to compensate them that is going to hurt, ie possibly several hundred million ongoing.

    The second thing is the tax is mooted on a falling dairy market. That might be just a business cycle but could also be due to a major ramping up of dairy production around the world; that would be nasty for our dairy producers if they have to compete against untaxed carbon production overseas.


    • Both true points.

      However, if we have defined the problem such that there is a carbon externality NOT taxing dairy is a industrial subsidy. Even if everyone else is subsidising dairy production, it isn’t clear we should be doing the same – so in that instance I think we can still justify the tax.

      The first issue is the one that concerns me most, the choice of re-distributive instrument isn’t based on the “cost” faced by households – but is an arbitrary lump sum payment. I think this is an area the policy could be improved – although I suspect the Greens wouldn’t disagree with that, so didn’t feel the need to go into too much detail on it 🙂

      • The other Neil

        But who is the beneficiary of the end effect of the industrial subsidy? The vast majority of our agricutural production is exported. If we really are one of he most efficient producers (including the production of emissions) then pricing the externality is only likely to shift the production overseas. If we are still (one of) the most efficient then we have probably reduced our output and suffered a wealth effect as a result without materially affecting global emissions and very likely increasing them.

        • As you say we accept a world price, so the surplus from the subsidy goes entirely to farmers. As a result if there is an implied subsidy:

          The agricultural production that only occurs because of a subsidy would be replaced by its next best alternative – thereby making more efficient use of our limited resources.

          The agricultural activity that is still taking place would be paying the full social cost of their emissions, rather than having other industries/households transferring them wealth.

          I do not see where the “very likely increasing” emissions bit comes from. In this context. In the offshoring context I could see a potential argument – but not in the case where it is just a transfer of wealth.

          • The other Neil

            The increasing emissions was a reference to offshoring. I am not sure I can accept your view that farmers receive the entire subsidy as clearly non-domestic consumers receive lower priced goods (assuming the externality exists and is not being priced). This may just be a wealth transfer, but I need to think about this a bit more.

            I guess my angle was more about taxing or pricing a global externality in a single country, where the national wealth effects are concentrated and not shared by external parties, except to the extent that they (may) pay more for the product. I say may as the reduction in demand for the NZ goods may lead to a decline in the exchange rate and so the external affect may be zero, but the domestic effect a reduction in real wealth.

            I guess at that point we can all sit around and congratulate ourselves on not actually changing global emissions.

            • In so far as there is no external agreement, a domestic carbon tax will lead to a misallocation of resources and poorer NZers – yes, likely, although we may be able to make some fancy argument about carbon producing industries having more inelastic supply … but that is a sidenote.

              The tax needs to be seen in the light of a future international agreement, and giving price certainty to firms and households now, hence why I felt the question about Kyoto was so important!

              • The other Neil

                I guess I can accept that the transition effects may be lessened if we applied a tax now or brought all industries into the existing regime, but i would really want to see some analysis of the net benefits of moving ahead of an international agreement. The costs would be real and now and the benefits would be uncertain and in the future. So I think we are on the same page absent a global agreement.

                Carbon producing industries are already in the existing regime (except farming). I know people don’t like the current pricing, but many people don’t like the pricing (or availability) of many goods, McDonalds, alcohol, sugar etc.

                The problem to date is that the affected products largely have inelastic demand and limited substitution. The net effect has been muted and wealth diminishing I believe for consumers.

                I know this site sits between theory and practical applications, but I have a fundamental problem with a carbon tax, even though i would prefer it over the trading regime. I just don’t trust politicians to use the tax to adjust the relative price of goods and leave the tax payer net neutral in after-tax income. They will all come up with a pet project to two (Green’s ‘Green Bank’ etc) and eventually the cause and effect of the tax will be lost to distant memory.

                • How the income is used is a good question – and that statement that it is used for a “tax-free threshold” is worthy of a whole other post of analysis!

                  The key thing I’d like to see is a statement regarding the expectation of an international agreement – the tax makes sense if we expect an agreement (tacit or explicit). If we expect no-one to act this argument is a lot weaker, and I think that is why my statement about the externality (which is functionally true for a nation state) led to so much twitter anger!

  • Sam Warburton

    Say that a global agreement says the efficient level of emissions are 1990 levels. NZ introduces a tax that gets us there. What liability exists? Unless the global agreement requires countries to compensate those still harmed by the efficient levels of emissions, that revenue is free to be used to lower other taxes or do whatever else, no?

    • That is very true – after I put the post up I thought I should note that. When I’m back in the office I will update to include that in the post.

      Would the tax they are discussing be sufficient to reduce our emissions by that much? I didn’t see any related estimates on that basis. As a result, the point of liabilities at least warrants a mention in the report right? That type of response would be massive from a country that, from my understanding, has a low responsiveness to carbon taxation (high renewable energy source, reliance on agriculture) – although if this is not true I would love to hear about it!

      I support this policy, as I said at the start of the post. It is primarily the way it functions with Kyoto, and the implied view of Kyoto, that I am interested in (and the way we redistribute revenue raised, but I’m keeping that as a separate question).

      • Sam Warburton

        My point was an illustrative one. Took exception to the statement that the revenue couldn’t be used for other purposes. A proportion maybe.

        Not sure it matters. It could be that the tax is the efficient global level such that some countries produce higher than 1990s and some less. Assuming, in this situation, world bodies are comfortable with countries taxing and using revenues elsewhere, there would still be no liability.

        • We are discussing national liability – as we have a “national” level government. So it does matter when discussing the costs and benefits for an individual nation. In net terms, the lower probability (and intensity) of a GWE is an aggregate win for the world, but some countries will have negative and some positive transfers.

          • Sam Warburton

            Yes, there are distributional impacts. I’m only talking about the accounting liability and whether tax revenue is required to pay any liability. In my second example countries don’t have liabilities because they are applying T*. If T=T*, it’s all good right? Again, only taking exception to the ‘taxes gotta go to liabilities’ claim.

            • Sorry I may have misread you earlier and I’m still a bit unsure – are you saying that there is a lump sum income transfer to net the liabilities between countries out?

              • After the twitter conversation I see where you are coming from – there isn’t necessarily a net liability, but there is always tax revenue (due to the marginal pricing of carbon). I don’t disagree and my aim wasn’t to equate the two (which is why I had a bit of trouble trying to answer the question 🙂 ).

                My point above was solely that, given a net liability (and therefore a capital outflow) is likely in the future of any agreement for NZ, this would need to be included in household income in some manner. The fact I couldn’t find it mentioned made it seem like it was missing altogether, which brought me to my concerns about what we do in the face of no international agreement!

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  • Matt W

    Not entirely related to your post, but, what the hell:

    A lot of the arguments against the carbon tax argument are about how it will hurt our export sector. Clearly this is a trade off against the benefits of the tax. I think it could be avoided by taxing carbon consumption rather than production. So exports are exempt/ get a rebate and imports get taxed in the same way as for GST. In this way we are focusing on NZ as a group of consumers and looking to change their behaviour. Trying to change the behaviour of our exporters is pointless on the basis that somewhere else without a carbon tax will outcompete us but the world price for the goods we export will be unchanged. I know this goes against the philosophy of global agreements to date, but I think the global agreements are bad for this reason. Having a unilateral carbon tax on consumption is far less distorting than a unilateral tax on production

    • Taxing carbon consumption would go against policy trends overseas (which we are trying to coordinate with) and would be seen as “trade protectionism” overseas, which would see us punished. The idea has been floated in the past – when we were all trying to figure out “where on the production process” liability should fall 😉

      • Matt W

        Yes fair points, (although the idea we would be punished doesn’t have a lot of empirical support to date.) My counter is – that figuring out was pre Kyoto. And it didn’t work. We should now be able to reassess these things. In hindsight base lining emmisions on a historic per country production basis (not per capita nor in terms of consumption) didn’t work.

        A consumption based approach is now being advocated again by many people. Particularly in Europe where emissions have been “off shored”

        To counter the protectionism attack we could agree to count any carbon costs already incurred by imports in the home countries. Could also do the same for exports but it would get messy. And also – is our GST seen as proctectionist? Because it works in the same way particularly if we trade with others without such a tax.

        • Alistair Connor

          Given that Chinese carbon per capita has overtaken Europe, I reckon that per-capita will become a viable option. Getting the Chinese on board will be more important than any free-riding from poorer countries.

          • India and Indonesia are likely to matter as well tbh, but getting China onboard would be useful

        • It doesn’t have much empirical evidence because no-one is doing it right – one of those situations where the theory was so compelling everyone actually avoided the issue!

          Given our GST often doesn’t fall on low level imported goods, and does fall on domestically produced consumption goods, I don’t think countries are too worried – I do buy your point that GST exemptions on exports can be seen as a form of subsidy though.

          I’m all for investigation of what you are after – I find it a credible idea for sure! Was just pointing out that people have pulled back from the same thing in the past, and that it is sort of a coordination issue between countries!

  • Alistair Connor

    Note: Today China announced that they will be capping carbon emissions. This is a first, and a complete game-changer with respect to the next round of post-Kyoto talks in Paris. Any nation which arrives there next year without sound plans for carbon pricing is going to look pretty silly. I don’t buy your argument about NZ’s “non existent” externality anyway — the thing is worth doing in itself, and hey, British Colombia hasn’t died of it.
    ETS has failed — the price has collapsed because the global market has collapsed (due to poor design of the UN scheme and political unwillingness in Europe to reduce quotas) so the Greens are right to ditch that.

    The details of who should be exempted for what are inevitably fraught and messy, so I give them a pass on that, and major props for putting up something workable.

    • Chinese announcement was out today? Knew something was out this week, good to hear it was today. Yar, it has been a good week globally for having big players get involved.

      I explain the externality thing here:

      There is no externality in a domestic sense, but there is a global free rider problem. I support the tax (as I say at the start of both posts) due to the second one. I was surprised how many people got caught up in the externality statement given I felt it wasn’t contentious – hence why I did an explainer.

      • The other Neil

        Apparently the China announcement was a ‘personal’ view.

        • Yar, without an actual defined “level” as well – it is this part that is disappointing

        • Alistair Connor

          You reckon it was unauthorised? People have been executed for less. No, the Chinese wanted to get that message out, because the other carbon event of the week was the EPA rules on US coal power plants. That’s a game-changer too : Obama doesn’t want to go to the Paris climate summit empty-handed again, after the Copenhagen disaster. China and the US will have concrete measures on the table, so any country which is proposing to free-ride is going to look pretty silly. After that… I look forward to a future joint US-Chinese naval task force sending gunboats to Australia and Canada, to enforce a carbon reduction treaty.

          • Yar China does this sort of thing all the time – it was definitely authorized. But an announcement had been on the cards for this week – they’d been pointing to it for a while. And what they announced was a bit disappointing, just like the US announcement.

            However, both could have been worse! We’ll see what happens in a few months at their next dual climate summit!

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  • Matt, a carbon tax by New Zealand is a futile gesture that makes us poorer and less capable and less wealthy in the event of having to adapt to changes in the climate in either direction.

    The international climate change conferences these days are attended by sub-Cabinet officials, bureaucrats, John Kerry and other non-important people.

    There will not be an international agreement that New Zealand will have to get on board.

    In any case if that agreement were to happen, there will be plenty of time to introduce necessary taxes and carbon trading systems when that treaty is signed, not now

    Geoffrey Brennan, in Climate Change: A Rational Choice Politics View, Australian Journal of Agricultural and Resource Economics, July 2009, argues that we will see many countries acting unilaterally to introduce carbon emission policies because expressive voters cheer for such policies.

    Brennan argued that the nature of expressive concerns is such that significant reductions in real incomes are probably not politically sustainable in the long term. This suggested to him that much of the carbon reduction action will be limited to modest reductions of a largely token character.

    There are many expressive voting concerns that politicians must balance to stay in office and the environment is but one of these. Once climate change policies start to actually become costly, expressive voting support for these policies will fall away.

    Abbott’s big bad new tax rhetoric in the last two Australian elections split away the working class and lower-middle class labor voters who worry more about bread and butter issues.

    There were 5 Republican senators who would have voted for cap and trade in April 2010: Lindsey Graham, Susan Collins, Olympia Snowe, Scott Brown, and George LeMieux. There were 57 Democrat Senators. It takes 60 votes to break a filibuster.

    President Obama could have fought harder to get the Bill the House passed through the Senate but he did not.

    • These are good points – and is part of the reason why I think the cost involved with the scheme should be clear to the public.

      It is nice for policy analysts, politicians, and me, to say we should have a carbon tax to “show we are keen”. But we should really make sure it represents the will of the people who are paying first!

      • The Greens’ proposed carbon tax is equal to a 4.56% rise in the company tax in the company tax

        • Although as a type of “factor” tax it is distributed differently. And given there is an interest in distorting the relative price, this sounds more like a feature than a bug 😉