The distributional politics of climate change policy

One advantage of the Coalition breaking the parliamentary consensus on an ETS is that more attention is being paid to the actual content and effects of Labor’s scheme. In responding to the Coalition’s ‘new tax’ argument the government has released (to the media, I cannot find any detail online) details of how ‘millions’ of people will be better off under the ETS.

This confirms the Opposition’s point and tries to shift the politics to an old-fashioned redistributional battle. The reason millions of people will be better off is that most lower-income earners will be ‘over-compensated’ for the ETS’s price effects. This is because actual lower-income household carbon emissions will vary considerably, depending on location, housing design, and lifestyle. To ensure that households with carbon emissions at the high end of the normal range are fully compensated, households with low to average carbon emissions will receive additional payments that cover their costs and add more, which can be used to improve their overall standard of living (including consuming more energy!).

This redistribution – along with the handouts to polluters – will be financed by, as Tony Abbott says, a new tax on people with above-average earnings. Take for example a single person earning $80,000 a year. According to the government’s calculations they will be an average $677 a year worse off under an ETS, equivalent to about a 4% increase in income tax.

Of course the Opposition’s yet to be announced more direct methods of reducing carbon emissions will also have redistributional effects. The costs of the Opposition’s scheme, however, are likely to be more evenly spread – costs to industry and consumers via regulation, costs to taxpayers via tax cuts that won’t happen (which will most affect higher income earners) and costs to recipients of government services from programs that won’t get funded at all or as much (which will most effect lower-income earners).

The respective effectiveness of the two approaches aside, the Coalition’s approach perhaps appeals more to the ‘this is a common problem, we must all make sacrifices’ aspect of climate change. The government’s line that millions of people will be better off under an ETS is effectively saying that millions of people need do nothing at all to assist with slowing climate change.

33 thoughts on “The distributional politics of climate change policy

  1. “The government’s line that millions of people will be better off under an ETS is effectively saying that millions of people need do nothing at all to assist with slowing climate change.”
    I read that to mean that millions of people will get more than they spend in dollar terms — I thought the statement had nothing directly to do with climate change (why would it? It’s not like the ETS is really going to do much to stop climate change — its main use in it’s current form appears to be wedge politics). Cynicism aside, I think the real problem is that the calculations only take into account number of kids and wages. This is sure to be an underestimation of the cost for people at the bottom end of the food chain since they tend to live further away from the their place of work (think Cranbourne etc.) and hence must spend much more on travelling (and ditto for people in the country), which will presumably go up in price a fair bit.


  2. I should make one further complaint,
    One thing that really peeves me about all this is not that it’s an ETS (it works fine for some types of smog when done properly, which this isn’t), but its just the next excuse for government welfare slop and forcing people into the rich and middle class welfare cycle. Apparently, looking at the table, the government is will to give assistance to households earning $200,000 a year (p. 24). I can understand giving assistance to families earning, say, $50,000, but $200,000 is just crazy — when does it ever stop?


  3. It’s interesting Rudd couldn’t be straight with the ETS. The Green’s suggestion of a straight auction and possibly no purchasing of foreign permits would at least have been comprehensible.

    But with the failure of Copenhagen this is surely going to be a much tougher sell. When someone runs an ad pointing out that a 25% cut in Australia’s emissions is about 3 months of China’s increase in emissions it is surely going to hit home. What happens when someone asks about how much a birthday cake is going to go up? What will Rudd say? The question probably cannot even be answered as it would depend on the income of the buyer.

    Abbott in his book mentions Lomborg, an interesting idea for the coalition to run would be a simple, low tax with the funding going mostly to alternative energy research but with some indexed to measured climate variables going to build possible nuclear power stations.


  4. There is the risk that the government has understimated CPRS price impacts. Even though the IPART NSW retail electricity price draft decisiononly accounts for the first two years of the CPRS’s operation, it incorporates a 25% increase in retail electricity prices due to the CPRS. Prices will rise further in later years as the permit price is allowed to rise. If this happens, even lower income earners will take a hit. And with growing air conditoning penetration and 50″ LCDs now going for less than $1000, household energy intensity is only going up.


  5. Lots of wiggle room in this statement.

    On average, the government can guarantee that middle-income earners will not be worse off as a result of the impact of the climate change policy we’re putting forward.


  6. Why not just impose a carbon tax, then reduce income tax in proportion, trying to keep the two changes net roughly neutral w.r.t. income distribution. Then deal with changes to the progressivity of the tax system later as the separate issue that it is. Urgh, this Government drives me crazy.


  7. Conrad – I’d be interested to see the assumptions behind these calculations. Clearly they assume that energy use increases steadily with income and the number of persons in the household. Though there are significant economies of scale in the person calculations – for example 4 persons in an $80,000 pa household are assumed to consume only 25% more energy than a single person on the same income – this seems reasonable.

    But you correctly point out that in some respects energy use could be inversely related to income, though because petrol prices are not going up in the medium term perhaps car travel is not included.

    But for example thinking about my own circumstances my current apartment isn’t much bigger than the one I had when I was a p/g student on less than one-third my current income (my extra income finances location, not space). And by living in a warmer climate (Melbourne now, Canberra then) there is scope for spending less on energy on my higher income.

    Better location means I also now walk to work when I used to drive as a student.


  8. And the effect on the climate of full implementation of the ETS would be …? Oh, that’s right, nothing: given we are about 1% of world (anthropogenic) emissions (and falling), such emissions constituting about 5% of total carbon emissions from all sources albeit likely a much larger factor in the increase in CO2 levels. But, apparently, we have to be seen to be “doing our bit” via an extremely expensive piece of “solidarity”.


  9. Any calculation of the deadweight losses associated with the tax, as well as the cost of administering the tax?

    I suspect that, should these be taken into account in the government’s calculations, then we would see that imposing the tax would make everyone worse off than not imposing it.

    Of course, after doing so it would only be fair to net out the benefits to each person of reduced CO2 emissions as a result of imposing the tax. Which, given Michael’s email above and the outcome of Copenhagen, would be, oooh, let’s say, something not significantly different from zero.


  10. Jeremy, the avoidance of some of the deadweight losses was the reason why the Frontier proposal prepared for Turnbull yielded much more benign GDP impacts than the Rudd CPRS ($72b reduction in GDP to 2030 compared with $121b reduction) even with a doubling of the target. Of course, all GDP impact modelling of the CPRS has been undertaken using CGE models (with all their limitations).


  11. I would assume that the compensation falls with income because of the methods used to deliver the compensation.
    That is, you don’t get a big fat cheque sent to you directly, but you are compensated by rises in pensions and other government payments, such as Family Allowances.
    If your income is too high to receive any of these, then you are not compensated.
    The second part of the theory is that low income households do not have the disposable income to cut down on their emissions; a higher income household can.
    Both will have the incentive to do so through the rise in their electricity costs.
    As for referring to the higher costs incurred under the CPRS as an increase in taxes for higher income earners, that’s a little dishonest. It is an increase in prices due to taxes paid by somebody else. This has been going on for eons but it’s the first time I’ve heard it equated to a rise in income tax.
    It is also a ‘tax’ the government wants you to avoid. Someone who objects to ‘paying’ it can take steps to ensure that the costs of the ETS on them are negative. If people are too complacent to take such actions, that’s their decision.


  12. “As for referring to the higher costs incurred under the CPRS as an increase in taxes for higher income earners, that’s a little dishonest. It is an increase in prices due to taxes paid by somebody else. This has been going on for eons but it’s the first time I’ve heard it equated to a rise in income tax.”

    It’s quite usual to talk about ‘tax incidence’, ie to focus on who ultimately bears the economic burden of the tax, rather than the entity that transmits the payment to the state.

    While obviously the ETS is not an income tax in its legal structure, since the tax incidence is only on those earning over a certain amount income tax seems to be to a good way of explaining its effects.


  13. But you could just as well argue that the ‘tax’ is imposed by the businesses, rather than the government, as the former could possibly decide not to pass it on (unlikely, I know!)
    More honest reporting would refer (as economists do) to the added costs incurred by higher income earners. It would also make it clearer that these are avoidable (we all know that ‘added costs’ depend on being prepared to spend more in the first place) and indeed are intended to be avoided.
    A higher income household, faced with increased energy prices, has more ability to invest in ways to avoid them than those on lower incomes.


  14. Mehitabel – The finances of the ETS are built on the assumption that high and middle income earners will finance compensation for low income earners and polluters; analytically this is a tax that will finance income redistribution.

    Except for poll taxes, every taxpayer has some capacity to vary how much tax he or she will pay, by working or consuming less, or reducing whatever other activity is being taxed.

    While the government’s estimates are likely to be very rough (as I note at comment 7) given that few if any households are in the medium term able to reduce their carbon emissions to zero, but many households get no compensation at all, the original post is a fair and honest description of what is happening.


  15. Andrew, this comes to one of the key Garnaut issues with the CPRS, that is that the compensation to both energy suppliers and income earners has removed the capacity for the CPRS to fund ‘compensation’ through substantive wider tax and welfare reform instead that could enhance productivity and even reduce inequality over time. We live in a political time when hypothecated spending/taxing is seemingly required, i.e. rather than seeing the totality of government action in the economy, people want to know that the CPRS will specifically make them better off. I guess that is politics hey ….


  16. I agree with Mehibatel on this one. The CPRS is not a tax – yes the effects on disposable income are like the effects of a tax, but if you want to pursue that argument then you would need to agree that rises in public transport fares are like a tax on the poor, and so on ad infinitum – i.e. sending price signals to people is a tax.

    As I just posted over at LP:

    “A few observations:

    A CPRS – like a carbon tax – will change relative prices – more energy intensive goods and services will become relatively more expensive. The fundamental assumption of consumer economics is that when some goods and services become more expensive than others, then consumers shift their spending patterns to consume less of the more expensive items. So even if households are fully or more than fully compensated for price increases they will still have an incentive to change their behaviour, i.e. use less energy. The exceptions are those who are so budget constrained that they can’t reduce their energy consumption, and those who are so rich that they couldn’t care less.

    Now when I say fundamental, I mean fundamental. If you reject the idea that a CPRS even with compensation will change consumer behaviour, then you are rejecting basic microeconomics. Now some of the people who come here might reject the axioms of microeconomics but one of the weirdest things about this debate is that some of the people who consider themselves economic rationalists do not appear to understand this. There was a posting at Catallaxy for example a few weeks ago that was based on the idea that compensation would mean that people wouldn’t change their behaviour. Some financial journalists also do not appear to understand this.

    I’m not so sure about this but my understanding is that a CPRS – unlike a Carbon tax – does not give the government any money – all the action is in the trading in the private sector and the government doesn’t collect any more tax revenue. So to decribe a CPRS as a great big tax is misleading – it’s true that energy prices will increase under a CPRS but the money doesn’t go to government. So the problem is that government won’t get additional money from the CPRS but its compensation scheme will cost money, so the budget deficit will increase.”


  17. Peter, I agree with you that a CPRS should encourage consumers to shift spending away from carbon-intensive goods and services despite any compensation – after all, it is the price at the margin that matters, assuming consumers are informed and rational.
    But the CPRS is like a tax. While some permits will be allocated to polluters for free, the rest will be auctioned and the government will get the revenue, which is can use for compensation or whatever. The problem is that – particularly under the deal the Government negotiated with Turnbull – the compensation promised (excluding free permits) well exceeds the amount raised from sale of the auctioned permits, worsening the deficit.


  18. Peter – I agree that there is still an incentive for compensated households to reduce their energy consumption; I worded that part of my post carefully, “need do nothing at all” (not won’t do anything at all). The difficulty is that many of the ways of saving energy – more efficient applicances, insulation, moving – require significant capital investment that the ‘over-compensation’ won’t fund. So I would expect only minor behaviour change in this group, though energy costs will become an increasing factor when making capital decisions, eg what applicances to buy, housing type.

    I don’t think your public transport analogy works. Public transport charges are a fee for service, even though the price is subsidised. In a legal sense, the CPRS is closest to a licence fee. The best analogy I can think of is the taxi licensing system. From the consumer’s perspective, however, the CPRS functions like a tax, ie higher charges caused by government with no direct service provided in return.


  19. Andrew

    Electricity and gas bills are fees for services, just like public transport fares. The analogy is exactly the same – if a government increases transport fares, consumers don’t necessarily see any improvement in service, and so using your approach they will see it like a tax increase.


  20. Peter – Except that in this case there is no service being provided; indeed the whole point of the scheme is to slowly put the service out of business. At best it is a contribution to a global public good, at worst there will be significant private costs for no private or public good benefit.


  21. This is an argument that I’ve had with Alan Moran a few times. The CPRS is not a tax strictly speaking (which allows people like Peter above some undeserved wiggle room), in many respects it operates like a tax it is meant to a close substitute for a tax (as Sleetmute points out). It is a clayton’s tax – the tax you have when you’re not having a tax. It will raise revenue for government – through the auction process, GST and also capital gains taxation (but the government tried to put up the argument that capital gains from the sale of carbon units would ot be eligible for the capital gains discount – in other words, trying to be too clever by half) .

    I think Greg Mankiw said it best:
    Cap-and-trade = Carbon tax + Corporate welfare.
    The Australian version is more complex (but perhaps very Australian)
    CPRS = Carbon tax + Corporate Welfare + Welfare


  22. “The fundamental assumption of consumer economics is that when some goods and services become more expensive than others, then consumers shift their spending patterns to consume less of the more expensive items.”
    I don’t disagree with that, but I’m under the impression that many of the things that you need to become more expensive to reduce carbon consumption are not especially elastic in Australia (e.g., petrol and food), so unless some things are made brutally expensive, there won’t be a big (or meaningful) change. No doubt less of a change than population increase will make up for.
    This reminds me of all the fuss about water in Victoria — I think the main thing that changed people’s behavior was the government asking people to use less water, making information available about targets and so on available, not the increase in price.
    As can be seen from the water episode, no one is willing to increase the price enough so people like me might bother to think about water usage enough to reduce our usage substantially, so once the information campaigns run their course, that’s pretty much it and we are left with tiny elasticities. In addition, if people are silly enough to buy bottled water now in one form or another rather than install their own filter for a tiny price (which seems like most of the population and most workplaces now even in cities with good water supplies like Melbourne), it’s hard to see why they would reduce their usage for a few cents. This is why they must accept reality and build the new desalination plant — because demand is going to increase even if they don’t want it to under any politically realistic scenarios, no doubt like carbon usage without major changes to what they say will do something now.


  23. The campaign to reduce water has been amazingly successful – per capita daily usage in Melbourne is down more than 50% on the start of the decade. However this is probably because it has always been ridiculously cheap, which permitted very wasteful practices that have now been wound back. Electricity has always been relatively expensive so there has not been the ‘low hanging fruit’ of highly wasteful practices that can be fairly easily eliminated.


  24. The ‘campaign’ to reduce water use has been underwritten by some pretty draconian regulation. It is ridiculous that in a first-world country, people are carrying buckets of water from their bathroom showers to water their gardens. It’s just as ridiculous that people are prevented from washing their cars. Even at $3 per kL (three times the old tariff, reflecting a generous allowance for the cost for desal), water would be dirt cheap. Why should you have to sweep your driveway when for 10 or 20 cents you could spray leaves away?
    Conrad is right that electricity demand from domestic consumers is very inelastic. This is another argument against the Government’s CPRS, which would lead to a huge churn of permit revenue to compensation for little tangible benefit. The Frontier proposal would have avoided the big electricity price rise and permit revenue churn while sacrificing minimal demand-side abatement benefits.


  25. It is ridiculous that in a first-world country, people are carrying buckets of water from their bathroom showers to water their gardens.

    This is a point that should be emphasised again and again. I’m surprised that people will put up with sort of thing.


  26. “The campaign to reduce water has been amazingly successful – per capita daily usage in Melbourne is down more than 50% on the start of the decade. However this is probably because it has always been ridiculously cheap, which permitted very wasteful practices that have now been wound back”
    That’s true, but I don’t think price is what has caused wasteful practices to get scaled back at a consumer level (alternatively, it would be more interesting to know whether industrial users, who are the main users, have scaled back because of it) — I think it’s mainly due to government propaganda. If I was to continually waste water (say, use an extra 200,000 litres a year), for example, it would cost me about $200 a year more than now. That’s far less than I spend on buying coffee each year. This suggests to me the price is still so ridiculously cheap that the increases have had almost no effect (at least on me, and I doubt I’m an outlier in this case).


  27. Conrad – I agree, that’s why I called it a campaign (and others sensibly empahasised that regulation played a big role). They make good objections to that, but sweeping rather than hosing is much less of a lifestyle threat than electricity saving options, which for me mainly amount to being colder in winter (I have terrible circulation) and fewer cooked meals. I’m going to pay the extra bills rather than cut my electricity consumption.


  28. Given that the way the CPRS is supposed to work is not through substitution at the consumer end (because of the direct compensation) but through substitution at the producer end, has anyone done any analysis of how much the price of coal-based power has to rise before the natural substitutes (hydro, geothermal, solar) become price competitive?

    And will the CPRS raise coal-based power prices sufficiently to encourage substitution? If not, then the scheme may not work as intended.

    (It may be in the Frontier report that Sleetmute recommended – I haven’t had a chance to read through it yet).


  29. Given that Victoria has had no significant new dams during a period when its population went up 30%, the combination of restricted supply and increased demand with a ludicrously low ceiling on prices has had the absolutely predictable effect of shortages.
    Lots of regulation and propaganda has reduced usage, but much more inefficiently that raising prices would have done.
    Somehow, the larger debate never seems to cover such elementary supply and demand (and pricing) issues. Water is somehow “special” and shortages are due to “climate change”, not ludicrous under-investment in water infrastructure and prices unconnected to supply and demand.
    Once environmentalist sentiment gets into the mix (it, after all, is why there has been no new dams), anything resembling sensible policy seems to vanish: but one is dealing with the equivalent of religious fundamentalism, one which discounts evidence, consequences and human wants in the service of Gaia as much as any fundamentalist of more traditional scriptures. They even, like other religions, have their own network of schools: government schools, with some of the top private schools added in.


  30. It’s not so much about encouraging Andrew to turn the heater down a notch as it is about giving BigCorp the incentive to audit their 1MVA data centre and shutdown the ancient servers that have, unnoticed, been doing nothing but generating heat and blowing dust around for the last 10 years. Along with all the other similar practices that must be going on in the industries I’m less familiar with.


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