FEATURE: The economics of climate change

As the political wrangling over Australia's emissions reduction scheme continues, many policy analysts argue that an ETS is too complex, ineffective and open to fraud.

And critics on both the left and right say a carbon tax is a much better solution.

Joanna McCarthy

Last Updated: Mon, 7 Dec 2009 15:32:00 +1100

In 2006, the Stern Review described climate change as the greatest and most wide-ranging market failure the world had ever seen.

It argued that failing to tackle global warming could cost as much as 20 per cent of annual global Gross Domestic Product, whereas stabilising temperatures to manageable levels, would cost only 1 per cent of GDP - a figure later revised to 2 per cent.

In short, says Australia Institute economist and executive director, Richard Denniss, the cost of moving to a low carbon economy, was much greater than the cost of doing nothing.

"Now, people had been suggesting that for a long time, but what the Stern review did, was to quite comprehensively show that we would be irrational, we would be frankly mad to focus on the cost of tackling climate change, and ignore the cost of not tackling climate change," he said.

"It would be like if the fire brigade came to put out your house, wondering how much the water was going to cost. There are costs associated with tackling climate change, but the clear evidence is that the costs of not tackling it are far larger.

Carbon price

The question became the most effective way of putting a price on carbon: an emissions trading scheme or a carbon tax.

The EU and the Australian governments backed a emissions trading scheme - a market-based system which allows polluters to buy and sell carbon credits.

Many economists, though, preferred a carbon tax, with an ETS earning criticism on both the left and the right - among them Kenneth Green, a Resident Scholar at the American Enterprise Institute.

"The major problem with carbon trading is that it's an inappropriate mechanism to apply for the control of greenhouse gases," he said.

"It won't actually achieve the stated end, which is efficient reductions in greenhouse gases, and yet it will open systems - especially democratic systems - to massive amounts of corruption.

"There's almost an infinite number to game the carbon market system because governments are basically insincere about what they want. The point of these trading systems is to raise the price of energy, and that makes you less competitive as a country. They don't wan't that, so they try to hide it in various ways - by exempting sectors, by giving free credits, by giving counterveling tax reductions - it's too easily gamed in any system that's vaguely democratic."

Complexity concern

The Australia Institute's Richard Denniss agrees; he says the Australian government's scheme shows just how dangrous it is to rely on something as complex as an emissions trading scheme.

"Because the CPRS that might soon be voted into law is entirely ineffective as a policy tool," he said.

"It ignores the science when it's setting the targets and it provides an enormous amount of compensation to polluters, but because of the complexity of the scheme - frankly almost noone understands it - the government can get away with putting up a scheme that most voters think will work and most polluters know won't.

Kenneth Green says a revenue neutral carbon tax will deliver a much better outcome.

"If one wants to achieve near-term reductions in greenhouse gases, carbon taxes, especially revenue neutral carbon taxes are the way to go," he said.

"Because if impose a carbon tax and you rebate the revenue by reducing taxes which are harming your economy, you can actually administer a bit of a tune-up to your overall economy that offsets the impact of higher energy prices based on the tax."