So Now You Have Bought An Emissions Trading Scheme

What is it?

The emissions trading scheme, or ‘Carbon Pollution Reduction Scheme’, is a ‘cap and trade’ system. This requires firms to obtain a government ‘permit’ if they emit greenhouse gases.

The government caps the level of emissions by restricting the number of permits available. The government plans to progressively reduce the pool of permits made available each year-intensifying the competition for permits and making them accordingly more expensive. So how does a cap and trade system work?

Each year, firms acquire permits directly from the government through an auction process or some other allocation mechanism. The firms can decide whether to use those permits themselves, hold them for some future period, or sell them to other firms.

Over the course of the year, firms can emit only the quantity that they have permits for. Government audits emissions levels to ensure compliance

Used permits are surrendered to the government.

This process is intended to provide incentives to reduce carbon emissions, by favouring low (or zero) greenhouse gas emitting forms of production and consumption. And, to the extent that prices of goods and services are affected by price rises, the ETS is supposed to restrain demand. The reduction in emissions may be brought about by firms utilising lower emission technology or implementing carbon capture and storage systems. Firms that lower their emissions will need to buy fewer permits, and to sell unused ones to other firms.

Does the ETS apply to all emissions?

The ETS applies to a broad range of greenhouse gases. Firms will require permits to emit, carbon dioxide, methane, nitrous oxide, sulphur hexafluoride, hydrofluorocarbons and perfluorocarbons-the gasses nominated by the Kyoto Protocol. Nevertheless, carbon dioxide accounts for 74 per cent of the total.

But not all Australian greenhouse gas emitters require permits to emit. The ETS covers only the largest emitters-roughly 1000 firms. This leaves 25 per cent of Australia’s total emissions uncovered by the scheme. The announcement that petrol will effectively be excluded for up to three years from the ETS reduces the coverage by another 14 per cent.

The burden of acquiring permits varies from industry to industry. In most cases, it is the actual emitter who is responsible-for example, electricity generators or aluminium smelters. But in the case of the transport sector, there are millions of cars that individually emit only small quantities of greenhouse gas each year, but which add up to around 14 per cent of Australia’s total emissions. Because of the high burden that acquiring permits and monitoring emissions would place on individual motorists, the ETS will place the obligation of acquiring permits on petrol and diesel suppliers.

A critical problem with the government’s ETS proposal is the inconsistent burdens it places on emission sources. For example, agriculture will likely be excluded from the initial implementation of the ETS. But many agricultural practices such as wheat cropping will still be affected by price rises applying to vital inputs like nitrogen based fertiliser. Agricultural interests argue that they already offset their carbon usage (or could do so at low cost) by sequestering carbon within the soil but there is no provision to compensate and encourage such practices. These mismatched burdens on agriculture will reduce the industry’s international competitiveness.

Why not just a simple carbon tax?

The ETS effectively acts as a tax. It requires firms to buy-or be awarded-permits from the government in order to emit greenhouse gases. Certainly, the permit awarded by the government can be bought and sold in the market. But the ETS is, at its core, just a tax. And as a tax, it will raise the cost of production. This extra cost will, either directly or indirectly, be passed onto consumers, dramatically raising the price of goods and services across the economy.

What’s going to happen to all that money?

The ETS is going to bring the government a huge amount of additional money as it auctions permits each year. Conservatively, that amount will be at least $5 billion extra in the first year, not including the extra GST applied to permits traded in the marketplace. Reducing emissions by 60 per cent of their 2000 levels by 2050-as the government has committed to do-will require making fewer and fewer permits available, and the amount of money the ETS brings the government will increase massively.

The government has described the ETS as ‘revenue neutral’, however, the government only means that it plans to spend all the extra money it receives. This is no different from money raised from other taxes. The government has explicitly committed to use much of the proceeds of the tax (the figure of 50 per cent has been mentioned) to compensate low and middle income households, pensioners and other welfare recipients.
Other money will be directed towards subsidising energy efficiency technologies at the household level. In short, the government plans to return much of the money it taxed-a highly inefficient government practice that has been widely criticised in the context of welfare and family policy.

But instead of this elaborate tax churning, the introduction of the ETS should be an opportunity to cut taxes in other areas of the economy. With just the first year ETS windfall of $5 billion, the government could increase the tax-free threshold from $6,000 to $9,000, or entirely eliminate the top 45 per cent income tax bracket.

How will the ETS be implemented?

In order to deal with the political issues created by the ETS, the program will not be implemented consistently. For example, there will be the already announced temporary cut in petrol excise, which will partially offset the increase in the petrol price caused by the ETS. But cutting the petrol excise is inconsistent with the aim of reducing carbon emissions-though petrol usage appears to be relatively inflexible, an excise cut will ensure that there is no significant change in petrol consumption.

Perhaps more critical distortions in the ETS implementation are the treatment that ‘emissions-intensive trade-exposed’ industries will receive. These are industries which, because of their integration into world markets, will be less competitive in Australia due to the need to comply with the ETS. While not finalised, such industries could include aluminium smelting and chemicals manufacturing, some pulp and paper manufacturing, and ceramic products. These industries will receive some free permits-that is, unlike other industries, they would not have to bid and pay for all of their permits each year. This situation will persist until ‘broadly comparable’ ETSs are in place internationally-the opportunity for lobbyists and rent-seekers to manipulate this process is immense.

Further assistance will be given to the coal-fired electricity generation sector, subject to a range of inquiries. The nature of this assistance has not yet been determined, but it has, like the ETS itself, the potential to dramatically upset the investment attractiveness and economic structure of the electricity industry.

But most importantly: Will the ‘Carbon Pollution Reduction Scheme’ reduce carbon pollution?

Australia contributes 1.1 per cent of total global greenhouse gas emissions. Our contribution is dwarfed by big emitters like the United States which contributes nearly 21 per cent, China which contributes 17 per cent, and Russia which contributes just over 5 per cent.

Even if we entirely eliminated our carbon footprint, the impact on the global total would be statistically insignificant. Reducing emissions would do nothing for the Murray-Darling Basin, or the Great Barrier Reef, or Australia’s rainfall patterns, even if human-induced climate change was the culprit. What matters for the environment is global emissions, not Australia’s emissions.

For this reason, the federal government is hoping that implementing a domestic ETS will apply pressure to the big emitters, and set the stage for a new international carbon trading scheme.

The ETS turns the Australian economy into a diplomatic bargaining chip, endangering Australian prosperity as it does so.