The carbon Budget

One of last week’s hot political issues was whether or not the budget would include the carbon price. Today’s blog looks at what the budget would have looked like if it included the carbon price.

REVENUE

The starting point is to recognise that the creation of a carbon scheme creates a new set of assets. Whereas previously the ability to emit greenhouse gases to the atmosphere was without cost, once carbon is priced such a right becomes of valuable. The value of this asset is represented by the emissions to be coverage by the scheme multiplied by the carbon price. Emissions covered by the scheme will be approximately 450million tonnes CO2e per year. So a price of $20/tCO2e yield a value of $9b.

The price is set to increase by 4% over CPI, let’s say 7%. So it would be $21.40 in 2013/14, $22.90 in 2014/15 and so on. At the same time, as a result of the price signal, emissions will be reducing, and if there was price on carbon they would significantly increase by +24% according to the projections. If emissions need to get to 5% below 2000 levels by 2020 (ie around 420MT), assuming a constant linear reduction, collections will increase over time:

This assumes no contribution from the Carbon Farming Initiative or import of international permits, which would each reduce the revenue.

EXPENDITURE

It is important that the revenue is fed back into the economy in some way, so the carbon cost does not become a dead weight loss. If there were no other calls on the funds and no political considerations, economists would argue that these funds should go to remove the most distortionary and productivity-zapping taxes in the system, such as payroll tax, and to reduce rates on income (business & household) taxes to stimulate the economy.

In the real world, however, there are many calls on these funds. Principally, this is a question of equity, and carefully targeting how the impacts of the carbon price are felt across the economy. The principal calls are for:

• Emission Intensive Trade Exposed (EITE) industries; with the risk of carbon leakage if they are to face a carbon cost before the price of the commodity they are producing includes the impact of a global carbon price;
• Households; who will be paying higher electricity, fuel and, to a much lesser extent, other prices;
• Coal-fired electricity generators; who while not trade exposed are emission intensive, and face significant changes to asset values;
• R&D & Infrastructure; as Garnaut identified in his 2008 Review, funds raised from carbon price can be used to address market failures not otherwise corrected by the implementation of the carbon price.

Dividing up the $9-10b pie is one of the current activities of the Multi Party Committee on Climate Change. But the indications are that around half will go to households and a majority of the remainder to EITEs.

Note that it’s the job of the carbon price itself to be the main driver of redirecting financial and economic resources away from highly emission intensive activities and towards lower emission intensive activities. It is not the job of the allocation of the budget. That’s why the government (and previous governments) have in the main rejected calls for the use of the funds for deploying renewables. This logic can also be seen in the axing of several Rudd era initiatives from the budget, including funding for the CCS Institute and some of the solar projects.

INFLATION

The carbon price will have an impact on inflation by increasing the cost of a range of emission intensive household goods, mainly electricity (~20%) and petrol (~6-7c/l). All other goods are not that emission-intensive, and it’s likely that we wouldn’t even notice the impact at the check-out.

Not having the modelling capability in-house, I turn to the modelling work done by Treasury in 2008 on the CPRS, on the basis that the price impact of the CPRS will be broadly the same as that of the proposed carbon price under the MPCCC, and that it’s the carbon price itself that determines inflation and not the budgetary allocations.

Emission pricing produces a one-off rise in the consumer price index (CPI) of around 1-1.5 per cent for emission prices in the CPRS scenarios, which start at around A$23-32/tCO2-e (A$20-28 in 2005 dollars). Emission pricing is expected to have minimal implications for ongoing inflation; however, changes in coverage (such as extending the Carbon Pollution Reduction Scheme to agriculture in 2015) could produce additional smaller increases in the CPI at that time.

Cattle-related goods (milk, beef) would also go up (eg milk ~2c/l) if agriculture, particular ruminant methane, was included in the scheme (which it isn’t).

GROWTH

In a previous article, I touched on the impact of growth. The modelled estimate is a shaving of 0.1-0.2% of GDP per year, again based on Treasury modelling (which is currently bring updated). While this is the headline figure, underneath this occurs a restructuring of the economy, with some sectors (eg abatement activity, new energy plants) seeing higher growth than previously and others contracting.

AFTER 3 YEARS

Note that once we move to a floating price and fixed target, as opposed to the initial fixed price period, revenue will come from auctioning of permits rather than selling them at a fixed price. Around half the permits may be auctioned, with that amount still going to households. But the allocation of free permits to EITEs and other sectors would not be seen as a cash item in the budget.

So that’s it at a high level. Sounds like we’ll have to wait for the MYEFO to see it in the detail.