Ross Garnaut discusses the economics behind the carbon tax

Top Conversation author Professor Stephan Lewandowsky and former Western Australian Premier Carmen Lawrence were part of a group that sat down with Ross Garnaut during his recent visit to UWA.

During the wide-ranging conversation they discussed Garnaut’s input into the government’s carbon pricing plan.

As part of the lead-up to Julia Gillard’s announcement of the carbon price on Sunday, this discussion provides insight into how the hard decisions were made.

Stephan Lewandowsky: The framing of a tax is extremely important. One of the things that makes it easier for people to accept a cost is if it’s presented as a partial sacrifice of a gain rather than a loss. What’s surprised me a great deal is that there’s been very little of that frame. For example, people always talk about how were going to lose out on GDP but no-one says that, well, we’re actually still going to have GDP growth, there’s just going to be a little less of that. The data are quite striking on that: to sacrifice a gain is much easier than to actually lose something.

Ross Garnaut: Yes well if you look at my modelling from 2008 it means the income level we would have reached in 2048 [without a carbon price], we reach in 2051 … I have to say that I’m not as confident about the continuation of economic growth in Australia as I was then but that’s a different matter. I never use the word “tax” to describe the Emissions Trading Scheme with a fixed price in the early years that I recommended in 2008 and again in 2011. If I’ve got enough time for a number of words I say, “an emissions trading scheme starting with a fixed price.” If I’ve only got time for two words I say, “carbon pricing”.

Adam McHugh, Murdoch University: The other two words that you’ve been saying recently are “tax cuts” …

Garnaut: Not all of the carbon revenue should be used for tax cuts. We need some money for innovation. We also need some money for assistance to trade exposed industries, though I’ve tried quite hard to get a bit of discipline into thinking about that. We need some carbon revenue for offsets for the rural sector until agriculture’s covered by the scheme … and then I suggested 55% of the revenue should go to tax cuts and other household benefits.

Lewandowsky: One thing I was hoping to connect to was the funding required for innovation, I guess you mean renewable energy sources …

Garnaut: Well, low emission technology generally. Because when you get a big structural change like this, the cost of it will depend on the speed with which people take up new technologies that didn’t make sense under the old relative prices but do make sense under the new ones. You never get enough investment in innovation when a lot is required quickly if you rely entirely on private markets because of the knowledge gains the whole community gets from the pioneers making mistakes.

Lewandowsky: Is there enough left for those innovations?



Garnaut: I’ve been working hard to preserve a fair bit. I failed in Kevin Rudd’s scheme, but I keep making the case. I am hopeful this time.

Terry Edwards, Distinguished Teaching Fellow, Center for Petroleum and Energy Research, UWA: One of the observations that you hypothesise in this year’s report is potential trade retaliation in the future between countries that do adhere and do mitigate and do reach goals and those that don’t. You can possibly even envision a return to tariff barriers and that sort of thing.

Garnaut: In both Europe and the United States there’s very active discussion of this. In the US when the Waxman Markey bill was put to the Senate there was a clause that gave the administration power to impose old fashioned tariffs on countries that weren’t doing enough. One can just imagine how that would be used in practice I’m sure our steel would cop it. It would become a simple protectionist device once it was in place. The European proposals for post-2012 have had provisions for an imposition of levies against imports from countries that are judged not to be doing enough. Unless there’s an acceptance of broad comparability of effort across the world, I see it as more or less an inevitability. As I said in the final report, Australia and New Zealand will be the biggest victims of that because we’re not naturally part of any group.

Carmen Lawrence: You’ve been studying emissions trading schemes now for some time. I wonder what your current assessment is of the likelihood of such a scheme succeeding at a national level and being able to be exported and generally adopted in other parts of the world, particularly the less developed government and financial systems.

Garnaut: We’re a system with quite a strong tradition of compliance with financial laws. I think it’ll be all right here. We’re actually quite good at regulating those sorts of transactions–unlike the United States. But I don’t think an Australian scheme is suitable for developing countries, I said that in the initial report.


 Lawrence: But how do you think the European ETS is going? Because the prices are all over the place.

Garnaut: They made some mistakes at the beginning. They handed out far too many permits and there was a really crazy element of the arrangements that gave individual countries some flexibility in how many they handed them out, so naturally permit prices camee under pressure. There is more scope for allocating an excessive number of permits when you’ve got a lot of national governments as well as the central government operating it. So that was a bit of a mess to begin with.

Of course, as soon as the existence of the scheme creates scarcity for the permits, the permits will embody the value … but they were getting permits for free and passing on the cost, so it actually led to a stock market boom for electricity generators. Because they were doing it that way they weren’t generating any income, so there was no money to compensate low-income earners. So the initial European ETS was an instrument for quite substantial distribution of income from ordinary households towards the energy business. That didn’t help the political acceptability of the scheme early on in Britain. The strong treasuries of Europe – the British treasury, the German treasury – knew that mistake at the time and recommended against it and once everyone could see what was happening it became easier to argue against it.

The post-2012 arrangements are much more disciplined on these matters. If something like I propose gets up it will start better than Europe is now. I think the European arrangements, for all the problems, have been helpful in substantially reducing emissions and made people and businesses much more conscious of the need to reduce emissions. And also the ETS has got Europe over a hurdle so there’s greater acceptability going further. The recent UK climate commission recommendation is quite radical and it doesn’t seem to have caused a very big stir.

Stephan Lewandowsky receives funding from the Australian Research Council and the Swiss National Science Foundation. As is standard around the world, the funding agencies expect the grant holder to produce high-quality peer-reviewed research but do not dictate or expect any particular outcome. The funds also do not affect the grant holder's personal income or financial circumstances. Merit-based public funding is essential to ensure that science can be conducted in the public's interest without regard to potential commercial interests.

Carmen Lawrence is Chair of the Australian Heritage Council.

Ross Garnaut is affiliated with the Garnaut Climate Change Review and the Garnaut Climate Change Review Update 2011.