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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