Carbonomics is nice in theory but does it add up?
With the debate on the carbon tax getting very emotive it’s essential to understand the economics of the tax and whether it will achieve what it’s setting out to do.
Here the issue is very simple. Will the introduction of a carbon tax lead to a significant reduction in carbon dioxide and other greenhouse gas emissions?
Given that the stated objective of a carbon tax is to reduce greenhouse gas emissions, it’s clear that the success or failure of the tax will depend on the whether or not a reduction is achieved and at what cost. Understanding the cost of the carbon tax is fundamental to understanding its impact on the consumer, particularly given that it’s the consumer who will ultimately pay the tax.
Since the tax is imposed on certain types of greenhouse gas emissions arising during the production of goods or services, it’s clear that the tax adds to that cost of production and this will be passed onto consumers. As the cost of producing the goods or services goes up, the tax-affected companies will push up the price of the goods or services to consumers.
As the carbon tax increases so does the price of affected goods or services. In fact, the proponents of the carbon tax freely acknowledge that the tax will push up prices to consumers and the Federal Government has even indicated that the tax will lead to increases in the Consumer Price Index which measures inflation in Australia.
What’s the purpose of the carbon tax raising consumer prices? The theory is that the higher prices are intended to lead to a reduction in the demand for those goods or services that generate or give rise to greenhouse gas emissions.
The theory continues that as the carbon tax raises the cost of producing goods or services any company affected by the tax would be looking for ways to reduce its greenhouse gas emissions and its future carbon tax liability.
Now there are several problems with the practical application of the theory. First, a change in consumer demand for goods or services depends on not only the price of the particular goods or services, but also the availability of alternatives for those goods or services. Changing consumer demand or behaviour is easier said than done.
Seeking to change consumer demand through price rises is quite unpredictable as consumers may not be price sensitive regarding certain goods or services. For example, consumers will generally choose to pay higher prices and not reduce their demand for goods or services when it comes to basic necessities, or where there are no or few real alternatives to the particular goods or services.
Quite simply people will still need to buy food, heat their homes or use airlines when travelling around Australia. These are covered by the carbon tax and consumers will simply pay more for these rather than buying less.
In practice, therefore, the price of food, heating and domestic air travel will keep rising to reflect the ongoing rises in the carbon tax and consumers will be forced to pay those higher prices given the lack of real alternatives for those goods or services.
For other goods or services, any reduction in consumer demand and in greenhouse gas emissions will be linked to how price sensitive consumers are to price rises attributable to the carbon tax. The theory is that the higher the price increases attributable to the carbon tax the greater the potential reduction in demand and, ultimately, emissions.
That means that substantial price rises are needed to secure substantial reduction in emissions. The problem for supporters of the carbon tax is that the Federal Government has emphasized that the tax will initially only impose small price rises and this means that any reduction in consumer demand and emissions will also be small and take longer to achieve.
Significantly, if consumers don’t reduce their demand for particular goods or services, then reducing emissions of greenhouse gases in relation of those goods or services will become increasingly harder.
Any meaningful reduction in emissions would then depend on those companies that produce the emissions actually changing their production methods to reduce emissions. The problem here is that if the affected companies are in highly concentrated markets the companies can simply pass the higher costs of the carbon tax onto end users, or more precisely consumers.
Given that consumers may not reduce their demand for the particular goods or services following the imposition of a carbon tax and given that some markets are highly concentrated allowing affected companies to simply pass the tax onto consumers through higher prices, there is a real danger that the carbon tax may not lead to any meaningful reductions in greenhouse gas emissions in key industries.
The problem with ongoing price rises as a result of the carbon tax could even get worse in highly concentrated markets as affected companies may seek to raise consumer prices well beyond any carbon tax-related increases.
A lack of transparency and real competition in highly concentrated markets creates an obvious environment for the few dominant market players to price gouge consumers.
This means that affected companies could actually hide behind a carbon tax to raise consumer prices by an amount beyond that attributable to the tax. Here the carbon tax could be used to justify existing or future rip offs by dominant companies intent on pushing up retail prices to the detriment of consumers.
All in all, unless the carbon tax changes the behaviour of affected companies and consumers in a manner that reduces greenhouse gas emissions in a meaningful way, the imposition of a carbon tax will become just another form of revenue-raising by the Federal Government.
With the carbon tax raising very large sums of money attention needs to quickly turn to how that money is going to be spent. The Federal Government has said that half of the money raised by the tax will go back to households. So for every dollar that households spend on the carbon tax, 50% will be returned to households in varying degrees.
This will mean that households will be out of pocket by at least 50% of the tax paid. This also means that having received compensation households will be less likely to change their demand for goods and services and that will mean fewer reductions in greenhouse gas emissions. This will disappoint those seeking significant reductions in emissions.
Programs assisting industries to develop new technologies to try and reduce emissions will be welcomed, but the development of new technologies will take time and put increasing demands on the revenue raised by the tax.
Then we will have the creation of new government agencies which will take a growing share of the revenue raised by the tax. The growth in government agencies certainly does not reduce greenhouse gas emissions and is likely to increase them as the agencies need to be accommodated and their employees will no doubt need to travel around the country as part of their responsibilities.
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