Australia’s Ambiguous Carbon Legislation: A Primer

As Australia undergoes a record-level investment boom in its mining sector, the government’s yet-to-be decided price on carbon to be implemented in July 2012 will introduce a new set of costs and investment risks to Australian households and firms. The following primer examines the proposed carbon tax and examines some of its potential costs.

The Tax
In February 2011, Australian PM Julia Gillard announced that in July 2012, Australia would introduce a fixed-price on carbon and would transition to an emissions trading system sometime between 2015 and 2017.  The government has still not decided on the price it will set for each metric tonne emitted, though it is likely to be between A$20-A$30/mt.  Australia’s chief climate policy advisor, economist Ross Garnaut, recommends a price of A$26 per tonne while the mining industry favors a price of A$10. Australia’s Labour party supports a price of A$20-A$25/mt and the opposition-Liberal party to which PM Gillard belongs, maintains the price will be A$25/mt

The Rationale

Australia’s establishment of a carbon-tax is envisaged as helping the country meet two of its energy and climate policy goals. The first is reducing carbon emissions by 5% by 2020; the second is achieving its expanded-Renewable Energy Target (RET) of using renewable energy sources to meet 20% of Australian electricity supply by 2020. Though Australia produces only 1.5% of global carbon emissions the country derives around 80% of its electricity from coal and is the world’s largest carbon emitter on a per capita basis, according to The Economist.

There is also a political rationale to the carbon tax which helps explains why PM Gillard is pursuing the issue with fervor despite the fact that support for a climate change legislation has fallen to 41% from 69% in 2009 according to a poll released by the Lowy Institute on June 26. In 2010,  PM Gillard came to power in Australia’s closest election in 70 years, when the Labor party lost its majority and formed a minority government with three independents and the Greens. The defeat of former PM Kevin Rudd, who Gillard replaced, was largely driven by opposition to his carbon tax plan, which Gillard opposed.  Today, Gillard’s “Green-dependence” makes it very difficult to water down, postpone, or supplant the carbon tax with another policy.  Tony Abbott, the leader of the opposition, favors a plan of “direct action” where investments are made in projects and technologies that reduce emissions.

Costs and Risks of the Tax

It is not within the scope of this primer to address the environmental costs and benefits of Australia’s carbon tax. The focus is instead on the economic costs and potential risks that such a tax would pose to Australia’s households, firms, and the greater economy.

Higher cost of living: A price on carbon will raise electricity rates and could reduce jobs in the mining sector, which Commonwealth Bank estimates may account for more than 7% of nominal GDP in FY 2011. A contraction in the mining sector, which has been one of the largest sources of job growth in Australia, could lead to a reduction in employment, lower real wages, and an increase in Australians’ real cost of living.  To offset some of the costs associated with the tax  PM Gillard announced on June 27 that the Australian government would assist 90% of Australian households through tax cuts, extra payments to couples with children, and increased pensions.

Contraction of the mining sector: Australia’s economy is largely been driven by the resource boom: investments in the mining sector are estimated to rise by around 63% in FY2011(ending June 30, 2012) to A$83.3. A carbon tax that reduces activity in the sector could have an especially detrimental affect on Australia’s “two-speed” economy and reduce its terms-of-trade, which are at record levels.

Uncertainty over tax revenues: Though the carbon tax will almost certainly raise tax revenue in the short-term, it remains unclear the extent to which consumption will soften along with other sectors of the Australian economy which could result in a reduction in government revenue. The government is seeking to return to a budget surplus in FY2012 and narrow the FY2011 underlying cash deficit to 1.5% of GDP from the estimated 3.5% in FY2010. On this basis, a reduction in tax revenue in the medium-term, given declines in consumption and industry profitability, poses a risk to the government’s goal of retuning to a surplus.

Investment risk: The ambiguity surrounding Australia’s carbon price regime exposes industries working in carbon-intensive industries to greater uncertainty and makes long-term capital expenditure decisions more difficult. According to Deutsche Bank’s Head of Carbon Emissions Research, Mark Lewis, “those industries that will be most affected are those with very long-term capital investment structures. For them, the key point isn’t so much what the carbon price is today, it’s clarity around what it will be further down the line to give people the visibility to invest.”  Similarly Economist Warwick McKibbin, who is a  board member of the Reserve Bank of Australia argues that “the key to increasing investment in energy generation in this country [Australia], and it’s not about the carbon price today, it’s about the carbon price we expect to see in 10 years, 50 years, 70 years.”