Designing a carbon tax

Let’s look at the pic­tures (click for a larg­er image).

A car­bon tax on pro­duc­tion (sup­ply) cuts out­put through the impact of the tax on pro­duc­er returns which are low­er at any price lev­el as a result of the tax. Low­er returns means less pro­duc­tion. But a tax on con­sump­tion (demand) cuts demand by reduc­ing the amount con­sumers can buy at any giv­en price. The impact of the two on out­put can be the same, depend­ing on the size of the tax and the price-respon­sive­ness (elas­tic­i­ty) of sup­ply and demand.

But the cru­cial dif­fer­ence for an exporter of coal and LNG is that cut­ting our local sup­ply by means of a pro­duc­tion tax means high­er prices: in export mar­kets, too, if some but not all export mar­kets also apply a pro­duc­tion tax. Although the tax is assumed to be suf­fi­cient­ly large to reduce demand, pro­duc­er returns in the glob­al mar­ket could be bet­ter than they are today because we will not be tax­ing pro­duc­tion for export. The ‘wind­fall’ for our untaxed exports would be tak­en away by a bor­der-tax adjust­ment (‘duty/excise’) in those export mar­kets where a pro­duc­tion tax also applies. But in devel­op­ing coun­tries that do not impose tax­es on car­bon (Chi­na?), the only impact will be rise in the glob­al price of coal, LNG etc. reflect­ing the price impact in the glob­al-mar­ket of pro­duc­tion tax­es in devel­oped coun­try mar­kets.

Carmody’s oth­er objec­tions to a pro­duc­tion tax are not very per­sua­sive:

  • He fears bor­der-tax adjust­ments in trade—exempting exports from a pro­duc­tion tax and tax­ing imports to the lev­el of the local pro­duc­tion-tax equivalent—will be messy. But con­sump­tion tax­es result in the same adjust­ments for any man­u­fac­tured exports that use taxed com­po­nents. They have worked smooth­ly and un-con­tro­ver­sial­ly in glob­al trade for decades.
  • He argues that if Aus­tralia uses a pro­duc­tion tax then our pro­duc­ers will move off-shore to places where there is no such tax. But it’s not so easy to move coal mines or LNG pro­duc­tion and, at the planned rate of $20 per tonne of car­bon, the tax is like­ly to be a small fac­tor in deter­min­ing where to mine. In any case, bor­der-tax adjust­ments elim­i­nate the advan­tage for even man­u­fac­tured prod­ucts to relo­cate pro­duc­tion to ‘low-tax’ coun­tries.

One Comment

  • John Humphreys wrote:

    A tax on pro­duc­ers will either be passed on to con­sumers (if demand is rel­a­tive­ly inelas­tic), or it will reduce the via­bil­i­ty of the pro­duc­er (if demand is rel­a­tive­ly elas­tic).

    Demand for elec­tric­i­ty is rel­a­tive­ly inelas­tic, so the cost increas­es are like­ly to be passed on to consumers—both house­holds & busi­ness­es. Some of those busi­ness­es will then pass on the high­er costs to *their* con­sumers… but some oth­ers will have to com­pete against untaxed for­eign goods and so will be at a com­pet­i­tive dis­ad­van­tage.

    Putting the price at the con­sumer end will lead to the same pro­duc­er incen­tives… as peo­ple will pre­fer to buy (cheap­er) low-car­bon goods and pro­duc­ers will pre­fer to buy (cheap­er) low-car­bon ener­gy. But a con­sumer tax avoids the prob­lem of being at a com­pet­i­tive dis­ad­van­tage com­pared with for­eign firms.

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