Exempting farmers from the CPRS: can we go the whole hog?

The Government proposes to exempt farmers from its Carbon Pollution Reduction Scheme (CPRS). This indefinite exemption covers direct cost increases otherwise arising if farmers had to purchase CPRS emissions permits.

Indirect cost increases affecting “upstream” and “downstream” supply chain inputs (for example, farmers’ purchases of electricity) will still increase farm prices, as measured from farm gate to final purchaser.

In GST jargon, farmers will be “input taxed” under the CPRS. This will increase export- and import-competing product prices. Eliminating these input cost effects on farm products would require exemption of the entire farm input supply chain. In practice, this covers most of the economy.

Farmers might be encouraged to reduce emissions by earning “carbon credits” for activities reducing greenhouse gas emissions (details aren’t available yet). If this shift from a “stick” to a “carrot” approach has merit, why stop at farmers?

Why not go the whole hog? Ditch the entire CPRS emissions permit regime, and adopt “carbon credits” incentives for the whole economy. After all, emissions reductions can be promoted two ways.

Taxes can be imposed on “bad” activities - emitting greenhouse gases. Alternatively, subsidies can be offered for reducing “bad” activities - reducing greenhouse gases.

In practice, bits of both approaches are envisaged under current policy in a number of countries.

Crucially, non-harmonised national action on climate policy is enshrined in agreements like the Kyoto Protocol, and national emissions production is the policy target for each country. In this context, rewarding reduced emissions, rather than punishing their production, has advantages.

Exports and import-competing products would no longer suffer losses of competitiveness if countries acting first were to subsidise emissions-reducing technologies for their own production, rather than taxing their emissions.

The “carbon leakage” problem for “first mover” countries would be eliminated. This would help remove impediments to developed countries acting ahead of developing countries, for example. “First movers” could act early, confident that late (or no) action by others would not adversely affect their international competitiveness.

If subsidies are less painful than taxes in producing the desired emissions reduction outcome, what are we waiting for? The CPRS taxation approach has failed since 1997 (the Kyoto Protocol) and earlier.

Sadly, there’s no “free lunch”. There are at least three practical problems with this approach.

The first is how to measure emissions reductions relative to “business-as-usual”. This is essential: (i) for ensuring the effectiveness of the subsidy-based approach; and (ii) for its efficiency - deciding who is eligible for the subsidies, and for how much.

This is difficult. It requires quantification of the “counterfactual” situation, (i.e., what would have happened in the absence of the subsidy scheme) in order to determine how much emissions have been reduced. There’s great potential for “rorting”. (Look at responses to environmental incentives in Australia, such as for home insulation, or in PNG.)

The CPRS tax approach “only” requires measuring actual emissions produced. This is hard. Good as Australia is on this, “carbon accounting” is still a work-in-progress. But the CPRS does not require estimation of the (unobservable) business-as-usual emissions path as well.

The second problem is Australia’s World Trade Organisation (WTO) obligations. When do production subsidies applied to selected Australian exports (for example, agriculture) become behind-the-border protection, inviting WTO action?

If farmers aren’t directly penalised by having to buy emissions permits for the greenhouse gases they produce, but can get “carbon offsets” for emissions reducing activities, can they “make money” in net terms out of the deal? If they can, are they getting export subsidies? If they are, that’s protectionist. Australia’s not the worst offender on agricultural protectionism, but increasing it hardly aids our campaign to reduce it overseas.

If others follow, this might clog up the WTO with an avalanche of trade rule breaches, souring the global trading environment and slowing world growth. At worst, we send a signal for others to use the cover of a “green” policy (with exemptions) to veer further into old-style protectionist habits. The global economic crisis has already stimulated such action around the world (and here). We don’t need to encourage it further.

Finally, how does Australia pay for large emissions reduction subsidies?

Financially, taxing emissions and subsidising emissions reductions are different.

Taxing emissions delivers revenue that can be used to finance reductions in other taxes, increases in subsidies, or increases in transfer payments to lower income groups. The focus is raising relative prices for emissions intensive products, not reducing real incomes. However, the extra revenue only lasts as long as emissions continue, and declines as they decline.

Subsidising emissions reduction is different. There’s no immediate source of extra revenue. The costs of reducing emissions must be paid for out of existing income and revenues.

If we are currently consuming our environment unsustainably, but don’t feel this because there’s no price on emissions, this makes sense. The benefit we pay for is a better environment later.

Subsidies should just offset the extra cost of producing goods and services with fewer emissions, compared with current technologies.

Emissions reduction subsidies increase Budget costs. These will be passed on in higher taxes and charges, or reduced government spending.

Will farmers get net “carbon offsets” via the detailed regulations if the CPRS legislation is passed?

I wouldn’t bet on it.