Tuesday, October 20, 2009

Ken Henry on tax reform

If the tax structure from early last century prevailed today, we would have to raise $40 billion from excise and $230 billion from tariffs to meet today's revenue demand. At that rate the excise on a schooner of beer would be around 7 times what it is today. And I shudder to think how much a television set would cost.

That's Treasury head Ken Henry, speaking on lessons from past tax reform experience. Henry is chairing the review of Australia's tax system and he singles out road pricing to address congestion as a perfect candidate for reform:
When vehicles drive on a congested road they impose costs on other drivers. Each driver thinks of their own need to get to their destination, not considering how, by taking up space on the road, they impinge on the ability of other drivers to do so. There is no means for one driver to coordinate with others, to bargain about who should have priority, so that they can all be better off. This results in a predictable 'tragedy of the commons' which is estimated to waste around $9 billion a year in avoidable congestion costs, increasing to around $20 billion by 2020. Such costs will only increase with faster population and economic growth.

Worth a read.

Friday, October 16, 2009

Climate Change Blog Action Day

Apparently today is Blog Action Day for Climate Change and I thought I'd throw it open to my wonderful blog readers.

I find myself alternatively optimistic and despairing on climate change. How bad is it going to be? Are we going to do what it takes to avoid the worst? And what do you think is going to be the most help? People and communities and businesses taking action themselves? National governments agreeing on strong action at Copenhagen and setting up strong domestic laws, like emissions trading? Peak oil or economic crisis reducing emissions automatically? Or technological breakthroughs making it easier than we thought? Or will it take some real environmental crisis to get the impetus?

What do you think? Put in your two cents for Blog Action Day - bloggers, regulars, visitors and lurkers!



Thursday, October 08, 2009

What's the Opposition's climate policy?

I saw Maclolm Turnbull interviewed the other night saying that he supported emissions trading and reminding people that emissions trading was indeed government policy under the previous Howard Liberal government when Turnbull was Environment Minister (it was pretty token and very very late if I remember rightly). He also said that it had been on their "legislative program" to introduce (I guess they ran out of time; 11 years in government only gives you so much time to make new laws). He said the Coalition didn't oppose emissions trading (it was Coalition policy) - what they oppose is Labor's confused and costly scheme.

It all made me think: what is their position? I don't recall them articulating what exactly they don't like about the proposed scheme and what they would do differently. It seems that every public figure and lobby group in Australia has said what they do and don't like about the scheme and how they'd like it changed - except our opposition party.

Can this be right?
Picture: abc.net.au

Tuesday, October 06, 2009

Emissions trading: Auctioning permits vs giving them away

As I've talked about before (The great permit give-away), one of the big debates in emissions trading is whether to auction most of the permits or give them away free to industry. Under the Australian CPRS it looks like more and more will be given away, to industries that are particularly affected and/or have to compete with overseas industries that do not face carbon costs.

There's a few myths going around about the different results from allocating and giving away permits.

One myth that I hear from the green side is that if you give permits to companies for free, they have no incentive to reduce their emissions.

A myth I hear from the industry side is that if they're given free permits, they won't have to raise their prices to recover the additional costs of permits.

But in theory, you get the same carbon price and the same impact on, for example, electricity prices, whichever allocation method you use.

The reason is trade and opportunity cost. Even if a firm gets permits for free, the permits still have a value. They can be sold. Other firms will need to buy them if they want to expand production and the firm with free permits can choose to sell or use the permits. If it can reduce its emissions more cheaply than the permit price then it has an incentive to reduce its emissions and sell the permits - even if it got the permits for free.

And if a firm gets permits for free, will it pass the savings on to its customers? Well maybe. But its competitors will still have to buy permits at market price. And the firm (and any other firms in the industry) will have to buy more permits if it wants to expand. So, at the margin, firms will need to take the permit price into account. Now the firm with the free permits could undercut its competitors. Its market share would then increase and it would have to buy more permits - at the market price. Or it could just charge the market price for electricity and pocket the difference as pure profit.

That was the experience under the EU's emissions trading scheme, where German electricity generator RWE passed the "cost" of permits onto its customers, even though it had received most of those permits for free. The result was a windfall profit of about $6.4 billion for RWE in the first 3 years of the scheme, and electricity prices that rose by 5% a year.

A new experimental study (PDF) also casts some light on the theory.

Experimental economics is a fairly recent and fascinating field where the predictions of economic theory are put to test in the lab. Testing economic theory in the real world is fraught because it's almost impossible to isolate the parameter you're testing from the thousands of other factors that could be affecting the outcome. What's the effect of the stimulus package on retail spending? No-one really knows because there are so many other factors affecting retail spending: unemployment, interest rates, exchange rates, etc etc. You can't control for them all. In the lab, you can control the environment. (The trade-off is whether you can translate behaviour in the lab to behaviour in real life.)

In this study, participants were randomly assigned roles as high emitting or low emitting firms in a simplified industry. In one treatment, high emitting firms were given free permits, while in the second treatment, permits were auctioned. Trading of permits was then allowed freely in both treatments and firms also then decided on how much they would produce and the prices they would charge for their products, taking into account the need for permits and the decisions of their competitors.

The results are interesting and accord roughly, but not exactly, with the theory:
  • Under free allocation, most permits remain with the high emitters who received them for free, apparently because the high emitters are able to use their market power to keep the permit price high and reduce trade.

  • Firms pass the cost of permits through to their customers under both treatments (even if they got them for free). Surprisingly, product prices are even higher under free allocation (not sure why this is the case).

  • With free allocation of permits, the high emitters walk away with large windfall profits. These disappear with auctioning, with the surplus instead going to the government as auction revenue and to consumers in the form of lower product prices.

This study adds further support to the idea that permits should be overwhelmingly auctioned, not given away. Permit giveaways benefit no-one other than the companies who get the free permits, at the expense of their competitors, consumers and taxpayers.

Goeree, J., C. Holt, K.L. Palmer, W. Shobe and D. Burtraw (2009). "An Experimental Study of Auctions versus Grandfathering to Assign Pollution Permits." RFF Discussion Paper 09-39, Sept 2009.

(HT: Climate Changes)