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Carbon pricing is still the best way to cut emissions, if we get it right

Forestry is credited under New Zealand’s emissions trading scheme. World Resources Institute/Flickr, CC BY-NC-SA

Carbon pricing is still the best way to cut emissions, if we get it right

Forestry is credited under New Zealand’s emissions trading scheme. World Resources Institute/Flickr, CC BY-NC-SA

The Coalition government has recently axed Australia’s carbon “tax”, leaving us with no carbon price. Alternatives include the government’s “Direct Action” plan, or Clive Palmer’s proposed emissions trading scheme (ETS). Neither, as currently proposed, provides an effective price on carbon.

Former Labor climate change minister Greg Combet recently said that the carbon price repeal was “no more than a setback” and that carbon prices are the “most economically efficient, environmentally effective and socially fair” way to reduce carbon emissions.

Meanwhile, across the Tasman Sea, New Zealand has an ETS, although it is not working well. In fact, ahead of September’s general election, the New Zealand Green Party has announced that it wants to introduce a carbon tax to replace the ETS.

A carbon price is still the best and fairest way to achieve emissions cuts, but as Australia and New Zealand show, it’s not easy to get it right. How could carbon pricing be improved?

To trade or tax?

The answer lies in why the Greens have decided that it would be better to have a carbon tax instead of New Zealand’s ETS.

Ordinarily, an ETS should be the best way to reduce carbon emissions. This is because an ETS encourages firms, farms or households, for example, to reduce emissions by establishing a free market in carbon permits. Those who cannot afford the price to pollute have an incentive to reduce their emissions, while those who can will buy permits.

While the government can also set a price with a carbon tax, it does not know how much emitters want to pollute. This is why a market in permits can encourage emitters to reduce pollution to a desired level better than a tax might. The government can set the level and let emitters determine the price.

However, for an ETS to work effectively, the carbon price needs to be meaningful, and all participants need to cooperate and should be treated the same. By all accounts, this is not how New Zealand’s ETS has operated since it was introduced in 2008.

Is New Zealand’s ETS broken?

At the time, New Zealand’s ETS was heralded as a comprehensive cap-and-trade permit scheme, which included all economic sectors and all gases. However, the effectiveness of the scheme suffered from its reliance on offsets from forestry and from cheap overseas carbon units.

The scheme was modified in 2009, when the government deferred the inclusion of New Zealand’s agriculture sector, which accounts for about half of emissions. It also legislated transition arrangements, which included a “two-for-one” surrender obligation, whereby all emitters, except from forestry, were required to surrender only one unit for every two tonnes of emissions, and a NZ$25 price cap on New Zealand carbon units.

These features, combined with the collapse of carbon prices internationally, mean that New Zealand now does not have a meaningful carbon price. Its biggest polluters have not had an incentive to reduce their emissions or invest in low-carbon technologies.

In fact, they have effectively been subsidised to pollute. Firms, such as some power companies, have charged consumers for a higher carbon price than they have had to pay. This has been possible because of the price difference between NZ carbon units and cheap overseas units.

Even forestry — New Zealand’s carbon sink — is set to become a net polluter by the mid-2020s. This is when the forests that were planted after 1989, to meet carbon-reduction targets, will be harvested. The weak carbon price is not helping to encourage enough new planting to replace what will be felled.

The Greens have a point that the ETS is not working well.

A simple, comprehensive carbon tax

What is remarkable about the Greens' carbon tax plan is that it has not been framed as a way to save the Earth. The Greens have instead justified their proposed carbon tax as a better way to manage New Zealand’s carbon emissions.

In the absence of an effective global ETS, a domestic carbon tax is likely to be a better way of encouraging emitters to reduce emissions in countries that produce a relatively small share of the world’s greenhouse gas emissions, such as New Zealand and Australia.

Over the short to medium term, a tax would send a clearer price signal of emissions costs than an ETS with many offsets and loopholes. The Green’s tax would be set at NZ$25 per tonne on CO2 equivalent emissions for all sectors, with two exceptions for dairy and forestry.

The Greens would require dairy farmers to pay NZ$12.50 per tonne, because the party believes that farmers would not be able to pass on emissions reduction costs. This would make their exports less competitive.

Forestry would also be credited at NZ$12.50 per tonne of CO2 stored. The Greens' tax would be simpler than the ETS and include biological emissions, at a reduced rate.

If the rest of the world ever entered into a carbon trading scheme, to comply with the Kyoto Protocol targets, the Greens' tax would put New Zealand, if it chooses, in a robust position to participate. The tax should have helped New Zealand reduce its emissions and adapt to the costs better than its broken ETS.

Implications for Australian carbon policy

Australia would also be better off to adopt such a carbon tax than either of the alternatives (as opposed to the carbon-pricing mechanism that has just been repealed, which was designed as the first, fixed-price period of an ETS).

The government’s Direct Action policy does not require emitters to pay the cost of their emissions — it pays polluters to reduce them. Further, with the possibility that the biggest polluters will neither make all the reductions that they could nor participate at all, Direct Action is likely to be ineffective at reducing Australia’s carbon emissions over the long term.

The Palmer United Party’s proposed “zero-price” ETS would be ineffective, too, as a carbon price would only be introduced once the United States, Japan, South Korea, the European Union, China and India have taken significant action to reduce their emissions. As with New Zealand, a tax would prepare Australia for an ETS.

Maybe the Coalition, and the New Zealand government, should take a leaf out of the Greens' book when it comes to fairly managing Australia’s carbon emissions and implement a simple, comprehensive carbon tax.