Australia: Carbon choices

Wednesday, July 23

Climate change policy was central to Prime Minister Kevin Rudd's election campaign last year. While his ratification of the Kyoto treaty in December was an important symbolic step, the July 16 release of a government Green Paper on a proposed emissions trading scheme (ETS) represents more concrete progress.

Political climate

The long drought, attributed to climate change, in the Murray-Darling river basin (which supports 70% of Australia’s irrigated agriculture) has increased Australians’ sensitivity to climate-related issues.  Still, passage of legislation is likely to be challenging, since Rudd government has also committed to broad-ranging reform of the tax and welfare system over the next two years. 

Since this is also likely to create winners and losers, households may be insulated from the full effects of the ETS in the early years. Even so, the Treasury estimates that if the permit price per tonne is 20 Australian dollars (19.4 US dollars), the inflationary impact is likely to be a one percent increase in the consumer price index in the scheme's first year

Cap and Trade or not

Debate has centred on the choice between a cap and trade scheme, as proposed by Australian National University (ANU) Professor Ross Garnaut and a hybrid scheme proposed by the ANU's Professor Warwick McKibbin.

The McKibbin scheme is a hybrid between a carbon tax in the short run, and cap and trade in the long run. The government would allocate, for free, tradeable long-term permits consistent with reaching a desired level of emissions in 2050. It would also sell extra annual permits at a predetermined price. Emitters could choose their optimal adjustment path to the desired long run position.

By contrast, under cap and trade the government sets the transition path of emissions, and it is the traded price of the emission permits that adjusts to market conditions. It is generally recognised that a carbon tax, or the hybrid scheme proposed by McKibbin, has efficiency gains relative to a cap and trade. However, Garnaut and the Rudd government appear to prefer the cap and trade so as to align it with the UN framework and to ensure earlier emission cuts.

Strategy

The government wants the ETS scheme in place as soon as possible, to provide a longer-term framework for investment decisions and allow Australia to participate more forcefully in post-Kyoto negotiations.  However, the political challenges presented by simultaneously implementing two major reforms -- the ETS and broad-ranging reform of the tax and welfare system -- are significant. While the public will generally be supportive of the former, political realities are likely to delay the latter until after the next election, due in 2010.