Taxing emissions or trading them? A question for Turnbull

Discussing the merits and demerits of a tax on carbon dioxide emissions or an Emissions Trading Scheme (ETS) might seem rather passé. However, the debates could soon become fashionable if the Liberal Party of Australia changes its leader to Malcolm Turnbull. If events unfold in a way which will pop Turnbull into the Prime Minister’s office, the Liberal Party will have to answer a difficult question. Is the carbon tax dead and buried or will it be resurrected?

The politics of this question are complex. Tony Abbott’s current government won an election with a mandate to erase the carbon tax and ETS from the books of legislation. Turnbull lost himself leadership of the Liberal Party by providing the former Labor government with bi-partisan support for its proposed carbon tax and ETS. Sorting out the politics of answering this question is not the concern of my article.

What is a tax on carbon dioxide emissions or an ETS? Before answering these questions, some details need to be outlined. Some machinery releases greenhouse gasses, like carbon dioxide, into the sky. The temperature is said to be rising as a consequence of these greenhouse gasses entering the atmosphere. A rise in the earth’s mean temperature could be a serious threat to humanity. If this threat is to be mitigated or evaded, the average temperature of the earth needs to rise at a slower rate. To slow the rate of increase of the earth’s temperature, fewer greenhouse gasses should be emitted.

The makers of policy who are concerned with a rise in the globe’s temperature should seek to reduce the amount of carbon dioxide being emitted. But how? One way would be to place a tax on the carbon dioxide emitted by firms when producing their goods or performing their services. The idea of this tax would be to provide firms with a disincentive to emit carbon dioxide during their daily business.

Julia Gillard’s government introduced a law which worked in such a way after making a deal with the Greens. However, the policy was not formulated under the chapter of the constitution which deals with taxation and was done in the name of an ETS instead. In the early stages of the Gillard Government’s Clean Energy Bill of 2011 the ETS would have worked in the same way as a tax on carbon dioxide emissions, but the free market would have dictated the price at which firms and countries would buy permits to emit carbon dioxide after our ETS started to work in conjunction with Europe’s.

Would such a tax or a price on carbon dioxide be effective in reducing the amount of carbon dioxide emitted? Unfortunately, the Clean Energy Bill did not remain long enough for me to give you a well-substantiated answer. All I can do is theorise about the matter. I will start by raising some moral concerns about an ETS. Let us assume that there is a global ETS whereby each country has any number of permits to emit greenhouse gasses and those permits are for sale on a free market. There would be well-developed countries as well poorly developed countries in this market.

A well-developed country, like Australia, would be quite able to buy a permit to emit a certain amount of greenhouse gasses from a poorly developed country like Fiji, whereas Fiji might find it hard to buy such a permit from Australia because Fiji would have less purchasing power on this market for permits to emit greenhouse gasses. Electricity is needed by firms in the modern economy and it is one condition for economic development hence. An ETS could act as a barrier to a country like Fiji’s development.

I will now move on to theorise about the effectiveness of a tax on the emission of carbon dioxide. The elasticity of demand measures how responsive is the demand for something when there is a change in the price of that thing. On one hand, the demand for something is said to be elastic when a change in its price is met with a greater than proportionate change in the quantity demanded of it. On the other hand, the demand of something is said to be inelastic when a change in its price is met with a greater than proportionate change in the quantity demanded of it.

The elasticity of something’s demand is often determined by the thing’s necessity. If something is needed by firms and it is needed always by those firms, the demand of that thing will likely be inelastic. In other words, a firm won’t be deterred by the price of that thing if they will always need it when they produce their goods or perform their services.

Cars and electricity are examples of goods which are needed by the modern firm in the modern economy; they are examples of goods whose demand does not change too much when there is a change in price. For example, the elasticity of the demand for cars in the U.S.A. is -0.17 which means that if there was a rise in the price of cars by one per cent there would be a 0.17% drop in demand. That isn’t too small a fall in demand.

If I were to put it differently, I would say that increases in the prices of goods which emit carbon dioxide will have little effect on the amount of carbon dioxide emitted by firms because the firms will always need things like cars and electricity. The elasticities of such goods are indeed low. Hence a tax on carbon dioxide would not achieve its end of reducing the amount of carbon released into the atmosphere to a satisfactory level.

If Malcolm Turnbull does become Australia’s Prime Minister will he still think that a tax on carbon dioxide emissions or an ETS should come back? This will be a question about which he ought to think deeply.