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Is Garnaut’s $26 per tonne the right price for carbon?

The most important single number in the latest Garnaut Review is 26, the proposed starting value for the carbon tax, expressed in dollars per tonne of carbon dioxide emitted. By coincidence, this is exactly…

Not that large? $26 is the single most important number in Garnaut’s report. AAP

The most important single number in the latest Garnaut Review is 26, the proposed starting value for the carbon tax, expressed in dollars per tonne of carbon dioxide emitted.

By coincidence, this is exactly the value I found (in a submission with Flavio Menezes and Liam Wagner on the Rudd government’s Green Paper on the emissions trading scheme) that would equate the costs of electricity generated from existing gas, brown coal and black coal power stations.

That estimate is a couple of years old and other methods give somewhat higher estimates, but the central implications are unaffected.

Given a carbon price that starts at $26 per tonne and rises over time, coal-fired electricity will gradually be pushed to the bottom of the ‘merit order’ in which power stations are added to the grid, based on their bids to supply power to the market pool.

New construction will be dominated by gas and wind power and brown coal power stations, the most polluting, will face an early shutdown.

Since, with our current generating mix, one Megawatt-hour of electricity is associated with about a tonne of CO2 emissions, a price of $26 per tonne will increase electricity prices by around $26 per MWh or about 2.6 cents per kilowatt per hour.

That’s small compared to the increases in prices we’ve seen as a result of higher distribution charges, so the tax won’t have a big effect on household electricity consumption, at least in the short run.

However, the effects on the mix of supply sources should be sufficient to produce the reductions in emissions required to achieve the 5% reduction on 2000 levels promised by the government.

As Garnaut points out, a price of $26 per tonne is comparable with the prices prevailing in the EU Emissions Trading Scheme and the price used in regulatory decisions in the US (currently $US21 per tonne).

It’s well below the price proposed in the UK as part of their commitment to reduce emissions 50% below 1990 levels by 2025.

Politically, the price is well below the $40 per tonne the Greens would prefer, but high enough that they are unlikely to be blamed by their supporters for accepting it as a necessary compromise. Conversely, the price is low enough to make nonsense of Tony Abbott’s claims about a Great Big New Tax on Everything.

At a rate of $26 per tonne, a broad-based carbon tax could be expected to raise around $11 billion or about 20% of the revenue raised by the GST.

The revenue can be expected to rise roughly in line with national income, given a 4% annual increase in the real price, partly offset by a gradual decline in carbon emissions.

But it is never likely to go much above 1% of national income, and the predicted price effect is also around 1 per cent on average.

The revenue is sufficient to fund some fairly generous compensation for low and middle-income earners.

Garnaut suggests raising the tax free threshold to $25,000 in line with the recommendations of the Henry Review. Higher income earners would face some increases in marginal rates.

They would pay no more in income tax, but would have to bear the cost of the carbon emissions implicit in their consumption choices.

Overall, Garnaut’s proposals are economically sensible and easy to understand.

They should be more politically saleable than the Carbon Pollution Reduction Scheme, which fell into the trap of trying to please everybody, and ended up satisfying no-one.