Do climate policies have a budget 'black hole'?

Outgoing Secretary to the Treasury, Ken Henry, concluded major tax reform packages mustbe 'purchased'. That is, they must cost the Budget a reduced surplus if reform 'losers' are to be compensated (eg, via tax cuts), to make packages politically acceptable.

Having participated in the tax reform process in Australia since 1984, I think Ken is right. Does this also apply to greenhouse gas abatement policies?

I don't know Ken's opinion, but I think the answer is 'yes'. Climate policy is effectively about tax reform packages, whether it's 'direct action', carbon prices or emissions trading schemes (ETS). Global warming benefits of climate policies would accrue far into the future, not the next few years. The case for 'purchasing' reforms reducing greenhouse gas emissions is stronger than for 'conventional' tax reforms.

Ross Garnaut now suggests linking introduction of a carbon tax with broader Henry Review tax reforms. Does this imply carbon tax revenue can 'purchase' not only climate policy but also other tax reforms?

I don't think so, without a new round of Budget savings. A practical revenue-neutral carbon tax cannot maintain real consumption spending, let alone increase it via net tax cuts.

So, to 'purchase' climate policy (and other?) reforms, where's the money coming from? We don't have a lazy $5 - $10 billion or so Budget surplus at present. We might need new savings of that order just to get back to surplus (in a 'headline' sense, not a 'structural' sense).

This applies whether policies target national emissions production or consumption, and use an ETS, carbon taxes, or so-called 'direct action'. Consider some examples.

Assume a 100% effective climate policy stopping all emissions targeted. This would require impossibly detailed information, and be administered by an Omniscient Being rather than fallible politicians.

This policy maximises cuts in greenhouse gas emissions – the object of the exercise. Policy costs – whether regulation, purchase of abatement commitments, or an emissions tax – would be charged to the Commonwealth Budget and/or increase costs to energy producers and users.

Taxes, and/or energy prices would rise. Budget savings would also 'cost' those affected. (See Panel A in Figure 1.)

This 'perfect' climate policy can't be 'purchased' from revenue it raises. There is none.

Alternatively, assume imposition of an ETS or a carbon price that is 100% ineffective (eg, the price is too low). Economic activity continues with the same emissions. Revenue collections are maximized, because emitters now pay for their emissions.