ECONOMIC ISSUES

Australia’s Carbon Tax

Insights

What Has Happened?

In 2011, Australia’s population represented 0.3% of the global population, yet of the world’s total greenhouse gas emissions they were a 1.8% contributor.

 

In 2011, the Gillard government introduced the Clean Energy Act 2011 which introduced a carbon price of $23 per tonne. Carbon pricing refers to a tax on producers who are required to pay a certain amount in line with the amount of carbon they emit into the atmosphere.

 

This policy aligned with the Climate Change Convention and Kyoto Protocol 2005, international agreements that Australia was a signatory and had an obligation to follow. The central tenet of these agreements was primarily to oblige governments to reduce greenhouse gas emissions and in turn propagate a structural shift towards cleaner forms of energy.

 

The law was applied to approximately 500 of Australia’s largest polluters and to a certain extent, achieved its goal by reducing the country’s greenhouse emissions by 1.4% one year after its introduction according to the Department of the Environment.

Tracing Australia's Emissions


Despite this feat, the carbon tax was found to also have increased electricity costs for households and businesses. According to the Treasury, it was estimated that the introduction of the carbon tax caused a $9.90 per week on average increase in the cost of living for households.

 

In here lies a trade-off and conflict of policy goals, with a key question at the heart of the matter – what cost was the Australian public willing to incur to preserve our environment?

 

After the election of a new government led by Tony Abbot, the carbon tax was removed in line with a Liberal-National campaign centred on a promise to “axe the tax”. With the power of democracy, the public gave their answer to this key question- the majority were in favour of short run benefits with little concern for the longer term.

 

The Australian government did repel the carbon tax, but introduced a Direct Action policy which provided financial incentives for polluters to reduce emissions as a replacement. 

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Reducing Negative Externalities

The rationale of the carbon tax was to ‘internalise an externality’ and in effect reduce the production of this externality itself. A negative externality refers to an adverse spill over effect, that is public costs incurred on those not involved in a transaction which only takes into account private costs and benefits in the price mechanism. In this situation, the adverse effects of carbon emissions are not priced in a transaction between a buyer and seller, a concept that is referred to as market failure. The rationale of the carbon tax is to essentially set a price on greenhouse gases – measured by the amount of carbon a company emits. In essence, this tax ‘internalises’ this externality as costs are now considered and accounted for in the pricing of the good and/or service.

We also refer to this type of carbon tax as a Pigouvian tax.

Carbon Tax Effect on Supply and Price

As indicated above, the size of this tax is always the vertical distance between the curves, effectively reducing the production of this negative externality from Qm to Qs0. Furthermore, the increase in price on the vertical axis, illuminates how the price of the externality is now taken into account in the transaction. 

Cost Push Inflation

Cost Push Inflation Visual


As indicated on this diagram, the effect of the tax will decrease the supply of the good, effectively reducing the production of the externality (in this case greenhouse gas emissions) but also increase prices from P to P1. The tax itself represents an increase in production costs imparted on business, who then in turn, pass on these cost increases in the form of higher prices – an effect known as cost push inflation.

Decrease Economic Growth

A reduction in the production of goods and services as an effect of the carbon tax illuminates a key policy conflict; short run economic growth and long run environmental sustainability. Gross Domestic product is defined as an increase in the total production of goods and services over a period of time, which is clearly impeded by a policy that is targeted at reducing the production of particular goods and services that contribute to environmental degradation.


Moreover, on a demand front, by removing the carbon tax, it can be argued that disposable household income improves through reductions in inflationary pressures as mentioned above, elevating household consumption and improving the quality of life for those in the lowest quintile. This notion is supported by economic theory that suggests that the carbon tax essentially acted as increased costs for households and propagated contractions in demand. 

 

Contractions in household demand

Alternatively, economists also argue that short run impediments on economic growth in favour of sustainability will in the long run, increase productive capacity as future generations and economies will operate amongst a cleaner and more readily available resources than would have been the case if they were exploited and overused in the past. Considerably, Australia’s reliance on mining exports brings forth the paradoxical controversy in this conversation - with a world rapidly moving towards clean sources of energy should Australia not reap the full rewards of our abundant natural resources whilst they remain in demand?

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