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Key departmental publications, e.g. annual reports, budget papers and program guidelines are available in our online archive.

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Taxation and the Environment

Environmental Economics Seminar Series
Department of the Environment, Sport and Territories
March 1996
ISBN 0 642 24878 8

Carbon taxation: an evaluation of options and outcomes

Andrew Chisholm
Tasman Institute

Introduction

This paper briefly outlines some of the carbon taxation options which have been suggested for Australia. Potential costs are compared on a standardised basis using some relatively 'back of the envelope' calculations. The options are then evaluated from the point of view of economic efficiency and cost effectiveness. The conclusion is that the options being proposed are neither economically efficient nor cost effective. Given the current state of greenhouse knowledge, carbon tax policies cannot be shown to balance costs with benefits. The options proposed focus only on a narrow number of emissions sources and do not encompass sinks at all. In addition, they provide no mechanism for encouraging international cooperation in meeting emissions abatement targets.

TABLE 1 - Tax Rates for Alternative Carbon Tax Proposals (1993-94 $A)

Carbon Tax Rates

$/Tonne CO2

$/Tonne Carbon

Small Taxes and Charges with No Revenue Recycling DEST Proposed Levy

$1.25

$4.59

ACF Budget Proposal

$5.45

$20.00

Large Taxes to Stabilise Emissions at 1990 levels with Revenue Recycling Applying the Average Required Reduction in All Sectors to the Energy Sector

$7.71

$28.29

Stabilising Energy Sector C02 Emissions

$30.35

$111.39

Stabilising Energy Sector Emissions without 'No Regrets' Measures

$47.33

$173.72

Note: Where necessary, tax rates are imputed from WEDGE modelling results

 

Carbon Tax Rates

Carbon taxation options

Broadly speaking, the various carbon tax options that have been evaluated or suggested in Australia can be divided into:

Within these two broad groups, Table 1 identifies some of the specific carbon tax proposals that have been suggested or modelled for Australia.

The first two options, from the Department of Environment, Sport and Territories (DEST) and from the Australian Conservation Foundation (ACF), are carbon tax levies without revenue recycling. The now defunct DEST proposal was for a $1.25 levy per tonne of carbon dioxide on fixed sources of carbon. This converts into a tax per tonne of carbon of about $4.00. The ACF's alternative budget proposal was for a tax of $20 per tonne of carbon, which translates back into $5.45 per tonne of carbon dioxide.

A potential area of confusion in the carbon tax debate has been the different ways the carbon tax rate can be expressed. The ACF and the Department of Conservation have quoted their rates in different units of measurements making comparisons potentially misleading. You have to compare like with like.

When units are standardised in either tonnes of carbon or carbon dioxide, the ACF proposed tax is about four times larger than the Department of Environment's. In other respects they are similar. It appears that revenue was not to be used for reducing taxes but financing other government expenditures, in particular environmental related expenditures. In addition, the tax base was predominantly to be on fixed emissions sources.

Other options recently assessed in the public debate aimed at stabilising Australia's carbon dioxide emissions from human sources at 1990 levels by the year 2000 with a much more severe carbon tax. To limit the negative impacts of the taxes, revenue was generally handed out as a cut in other taxes.

In the revenue recycling stabilisation options examined here, revenue recycling is achieved with a cut in income taxes.1 Three alternative options are examined. The first two assume that no regrets policies achieve a seven percent reduction in annual emissions in the year 2000, as estimated in Australia's National Report to the United Nations Framework Convention on Climate Change. The last option assumes that these no regrets measures are ineffective. The options are:

Most of the modeling work done by the Tasman Institute and others on using carbon taxes to reduce carbon dioxide emissions in Australia has focused on the last option: energy sector stabilisation without no regrets measures. The estimated carbon taxes for this more severe option is around $47 per tonne of carbon dioxide, which translates into $170 per tonne of carbon.

Obviously there are other carbon tax options which could be considered. However, the ones outlined here cover the broad spectrum of scenarios recently debated in the public forum.

Note 1- Some analysts have examined the effects of using alternative taxes to recycle carbon tax revenue. Commons and Hamilton (1994) found that in the short run a payroll tax recycling option would have markedly different effects to an income tax recycling option. However, Zeitsch and Chisholm (1994) found that when more robust medium run assumptions are used for modeling carbon tax effects, using different tax instruments to recycle carbon tax revenue does not produce markedly different economic effects.

Emissions reductions achieved

The emissions reductions and economic outcomes reported here are all imputed and interpolated where necessary from a range of WEDGE modeling runs. WEDGE is a multi-country, multi -industry economic model which has been extensively used for examining the costs of carbon taxes (see Industry Commission, 1992, Dec., 1992, and Chisholm et al 1994) Using one model as the basis for these 'back of the envelope' calculations, enables comparisons to be done on a relatively consistent basis.

Table 2 shows the estimated reduction in carbon dioxide emissions for the alternative carbon tax options. The first point of interest to note is that even the small carbon levies do effect some degree of emissions reductions. The government's proposed $1.25 levy achieves, in the modeling framework we are using, a reduction in energy sector emissions of 3.5 per cent. So it may not have been a totally ineffective tax in environmental terms.

The ACF budget proposal for a carbon tax of $5.45 per tonne of carbon dioxide would have achieved a reduction of 13.2 per cent in energy sector emissions. The various stabilisation, revenue recycling options have estimated emissions reductions ranging from 3.3 per cent to 20.2 per cent.

TABLE 2 -Reductions in Energy Sector Carbon Dioxide Emissions for Alternative Carbon Tax Options

% Reduction
in CO
2

Small Taxes and Charges DEST Proposed Levy

3.5%

ACF Budget Proposal

13.2%

Large Taxes to stabilise
Emissions at 1990 levels
Applying the Average Required
Reduction in All Sectors to the
Energy Sector

8.3%

Stabilising Energy Sector CO2
Emissions

16.2%

Stabilising Energy Sector
Emissions without 'No Regrets'
Measures

20.2%

Note: Reductions are based either on National Greenhouse Gas Inventory estimates or WEDGE modeling results.

Economic impacts

Impacts with revenue recycling

Table 3 shows the economic effects of the alternative options with revenue recycling. For the moment, we have assumed that DEST's proposed levy and the ACF budget proposal would also revenue-recycle - the additional costs to the economy if that does not happen are examined shortly. Economic impacts are imputed from a range of WEDGE models assuming that other OECD countries stabilise their own emissions.

With revenue recycling, the proposed levy appears to cost only $91 million annually (0.02 per cent of NDP). The ACF budget proposal costs $396 million annually representing a reduction from business as usual NDP of 0.09 per cent in each year.

At first glance, the stabilisation options appear to be the carbon tax scare scenarios. These generate the largest economic losses ranging up to $3.5 billion annually or 1 per cent of GDP. The percentage losses in GDP are an annual loss in GDP from business as usual GDP. They do not necessarily mean that GDP goes down - rather GDP is lower than the business as usual GDP would have been.

TABLE 3 - Losses in Net Domestic Product from Alternative Carbon Tax Options with Revenue Recycling (1993-94 $A)

Loss in Net Domestic Product

%

$m

Small Taxes and Charges DEST Proposed Levy

0.02%

$91

ACF Budget Proposal

0.09%

$396

Large Taxes to Stabilise Emissions at 1990 levels Applying the Average Required
Reduction in All Sectors to the
Energy Sector

0.13%

$561

Stabilising Energy Sector CO2,
Emissions

0.52%

$2,224

Stabilising Energy Sector Emissions without 'No Regrets' Measures

0.82%

$3,486

Note: Estimated losses are based on WEDGE modeling results assuming other OECD countries stabilise energy sector CO2 emissions.

Additional costs of not recycling taxation revenue

The important thing which has not come out clearly in the policy debate on DEST's carbon levy and the ACF's proposed carbon tax, is that, despite low tax rates, these proposals could cost taxpayers in general as much as some high tax stabilisation scenarios. Because of fundamental differences in the way the tax revenue was going to be used, the low tax proposals could still have been high cost proposals. Neither proposal involved using carbon tax revenue to reduce other taxes. Instead, at least some of the revenue was to be 'hypothecated' to particular items of expenditure on the environment.

Table 4 shows the total additional tax take that would have been withdrawn from the Australian economy with the DEST and ACF proposals. The use of this revenue would have had a fundamental effect on the costs of the two proposals. Spending the additional revenue on items of government expenditure, means there would have been no double dividend from reducing other distorting taxes in the economy. In addition, allocating the revenue to environmental expenditures raises important questions on how to value such activities. Finally, the absence of any compensating tax reductions raises important equity concerns particularly in energy based industries such as electricity and aluminium. A $1.25 carbon tax will have a large impact on the cash flows of these industries with nothing being handed back in the way of tax cuts.

It is difficult to fully quantify all the potential additional costs of using a carbon tax or levy to increase the total tax take rather than just replace other taxes. However, the consequences would be very different to the revenue recycling options which have been the major focus of the Australian empirical literature on carbon taxation. It is clearly wrong to call the DEST and ACF tax options low cost simply because they have low tax rates.

Evaluation of carbon taxes

Economic instruments can be an efficient way of achieving environmental objectives. If a number of conditions are fulfilled, carbon taxation could be an efficient and cost- effective means of limiting damage from greenhouse gas emissions. However, in all the carbon tax options considered for Australia, the following conditions have not been met:

TABLE 4 - Additional Tax Losses When Revenue Is Not Recycled

Tax Losses ($m)

Fixed Sites Taxed

All
CO2 Emissions
Taxed

Small Taxes and Charges DEST Proposed Levy

$303

$410

ACF Budget Proposal

$1,322

$1,786

Large Taxes to Stabilise
Emissions at 1990 levels
Applying the Average Required Reduction in All Sectors to the
Energy Sector
Stabilising Energy Sector CO2 Emissions
Stabilising Energy Sector
Emissions without 'No Regrets' Measures
Note: Tax revenue is based on National Greenhouse Gas Inventory estimates of emissions

It may be impossible to meet these conditions, but unless they are met it is wrong to claim that carbon taxation is either economically efficient or cost effective. A mixed bag of other policy tools could, in fact, achieve emissions abatement more effectively.

Equating tax levels to greenhouse damages

An efficient and cost effective policy instrument would be set at a level which equated the marginal costs of emissions abatement with the marginal benefits. If there is uncertainty about these costs and benefits, a carbon tax policy instrument should reflect some judgment on the probability of damages being high or low and there should be in -built flexibility for tax rates to adjust as additional knowledge becomes available. Otherwise, the carbon tax simply becomes an entrenched and potentially inefficient means of raising government revenue.

If the costs of carbon taxation are known to be high, but the benefits of emissions abatement are uncertain then this suggests that the initial policy thrust should be on obtaining better information, rather than implementing premature taxation policies whose effectiveness cannot be rationally evaluated.

Comprehensiveness

The aim of the carbon tax is not to reduce energy sector emissions but limit the potential damage from global warming. To be efficient and cost effective in meeting this objective, carbon taxation should be comprehensive in scope and cover all sources and all sinks, including reforestation and land clearing.

There are a number of ways in which reforestation and land clearing could be included in a carbon tax proposal. Work has been done by Piers MacLaren (1993) in New Zealand looking at emissions accounting methodologies for pine plantations. Tasman Institute (1994) has examined how carbon credits from pine plantations on land previously used for agriculture could be incorporated into a tradeable carbon emissions permit system or a carbon tax.

Further work needs to be done on economic instruments and emissions accounting methodologies for land clearing and alternative land management practices in Australia. If Australia's national greenhouse inventory is correct, land clearing is an important source of emissions in Australia and should be included in proposals for carbon taxation. Only when this work is done will it be possible to devise an economic instrument for greenhouse gas emissions abatement which begins to be cost effective and efficient.

International cooperation

For a carbon tax to be efficient from a theoretical economic point of view, it also needs to be applied uniformly to all global emissions.

The costs of reducing carbon dioxide emissions could be halved if there were some form of cooperation internationally and an attempt to approach the theoretical policy ideal of having an international carbon tax or tradeable permit system. (See Tasman Institute 1995). Even if a tradeable permit system or some from of joint implementation strategy could be implemented amongst OECD countries alone, the costs of emissions abatement in individual countries such as Australia would be much lower.

It is premature to recommend implementing a carbon tax before having issues relating to international cooperation sorted out. A carbon tax will not be an efficient economic instrument until there is some idea of how the tax system will handle carbon credits arising out of international joint implementation schemes.

Concluding comments

Bad taxes generally get worse. International experience tends to confirm that it is very difficult to change a tax once it is in place. The closest taxes to a carbon tax are indirect consumption taxes, such as the value added taxes levied in most OECD countries. The history of Value Added Taxes around the OECD demonstrates that a tax which is not adequately designed and comprehensive in scope will be open to abuse, will come under considerable pressure from sectoral lobby groups, and will gradually have its tax base eroded. As there is increasing pressure to widen exemptions, the tax becomes more complex and it becomes difficult to maintain its integrity.

Based on these experiences and given the uncertainty which still surrounds the greenhouse issue, energy sector carbon taxes appear to be a narrow and premature policy response. More emphasis should be given to devising policy tools which are international in scope, cover a broad range of emissions sources and sinks and are sufficiently flexible to respond to improved scientific information on the potential damage costs of increased greenhouse gas concentrations.

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