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New South Wales elections and carbon taxation

By Ben Rees - posted Monday, 21 March 2011


On Wednesday night, I had the misfortune to watch a TV broadcast debate between the NSW Premier and the Leader of the Opposition. The people of NSW have my deepest sympathy. Neither candidate had anything original or noteworthy to say. They both seemed entrenched in ideology and slogans from the 1980's. Since the GFC, the ideologies and policies of the 1980's are under question both academically and at grass root level. Politicians and their faithful media scribes choose to ignore this changed real world environment.

The one topic which had some meat to it was the carbon tax issue supported by Labor and denounced by the Opposition. So where does this leave ordinary people who have to decide on March 26 which version from the 1980's should be elected. In this short discussion, I will try and highlight the pros and cons of the carbon tax without becoming involved in the quagmire of climate change veracity

The first problem climate change supporters have to explain is how they can believe in modelling projections decades into the future. This requires heroic assumptions on behavioural patterns of all variables that influence climate and environment decades out from now. These assumed variable behavioural patterns must remain constant and unchanged. Should any single variable or new knowledge change the understanding of these variables into the future, then model projections made now become worthless. In the final analysis, models simply reflect contemporary value judgements of the model architect. How highly educated scientists can believe model projections decades into the future lies in political beliefs rather than sound reasoning

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The profession for comparison is economics. Econometrics (mathematical economics)has decades of experience in model building of economic systems. The underlying assumptions of these models beggar belief. The most questionable underlying assumption is rational man or rational expectations. This heroic assumption asserts that people will take best options available given all known information. The 2008 GFC sorted out these model dreamers rudely and savagely along with most other market based economic theories. To all but the economic modelling profession, model projections are considered something akin to voodoo economics. So the climate change zealots relying upon model projections, are little different to political spin doctors.

Remember media economists who were running around in the first quarter of 2008 demanding the RBA raise interest rates because of the mining boom. The RBA Governor was in London lecturing on the need for central banks to raise interest rates. This is real world evidence that economic models had not identified that the GFC had started earlier around September 2007. Except for Australian market economists, most other western nations were aware that something significant was happening by the first quarter of 2008. It was obvious to most observers that model builders had no idea of what was happening in the real world. The underlying assumptions of the models simply did not reflect the working of the real world and model projections were worthless.

Despite the convoluted messages being delivered by Professor Garnaut, policy to address pollution is not some profound concept known only to the enlightened few. The topic is taught in second and third year microeconomic courses. The concept is simple. Policy attempts to efficiently reallocate resources so the impact of an economic activity between two players does not impact negatively upon a third party. The impact upon a third party is called an externality which simply means an outcome external to the market system. The external outcome can be either beneficial or damaging. In the case of pollution, the externality is unwanted and harmful to those beyond the immediate market transaction of production and consumption. In the case of dirty energy production, the unwanted or harmful outcome is green house gas.

There are two academic policy instruments that can be used : taxation or subsidy. Taxation solutions can be either a direct tax upon output; or; by creating property rights which can be bought and sold in a structured market. Once property rights have been structured by legislation, permits are auctioned to the highest bidder. The taxation approach is much simpler. It just imposes a tax on output. The alternative policy instrument is a subsidy. Polluting industries are offered a bounty to change production systems and reduce harmful impacts.

No approach is costless to the underlying economic system. From economic theory perspective, the most efficient policy is to subsidise the polluter under strict and finite conditions. The less efficient method of taxation is the preferred political option of post 1980's "new right" of politics because it is supposed to be "market imitation".

The whole idea of intervention is to change behaviour of either the polluter or the consumer. For example, the tax option raises costs of production as the carbon tax becomes an input cost. Prices of goods rise and encourage consumers to substitute cheaper alternative products assuming they are available. Producers then either find cheaper production methods or close shop.However, once compensation is introduced at various levels of production and consumption, the efficiency of the tax becomes compromised. Policy becomes watered down and weakened. Providing compensation to consumers for rising prices does not encourage change to either consumption or production. It is self defeating. In the end, taxing of carbon combined with compensation devolves into simply broadening the tax base.

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Compensation through income tax relief becomes a contradiction in terms. The higher the income, then the greater would be the tax relief. Non- taxpayers would not receive compensation. Such a compensation system would simply redistribute from the poor to the rich.

It was amusing to watch the Treasurer argue that the proposed policy was not a tax but a levy. His point was that as no income was being taxed, it was a levy. That shows how little the subject is understood. Under the Australian Constitution, revenue sources for the Federal Government are either direct or indirect taxes. There is no such thing as a levy. Direct taxation is revenue raised from incomes of individuals and companies. Indirect taxation is raised from taxation on production and manufacture of commodities (excise duty, GST) and custom duty on imports of goods and services. So the whole debate over whether or not the carbon price is a tax or something else is simply political spin designed to confuse the public.

There is no question that any policy which seeks to raise cost of production, has ramifications far wider than the political debate is prepared to recognise. By imposing a carbon tax on industry, any firm trading internationally will be less competitive than non taxed international competitors. Domestic firms competing with tax exempt imports are similarly disadvantaged. In both situations, Australian employment must contract. The idea being floated that green industries will provide adequate alternative employment opportunities is a nonsense argument. Such claims are a revamping of the old discredited malleable capital fallacy. Under nineteenth century classical economic theory, if one industry closes down, another simply absorbed the idle resources and nothing changed. This proposition was discredited in the Great depression along with its economic philosophy.

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About the Author

Ben Rees is both a farmer and a research economist. He has been a contributor to QUT research projects such as Rebuilding Rural Australia. Over the years he has been keynote and guest speaker at national and local rural meetings and conferences. Ben also participated in a 2004 Monash Farm Forum.

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