The carbon tax wasn't a 'slug' to the economy and Direct Action may be a waste of money

Federal Environment Minister Greg Hunt, writing in the Fairfax opinion pages, has said that the now abolished carbon tax was a far more expensive way to reduce Australia’s carbon emissions than the Direct Action policy that replaced it.

He writes:

The carbon tax was a A$15.4 billion slug on the Australian economy – that works out at a cost of just over $1,300 a tonne for the emissions reduced.

It appears the Minister has taken the A$15.4 billion in revenue collected by the carbon tax and divided it by the “less than 12 million tonnes” of emissions reduction, to get just over $1,300 a tonne for the emissions reduced.

But tax revenues collected on emissions have no business being included in a calculation of the costs of reducing emissions. Measuring the cost of a tax on overall economic activity is not the same as measuring how much revenue was collected — not least because the revenue raised could be used elsewhere in the economy to provide infrastructure or mitigate against climate change.

Costs of emitting versus reducing carbon dioxide

Let’s consider what we’re measuring and why.

The social cost of carbon measures the expected cost to society of emitting “one more unit” of carbon into the atmosphere. Flipped around, it tells us the benefit of not emitting that tonne of carbon.

Estimates of the social cost of carbon depend both on our knowledge of the future impacts of warming, and the assumptions built into models to quantify these impacts on society. Unsurprisingly, they are controversial and subject to debate.

Hunt’s assertions relate to the cost of reducing carbon emissions per tonne; in principle we can compare this to the social cost of carbon, which tells us the benefit of emissions reductions.

His claim is that the cost of reducing emissions has been vastly decreased by using a subsidy approach (as in Direct Action) rather than a tax.

However, the first thing to understand is that the amount of tax collected under the carbon pricing scheme reflects taxes paid on actual emissions, not reductions in emissions.

There is also a difference between costs to the economy, and transfers within it. The amount of revenue raised through any tax is not a cost; it is simply a transfer from one “pocket” to “another”. The money has not been destroyed, and it remains available to be spent on something. It has distributional consequences, obviously, as the “pocket” where that money sits has changed, but total spending power within the economy remains undiminished. (Moreover, Australians received compensation via the tax system after the carbon tax was introduced.)

By contrast, the cost of a tax is what the economy – not an individual person or business enterprise – has lost as a result of the existence of the tax. Lower labour supply, fewer goods and services produced – these are the things we would typically count when assessing the burden imposed on an economy from any tax instrument. Hunt hasn’t provided credible estimates of these kinds of impacts.

Is there any simple way to quantify the costs of emissions reductions? In terms of the cost to individual businesses, the carbon tax was initially priced at A$23 a tonne. That means that for every tonne of greenhouse gases a liable business did not emit, they would save A$23. We would expect businesses to reduce any emissions they could where the cost to them was less than A$23 per tonne.

In other words, the amount of emissions reduction comes at a cost to that business of A$23 a tonne or less – not $1,300 a tonne.

Is Direct Action superior anyway?

If we assess the unit cost of emissions reduction under the previous carbon price as being (in the order of) A$23 per tonne, compared to $13.95 per tonne under the Direct Action policy, does this make the current scheme a winner anyway?

Not necessarily. First, ongoing revenue from the carbon tax can be used to fund, for example, public infrastructure investments, or to allow cuts to other more economically harmful taxes.

The cost of payments under Direct Action, by contrast, have to be funded by taxes elsewhere, or borrowed funds.

Second, the Direct Action scheme only involves commitments to reduce emissions, which have yet to occur, and may not be successfully achieved.

Third, emissions reductions contracted under the scheme may be offset by emissions increases elsewhere. Experts are concerned that the safeguard mechanism designed to prevent this has been weakened so much as to render it ineffective. This means there’s no guarantee that emissions reductions purchased under the scheme will translate to national emissions reductions, even though that’s what they are meant to represent.

The implication of all this is that Direct Action’s cost-effectiveness is unknown, and as things stand, possibly unknowable.

Michael Harris previously consulted for the NSW Department of Environment and Climate change on a project on soil carbon sequestration.