Tuesday, April 08, 2008

Tuesday Column: The real battle over Australians emissions trading scheme.

What if, while the attention of economists was focused on the Budget and the upcoming 2020 Summit, the really important economic decisions were being made elsewhere?

They are being made as we speak inside the new Department of Climate Change. Within weeks it will reveal the detail of the new emissions trading scheme that will be in force for decades.

From the outside it looks as if the battle has been won. All that's in play are the details. The independent inquiry being conducted by Professor Ross Garnaut supports such a scheme, the inquiry set up by the previous Howard government endorsed such a scheme, and the Rudd government won an election promising such a scheme.

But the details are the most important thing of all.

Think back to the introduction of the Goods and Services Tax. Would it have mattered much whether the low-income households who stood to suffer the most were compensated?...

Think back to the decision to effectively eliminate tariffs on the import of manufactured goods. Would it have mattered much whether motor vehicles were in or out?

Think back to the decision to introduce student loans. Would it have mattered much whether the loans had to be paid back at commercial rates or concessionally through the Tax Office?

Now think forward to mid last year and the emphatic endorsements from big polluters of John Howard's proposed emissions trading scheme. Why were so keen on it?

Chapter seven of the report of the Prime Minister's Emissions Trading Task force spelled it out.

The firms likely to suffer a “disproportionate loss of value” due to the introduction of pollution permits (in other words, the big polluters) would be given permits for free.

Their competitors – the smaller polluters and new energy producers attempting to start up – would have to pay.

As a way of buying the support of big polluters for the scheme, it was the best there was.

As a way of responsibly handing out public funds, it was a scandal.

As the doyen of Australian economic modelers Professor Peter Dixon of Monash University explained to me at the time: “It’s the same as putting a tax on carbon pollution and then instead of doing something useful with the proceeds, like cutting another tax, giving it to the shareholders of the polluting companies”.

Coincidentally the task force that recommended the scheme to Howard had on it representatives of those companies. Peter Coates was the chief executive of Xstrata Coal, Tony Concannon was the head of International Power, Chris Lynch helped run BHP Billiton, John Marlay
was chief executive of Alumina Limited.

The task force mounted an impressive defence of the handouts, quoting a US study as finding that “giving away allowances won’t shield firms or consumers from the price signal”.

As it happens, Professor Ross Garnaut agrees about that specific point. But he couldn't disagree more about the implication that it justifies corporate welfare.

A legend among Canberra economists, Garnaut is as dry as they come. While economic advisor Bob Hawke as Prime Minister in the 1980s he persuaded him to smash the system of import protection enjoyed by manufacturers since white settlement and to wind it down to near zero.

In an inspired move last year when he was still in opposition Kevin Rudd asked Ross Garnaut to conduct his own investigation of climate change.

Garnaut's approach was the antithesis of the Howard's task group's.

Whereas the Howard committee attempted to design a scheme that would pleased everyone – a camel - Garnaut, acting alone, was able to design a sleek machine without a hump.

“The complications in most schemes are about free allocation of permits,” he told me after his trading scheme report was released last month. “You need very elaborate processes to give things away.”

And he says there is no point in giving things away (except for trade-exposed firms such as aluminum producers, which would get support for the limited time that they ran the risk of being undercut by producers overseas).

He agrees that giving away permits to electricity generators and the like wouldn't shield anyone from price signals. He says they will bank the value of the permits and put up their prices anyway.

It is what happened in Europe.

As his report says, “most of the costs of the permits used in the domestic economy, including for electricity generation and automotive fuel, will be passed through to households. This will be the case whether permits are auctioned, or allocated for free”.

As he sees it, there is no point in handing permits worth billions to the worst of the existing polluters. There are better uses for the money.

His problem is that the former secretariat for John Howard's task group now forms the nucleus of Kevin Rudd's new Department of Climate Change. It is likely to be sympathetic to the camel of a scheme it came up with to appease existing polluters.

The government's decision is due in July.

Garnaut is worried that if the Howard scheme gets the go-ahead and the existing polluters are enriched, there won't be enough money left from the sale of the permits to compensate the people who will really need it.

Howard's task force as good as confirmed this.

It recommended that households “not be shielded”.

Garnaut sees things differently. He argues that as an environmental reform, the emissions trading scheme should not unintentionally “have large and arbitrary effects on the distribution of income”.

He says low income households in particular will have strong claims for compensation from the price increases imposed by the scheme. His report says firms seeking compensation should “have to establish the priority of their claims against those of households.”

Within weeks we will know whether either Garnaut or the existing polluters has won. The effects will be with us for decades to come.

The Garnaut Climate Change Review:

Emissions Trading Scheme Discussion Paper, March 20, 2008.

Interim Report, February 21, 2008

Prime Ministerial Task Group on Emissions Trading:

Final Report, June 1, 2007