Treasury modelling of a carbon tax

I teach my post-grad­u­ate stu­dents of inter­na­tion­al trade that the val­ue of eco­nom­ic mod­el­ling lies not in the pro­jec­tions —which are unre­li­able at best—but in the insight that build­ing mod­els pro­vides into how a trad­ing econ­o­my works.

The exchanges between Ms Gillard and Mr Abbott in the past day or so about mod­el­ling “com­pen­sa­tion” for the pro­posed car­bon tax sug­gest that the Prime Min­is­ter believes mod­el­ling is suf­fi­cient­ly accu­rate to guide the fine-tun­ing of her tax and “com­pen­sa­tion”. But if the Treasury’s 2008 mod­el­ling of the pro­posed ETS are an indi­ca­tionof the sort of advice she is get­ting about the impact of her tax then I can’t agree.

I’ve revis­it­ed the sum­ma­ry con­clu­sions of the 2008 Trea­sury report on the impact of Ross Garnaut’s sug­gest­ed $30 per tonne impost on CO2 emis­sions. These brief “talk­ing points” are jam-packed with pan­gloss­ian assur­ances and incred­i­ble assump­tions that allow Trea­sury to pre­tend that all will be well. But if you pay atten­tion to what the mod­el tells us about the struc­ture of our economy—stripped of the glow­ing gloss—the out­come is hor­ri­ble, espe­cial­ly con­sid­er­ing the utter futil­i­ty of the emis­sions-cut ges­ture. The tax will mean our econ­o­my will be small­er, slow­er-grow­ing, with few­er prospects and much less attrac­tion for for­eign investors…

The ital­i­cised text is from the Treasury’s sum­ma­ry of their report:

  • Large reduc­tions in emis­sions do not require reduc­tions in eco­nom­ic activ­i­ty because the econ­o­my restruc­tures in response to emis­sion pric­ing.
    • Facts: The mod­ellers project that with a $30/tonne CO2 price our econ­o­my would grow more slowly—despite some mad­ly opti­mistic assump­tions built into the model—so that instead of being 11% rich­er by 2020 we’ll be only 9% rich­er. That’s a dif­fer­ence of about $20 bil­lion dol­lars (or half of an NBN) in today’s mon­ey or about $1000 for every Aus­tralian.

      Just how mad are the assump­tions about adjust­ment built-into this mod­el? Here are the incred­i­ble assump­tions that Trea­sury has used to pad its esti­mates of elec­tric­i­ty sup­ply:
      By 2050, the share of elec­tric­i­ty gen­er­at­ed by car­bon cap­ture and stor­age ranges from 28 per cent in the CPRS -15 sce­nario to 39 per cent in the Gar­naut -15 sce­nario. The share of renew­ables con­tin­ues to rise strong­ly through the 2020s and 2030s. By 2050, the share of renew­ables is 40–51 per cent in the pol­i­cy sce­nar­ios, com­pared with just over 5 per cent in the ref­er­ence sce­nario (Chart 6.25).
      Memo: The major­i­ty of CCS pilot plants around the world have yet to be com­mis­sioned or are “on hold”, usu­al­ly pend­ing gov­ern­ment fund­ing. Aus­tralia has one, tiny, pilot plant due to come into oper­a­tion in 2011 with sub­stan­tial gov­ern­ment research sub­si­dies. As for renew­ables, accord­ing to the indus­try lob­by group, the “Clean Ener­gy Coun­cil”, renew­able ener­gy account­ed for 5.2% of (elec­tric) ener­gy con­sump­tion in 2009 despite sub­si­dies that the Pro­duc­tiv­i­ty Com­mis­sion esti­mates as equiv­a­lent to a cur­rent tax of $44–99 per tonne of CO2 saved by these indus­tries! On what basis then, does Trea­sury project a ten-fold increase in the pro­por­tion of renew­able sup­ply fol­low­ing the intro­duc­tion of a $30 CO2 price? Fan­ta­sy, pure fan­ta­sy.
  • Real house­hold incomes con­tin­ue to grow, although house­holds face high­er prices for emis­sion-inten­sive prod­ucts, such as elec­tric­i­ty and gas.
    • Trans­la­tion: The tax is not, in fact, fatal. The econ­o­my stum­bles on although, giv­en the unre­al­i­ty of the assump­tions, the gas and elec­tric­i­ty price impacts will be larg­er than the results indi­cate. The tax makes us poor­er and life hard­er, espe­cial­ly for those doing it hard now.
  • Some costs are unavoid­able and would arise regard­less of whether Aus­tralia choos­es to par­tic­i­pate in the glob­al mit­i­ga­tion effort. These costs arise from oth­er economies’ actions, par­tic­u­lar­ly through trade in ener­gy- and emis­sion-inten­sive com­modi­ties.
    • Trans­la­tion: This can be tak­en two ways; both bad. Either oth­er economies raise car­bon prices so we pay more for imports of every­thing OR oth­er coun­tries do not raise car­bon prices, we go it alone, and we don’t export as much as we used to. But the first is not hap­pen­ing and the sec­ond, if it hap­pens, will be our own stu­pid choice (not ‘unavoid­able’ at all).
  • Australia’s mit­i­ga­tion costs are high­er than most devel­oped economies due to its large share of emis­sion inten­sive indus­tries.
    • Facts: No ques­tion that this is right. We’ll cut our own growth and dam­age our com­par­a­tive advan­tage in trade for a reduc­tion in glob­al CO2 emis­sions that is unnec­es­sary and use­less (less than one hun­dredth of one per­cent).
  • Inter­na­tion­al trade in per­mits reduces the cost of Australia’s con­tri­bu­tion to the glob­al mit­i­ga­tion effort. Australia’s emis­sions fall sig­nif­i­cant­ly once new low-emis­sion elec­tric­i­ty gen­er­a­tion tech­nolo­gies become cost-effec­tive.
    • Facts: It’s hard to see a per­mits-allowance being cou­pled with the pro­posed car­bon tax: it would cre­ate too much leak­age (pur­chas­es from NZ) to allow the gov­ern­ment to fund its “com­pen­sa­tion” pack­age. But it won’t hap­pen even if we move to an ETS. The “per­mits” exchanges in the USA and Europe are col­laps­ing because the mar­ket has appar­ent­ly worked out that the car­bon pan­ic has peaked and the per­mits are are worth much less than their face val­ue.
  • Allo­ca­tion of some free per­mits to emis­sion-inten­sive trade-exposed sec­tors, as the Gov­ern­ment pro­pos­es, eas­es their tran­si­tion to a low-emis­sion econ­o­my in the ini­tial years. Shield­ing redis­trib­utes costs from shield­ed to unshield­ed sec­tors, and could redis­trib­ute costs amongst shield­ed sec­tors.
    • Facts: This device make the mod­el­ling out­puts look bet­ter. But free per­mits won’t hap­pen under a car­bon tax.
  • Australia’s com­par­a­tive advan­tage will change in a low-emis­sion world. Impacts on Aus­tralian pro­duc­ers will depend large­ly on their emis­sion-inten­si­ty rel­a­tive to oth­er pro­duc­ers.
    • Facts: Again, no ques­tion our com­par­a­tive advan­tage will change. As the Pro­duc­tiv­i­ty Com­mis­sion notes; for the worse.
  • Low­er demand for Australia’s emis­sion-inten­sive com­mod­i­ty exports could gen­er­ate ben­e­fits for oth­er export-ori­ent­ed and import-com­pet­ing indus­tries through its impact on Australia’s exchange rate.
    • Facts: This is the sil­li­est of all the talk­ing points. What it means is that non-resource indus­tries will breathe a sigh of relief because the min­er­als-led boom could be killed dead by emis­sions con­trols. The val­ue of the dol­lar (not to men­tion the lev­el of inward invest­ment flows) will plum­met and we’ll all be worse off. But, hay! Wool will again be a lead­ing Aus­tralian export!

      Here’s how the Trea­sury, with exem­plary sangfroid, describes our descent into to this mis­er­able “pol­lu­tion free” econ­o­my:
      Australia’s trade bal­ance improves as imports fall by more than exports. Imports fall as con­sump­tion and invest­ment fall. Aus­tralian exports fall, but are par­tial­ly held up by demand from Chi­na and oth­er economies ini­tial­ly not in the trad­ing scheme. The trade bal­ance reduces the cur­rent account deficit, reduc­ing Australia’s for­eign debt and for­eign inter­est pay­ments, lead­ing to a high­er GNP.”
      Trans­la­tion? We’re still not dead (yet) and we have less debt; but that’s because our econ­o­my is small­er and poor­er than it could have been. Duh!

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