Frank Jotzo: popular tax cuts and a carbon price that just might deliver

Tripling the tax-free threshold could be the spoonful of sugar that makes the carbon price palatable. AAP

Two years ago Australian climate policy looked dead. Now we are on the verge of legislation that puts a carbon price through much of the Australian economy, alongside new schemes to support renewable energy, improve energy efficiency and increase carbon sequestration on the land.

Although the carbon pricing scheme has its warts, the negotiations between Labor, the Greens and the Independents have also produced some genuinely positive outcomes. The package will not bring big reductions in emissions in the short term, but it can be the first step on the long road to a lower-carbon economy.

That long-term ambition is reflected in government now committing to an 80% reduction in emissions by 2050, up from 60% previously. Fresh from the government’s lockup, here is a look at the key features, and an early assessment of how they stack up against the yardstick of good policy.

The price

The scheme starts in mid-2012 with a government-mandated “fixed” price of $23 per tonne of CO2, rising to $25.40 in 2014-15. This fixed price period behaves like a carbon tax, but already uses the permit system needed for emissions trading.

The difference is that government issues an unlimited amount of permits at a fixed price. Once trading is introduced, there will be a fixed number of permits issued at auction, and a market price.

Today’s European emissions trading price in dollar-equivalent is $17, down from $23 a month ago on fears of recession and uncertainty about the effects of EU regulation on energy efficiency. Market expectations are that the price rises over time, and the Australian dollar is likely to come down, so by 2015 the the international price could well again be higher than the Australian price. Treasury assumes an international price of $29 in 2015.


Emissions trading will start in mid-2015. The price will then be determined in markets both through the interplay of domestic demand and supply, and access to international emissions units.

That will include offset credits from developing countries, and new types of offset units can be made eligible later. Linking with the NZ and EU trading schemes is on the cards, and possibly other schemes subject to quality standards and acceptable target levels. This means the Australian scheme will, in all likelihood, be deeply integrated with international carbon markets – in line with the open nature of Australia’s economy generally.

For the first three years of trading, there will be a guardrail for the price. There is a price floor set at $15, rising at 4% per year plus inflation, and a price ceiling that is $20 above the expected price in 2015-16, rising at 5% plus inflation.

The price floor helps manage risk for low-carbon investment, and will result in more domestic low-carbon investment. Getting this provision in is a win for the Greens. The price ceiling is very unlikely to ever be triggered – which is just as well as it would inhibit market operation and international linking.


The carbon price covers electricity generation and energy use other than for transport, industrial processes, fugitive emissions, and emissions from landfills.

The 500 largest emitters will have a direct obligation to hand in permits for their emissions, but emitters below the cut-off will still face higher costs for their carbon-intensive fuels. That is because their energy suppliers will have to hand in carbon permits, and will pass on the extra cost.

The same applies to household use of electricity and gas: suppliers will have to buy the permits, and pass the additional cost on to consumers.

Fuel for transport is only partially included. Private cars, light commercial vehicles, agricultural use, and gas powered vehicles will not face the carbon price.

For all others, a charge equivalent to the carbon price will imposed through changes to fuel tax credits and the fuel excise. Exempting private transport is one of the more regrettable compromises in the package, but the politics of petrol prices are clearly just too difficult.

A small fuel price increase would not have done much immediately, but longer term it would have accelerated the shift to more fuel efficient vehicles.

Agriculture is excluded from the scheme. That agriculture would be out had been clear for a long time, and a major reason for the exclusion is that measurement of emissions is difficult, and compliance with permit obligations at the farm level too costly.

Industry assistance

Emissions-intensive industries competing in international markets will get the same generous amounts of free permits as negotiated under the Rudd government’s CPRS.

The only real difference is that the arrangements are locked in for a shorter amount of time, and that the Productivity Commission will advise government on whether and when a shift to a principles-based system of industry assistance – which would likely mean less free money – should take place.

There will also be payments of about $1 billion per year to the most carbon intensive power stations, and the possibility of government loans to power stations and payments to close down stations.

The bottom line is that as under the CPRS, plenty of money will go to the highest emitting industries. This does not diminish their incentive to shift to cleaner production processes, but it is money that could have been used for low-carbon R&D and household assistance.

Household assistance

The standout feature here is a threefold increase in the tax-free threshold for income tax, to over $18,000. Together with changes to low-income tax offsets and marginal tax rates, this gives tax relief of $300 per year for anyone earning up to $65,000 a year, and $600 for people on $20,000 a year.

In addition there are increases in pensions and family tax benefits. The tax changes, inspired by the Henry tax review, and are good fiscal policy. Best of all, about one million people will no longer have to file tax returns.

The tax changes are likely to be very popular, and hence impossible to unwind. Any future government intent on reversing carbon pricing would have to find the money elsewhere to keep the income tax cuts in place.

Meeting the target

Most of the emissions savings in the short to medium term will come from power production and industry, switching from coal to gas for renewable energies, and improving energy efficiency, and putting in place technologies to clean up industrial processes.

Treasury modelling has over half of the early reductions coming from electricity generation. Significantly higher prices are likely to be needed to reduce Australia’s emissions to below year 2000 levels. This is because there is a strong underlying growth trends, including from resource industries.

Treasury modelling released today shows Australia’s domestic emissions at 12% above 2000 levels in 2020, even with a carbon price. On the other hand, experience has shown that market-based systems often achieve environmental outcomes more cheaply than anticipated. We might be in for a pleasant surprise, but don’t count on it.

Any shortfall between actual emissions and the target will have to be made up through international purchases of permits, including directly through businesses. Developing countries are the most likely supplier of emissions units, though it remains to be seen what new market mechanisms will be defined after the conclusion of the Kyoto Protocol.

What is the target?

The default national emissions target is a 5% reduction relative to 2000 levels, at 2020. A more ambitious target could be decided down the track, in line with Australia’s international pledge for a target between 5 and 25%, depending on what other countries do.

The big news out of today’s announcement is the government’s commitment to an 80% reduction by 2050. This will be factored into the decisions about near-term targets and amount of permits issued under the scheme.

Governance arrangements

A new Climate Change Authority, headed by former reserve bank governor Bernie Fraser, will advise the government on the future emissions caps within the emissions trading scheme, national emissions trajectories, and many other aspects of the scheme including the role of price floor and ceiling after the initial three years.

Government will have to respond to the Authority’s recommendations, and if it goes against the recommendations this will be highly visible in the public debate.

This change alone is a significant improvement from the previous scheme. Giving independent bodies a greater say in making progress on a very long term challenge like climate change.

Renewable energy support

The carbon pricing scheme announced today is part of a wider suite of policies to support R&D and investment in renewable energy, boost energy efficiency and improve carbon uptake on the land. The most important new initiative is the Clean Energy Finance Corporation, which will make available up to ten billion dollars of government loans for low-carbon energy investments.