Today, as part of the UNSW Grand Challenge on Inequality, we release a study entitled A Climate Dividend for Australians that offers a practical solution to the twin problems of climate change and energy affordability.
It’s a serious, market-based approach to address climate change through a carbon tax, but it would also leave around three-quarters of Australians financially better off.
It is based on a carbon dividend plan formulated by the Washington-based Climate Leadership Council, which includes luminaries such as Larry Summers, George Schultz and James Baker. It is similar to a plan proposed by the US (and Australian) Citizens’ Climate Lobby.
How it would work
Carbon emissions would be taxed at A$50 per ton, with the proceeds returned to ordinary Australians as carbon dividends.
The dividends would be significant — a tax-free payment of about A$1,300 per adult.
The average household would be A$585 a year better off after taking account of price increases that would flow through from producers.
This means Australian companies subjected to the tax wouldn’t be disadvantaged by imports from countries without it, and nor would importers from countries with such a tax.
The plan would permit the rollback of other restrictions on carbon emissions and expensive subsidies.
Our estimates suggest the rollbacks have the potential to save the Commonwealth A$2.5 billion per year.
It’s working overseas
Our plan is novel in the Australian context, but similar to one in the Canadian province of British Columbia which has a carbon tax that escalates until it reaches C$50 per ton, with proceeds returned to citizens via a dividends.
Alaska also pays long-term dividends from common-property resources. The proceeds from its oil reserves have been distributed to citizens since 1982, totalling up to US$2,000 per person.
It could be phased in
We would be open to a gradual approach. One option we canvass in the report is beginning with a A$20 per metric ton tax and increasing it by A$5 a year until it reaches A$50 after six years.
The dividends would grow with the tax rate, but the bulk of households would immediately be better off in net terms and much better off over time.
And it would be simple
Our plan doesn’t create loopholes or incentives to get handouts from the government, as have previous plans that directed proceeds to polluters.
It will not satisfy climate-change deniers, but then no plan for action on climate change would do that — other than perhaps the governmment’s direct action policy, which provides a costly taxpayer-funded boondoggle to selected winners.
But for those who understand that climate change is real, our plan balances the important benefits we gain from economic development and associated carbon emissions against the social cost of those emissions.
It does it in a way that provides compensation to all Australians, but on an equal basis, making the lowest-income Australians substantially better off.
It is the sort of policy that politicians who believe in both the realities of climate change as well as the power and benefits of markets ought to support.
In some political circles, hostility to climate policy has become a way of showing off one’s conservative credentials. But a suggestion for pricing carbon, grounded in classic conservative principles, has now emerged in the United States.
It has come not from the populist Trump administration, but from an eminent group of Republicans with impeccable conservative credentials, several of whom served as cabinet secretaries in previous Republican administrations.
Last week they published a manifesto entitled The Conservative Case for Carbon Dividends. In a nutshell, the proposal is for a carbon tax – yes, a tax – with the proceeds to be returned to all citizens as a “carbon dividend”, every quarter. More details in a moment.
The group accepts that climate change is real and that, regardless of whether it is human-induced, a human response is urgently needed. Moreover, they say:
Now that the Republican Party controls the White House and Congress, it has the opportunity and responsibility to promote a climate plan that showcases the full power of enduring conservative convictions.
Tax and dividend
The plan envisages a tax on fossil fuels at the point at which they leave the refinery or coal mine and enter the economy. It would start at US$40 a tonne and increase over time. This would force up the price of many commodities – most obviously petrol – and might be expected to anger consumers, were it not for the dividend strategy.
The dividend would be paid to all Americans, via the social security system. A family of four might expect a dividend of US$2,000 in the first year, rising over time in line with the tax.
The manifesto’s authors include eminent establishment Republicans, including James Baker, Secretary of the Treasury under Ronald Reagan and Secretary of State for George H. W. Bush; and George Shultz, Secretary of State in the Reagan administration and a former member of Richard Nixon’s cabinet. They are certainly sensitive to the political unpopularity of new taxes.
Their response is that this is not a tax that will accrue to the government, because it will be “revenue-neutral”: all of the money will go back to citizens. The carbon-pricing scheme introduced in Australia under former prime minister Julia Gillard was also revenue-neutral but returned money to consumers partly through income tax relief, which is less visible than a direct dividend.
The high visibility of a carbon dividend to the consumer arguably makes this a more politically palatable policy. For this reason the manifesto’s authors call their proposal a carbon dividend rather than a carbon tax. They calculate that the dividend would leave 70% of the population financially better off, particularly among working-class taxpayers. As they put it:
…carbon dividends would increase the disposable income of the majority of Americans while disproportionately helping those struggling to make ends meet.
The group argues that this proposal is consistent with conservative principles in various ways.
First, it is a market-based solution to the problem of climate change which maximises freedom to consumers and producers. Second, it will facilitate the rollback of Obama-era regulations such as the Clean Power Plan, which conservatives regard as the epitome of heavy-handed regulation. As the Congress has discovered with relation to Obamacare, it cannot simply repeal unwanted Obama legislation without replacing it with something widely seen as better.
Finally, they argue that the repeal of heavily bureaucratic regulations would eliminate the need for a bureaucracy to enforce them. This would facilitate smaller government, one of the abiding aspirations of conservatives.
Apart from these matters of principle, the group points to several other political advantages – not least the chance to bring the Republican Party back into the mainstream on climate change:
For too long, many Republicans have looked the other way, forfeiting the policy initiative to those who favor growth-inhibiting command-and-control regulations, and fostering a needless climate divide between the GOP and the scientific, business, military, religious, civic and international mainstream.
The manifesto’s authors point out that climate change concern is greatest among under-35s, as well as Asians and Hispanics – the nation’s fastest-growing ethnic groups. A carbon dividend policy would enhance the appeal of the Republican Party to all of these groups.
They acknowledge that it may be an uphill battle to win over the anti-establishment Trump White House. But, they say:
…this is an opportunity to demonstrate the power of the conservative canon by offering a more effective, equitable and popular climate policy based on free markets, smaller government and dividends for all Americans.
Conservatives like Bernardi continue to equate carbon pricing with socialism. Yet for these establishment US Republicans, taxing carbon is entirely consistent with their conservative principles. Bernardi and his like-minded colleagues in Australia would do well to consider the possibility that there is indeed a conservative case for a carbon tax.
Other ministers joined in. Treasurer Scott Morrison labelled the plan a “a big thumping electricity tax” and Environment Minister Greg Hunt branded it “Julia Gillard’s carbon tax on steroids”, warning of “even higher electricity prices for Australian families”.
The centrepiece of the Coalition’s climate policy, meanwhile, is the A$2.5 billion Emissions Reduction Fund. An important element of this scheme is the “safeguard mechanism”, which is due to kick in on July 1 this year. This has implications for the electricity sector and may also affect electricity prices.
These policies will affect the wholesale electricity market, in which electricity is bought from power generators and sold on to retailers and consumers.
As you can see from the figure to the right, the competitive component of the retail prices makes up about 50% of the typical household electricity bill, and the wholesale component typically makes up half of that. The other major cost is poles and wires.
So how exactly will the different climate policies affect electricity prices?
The safeguard mechanism (Coalition)
The safeguard mechanism will require Australia’s largest emitters to keep emissions below a baseline. This will prevent emissions reductions under the ERF being offset by increases elsewhere. Businesses that go over the baseline will have to pay.
The safeguard is based on the high point in annual emissions from the whole electricity sector between 2009-10 and 2013-14. Generators’ individual baselines and associated penalties only come into play if the whole sector goes over the baseline.
As you can see in the figure below, emissions have fallen by almost 20 million tonnes per year since the first baseline year (2009-10), partially in response to years of declining demand.
Current projections for electricity growth suggest that the baseline won’t be breached for some years. As such, individual generators are unlikely to be penalised, and wholesale prices would not be expected to change dramatically.
This also places a baseline on the electricity sector, but it is calculated on the basis of emissions intensity (tonnes of emissions per unit of electricity generated) rather than overall emissions. Generators with emissions intensity below the baseline (for example, gas generators) would earn credit, so “cleaner” power plants would generate more credits.
Power plants that go over the baseline (for example, brown coal) would have to buy credits for the amount they go over. “Dirtier” plants would thus have to buy more credits.
This is substantially different to a carbon tax or the previous emissions trading scheme. Under these policies, all generators are penalised, some more than others, as you can see in the figure below.
This difference is important for electricity prices. Dirtier plants would be expected to increase their selling price to cover the financial penalty on their emissions. But cleaner plants, earning revenue from selling credits, could afford to sell their electricity more cheaply.
This is important, because cleaner plants (typically black coal or gas) set the price. Gas in particular would probably be significantly cheaper under this proposal. As such, the impact on wholesale prices would be small, or negative.
In fact, as the AEMC itself noted, the impact on the wholesale market could be an increase or decrease in prices (depending on where the baseline is set).
The brown coal exit (Labor)
Another component of Labor’s climate platform is a plan to finance the closure of brown coal power stations, an idea first proposed by ANU climate economists Frank Jotzo and Salim Mazouz.
In this proposal, brown coal plants would bid for the payment they would require to finance their own shutdown, with the cheapest bid being selected. The remaining plants would pay this cost, in line with their emissions.
Similar to the ETS, it would be expected that this cost would be reflected in increased offer prices to the market from the remaining generators. The direct costs would be temporary (a one-off payment) and small, relative to the overall wholesale price.
Indeed, Jotzo and Mazouz estimated it could cause a one-off rise of 1-2% in retail power bills. Analysis company Reputex found the impact could be between 0.2% and 1.3%.
However, Danny Price of Frontier Economics has suggested that the scheme could push up retail power prices by between 8% and 25%, as the result of a short-term price shock. But given the significant excess capacity in the market, and assuming that the market is indeed competitive, it is hard to see how such a increase would happen.
This point aside, the price argument misses the point of the scheme, which aims to deliver an “orderly transition” away from brown coal. The longer-term effects on supply and price of a brown coal exit will be similar, regardless of how the industry closes.
In fact, if it were left entirely to the market, the sudden retirement of an entire power plant might create even more of shock. This proposal is chiefly about ensuring an orderly, predictable transition.
50% renewable energy target (Labor)
The final element of Labor’s climate platform is a 50% renewable energy target by 2030. At this stage, not much detail has been unveiled other than shadow environment minister Mark Butler’s pledge that it will be “designed in a way that does not disturb investor sentiment around the delivery of the existing Renewable Energy Target” – something that a sector beset by uncertainty would welcome. As such, it is quite difficult to speculate on how electricity prices might react.
The current Renewable Energy Target is a certificate scheme that requires retailers to buy a certain amount of renewable energy. The cost of these certificates is passed on through electricity bills. However, as shown by the government’s own modelling, the interaction with the wholesale market results in a net saving to consumers.
Interestingly, and as the AEMC points out, the electricity ETS is designed to be flexible and integrate with a renewable energy target. Indeed, such an ETS could drive investment in renewable energy, replacing current subsidies through the Renewable Energy Target. The 50% target could theoretically be achieved through the ETS alone, if the baseline was set at the right level.
A bipartisan approach?
As it stands, the government’s climate platform is unlikely to have any impact on electricity prices. However, it will also not have a major impact on the electricity sector’s emissions.
Labor’s policies will have an impact, but as the AEMC notes it may occur “without a significant effect on absolute price levels faced by consumers”.
The government’s current polices will require strengthening to further reduce emissions. To achieve this, the Grattan Institute and others including the Business Council of Australia have supported ideas that would turn the Liberal platform into something very similar to Labor’s.
Indeed, modelling commissioned by the government itself assumes that Direct Action will eventually morph into a similar baseline-and-credit ETS, in order to meet long-term climate commitments.
Political slogans aside, perhaps a bipartisan approach is possible, without a significant effect on power bills.