The carbon tax, compensation and households: a two-party comparison

The two major parties have taken different approaches to compensating households for the carbon tax. Jonas B

The two main political parties agree to reduce greenhouse gas emissions by 2020 to 5% below the 2000 level, or about a 20% reduction below business as usual. However, they propose very different policy interventions, which, in turn, will have different effects on households.

Labor government policies to reduce greenhouse gas emissions include: placing a price on greenhouse gas emissions by way of a carbon tax starting at $23 a tonne of CO2 from July 2012, and then switching to an emissions trading scheme from July 2015; recycling most of the approximate $8 billion yearly revenue windfall to households to raise their disposable incomes and to selected businesses; retaining regulations such as the renewable energy target, fluorescent light bulbs, and building design restrictions; and subsidies for investments in some low-carbon technologies and for farm capture of carbon.

If the Coalition is elected, it proposes to: repeal the carbon tax and emissions trading scheme; retain Labor’s increases in social security payments and lower income taxation; retain most of the current regulations; and implement a larger system of subsidies for businesses to reduce greenhouse gas emissions, but with the details to be decided.

For households, the Labor package can be described as a tax-mix change package. Placing a price on carbon is a type of indirect tax increase. Similar to the GST, most of the carbon tax ultimately is passed on to households as higher prices. Prices of carbon intensive products, and in particular energy, are expected to rise by from 9 to 11 per cent. But, prices of carbon extensive products, such as clothing, will rise very little.

For the average household expenditure mix, the cost of living will rise by about 0.7%. The increase in social security payments (some of which have been paid already) and reductions in income tax from July 2012 of up to $300 a year will increase disposable incomes for all low and many middle-income households to over compensate for the higher cost of their expenditure.

Election of the Coalition to government - assuming they follow their current policy - would leave the Labor government increases in disposable income, but remove the price on carbon. In turn, prices of greenhouse gas intensive products - and in particular, energy - would fall, and there would be a one-off fall in the average cost of living.

Initially, the carbon tax or cost of tradable permits, is an additional cost of production paid by about 350 large companies in the electricity generation, petroleum products, some mines and waste dumps, and some manufacturers. These represent about 60% of Australia’s greenhouse gas emissions. Most of the extra cost of the price on carbon will be passed on to customers as higher prices in the same way as businesses pass on higher costs of labour and materials.

Because all businesses use energy as an intermediate business input, in time all businesses in the economy will be affected by the price on carbon. The more energy intensive the business, the greater is the incentive to (and the reward from) changing production methods and the product mix to reduce the now more expensive energy input. In turn, these decision changes reduce their use of energy and their carbon footprint.

The relatively higher prices for greenhouse gas intensive products and the higher disposable income package will have a number of direct and indirect effects on households. First, the package changes relative prices to encourage households to shift their expenditure from greenhouse intensive products to greenhouse extensive products, and so to reduce their carbon footprint. As a result, some might keep warm by wearing an extra jumper and turning the heater down a bit; trade-in for a more electricity-efficient white appliance; catch public transport or walk rather than drive; and generally become more conscious in their use of electricity.

Second, lower and most middle-income households will be able to maintain their living standard because of the compensating increase in their disposable income - but in a less carbon-intensive way. In aggregate, household compensation will exceed $5 billion a year. Some middle income and all higher-income households will not be fully compensated for the higher cost of living. Some years into the future, and with the benefit of forthcoming information on the price of carbon under an emissions trading scheme, the government likely will revisit the income compensation part of the policy package.

Third, for some employees, policy interventions to reduce greenhouse gas emissions will result in changes of employment. Placing a price on carbon, or subsidising carbon reduction, involves structural changes throughout the economy. Some jobs will be lost in the carbon-intensive sectors of the economy, but new jobs will be created in industries and firms meeting the increased demand for and production of carbon-extensive products and production processes.