Garnaut's advice taxes both sides of politics

ROSS Garnaut has taken Julia Gillard's pledge to be an economic reformer at her word - he has advised Labor to exploit the revenue from pricing carbon to revive the Ken Henry tax reform agenda.

This creates new opportunities and fresh traps for both Gillard and Tony Abbott in the climate change battle that, so far, has destroyed Labor's poll ratings.

But the bigger picture in Garnaut's latest climate change update paper is his searing insistence that the choice Australia now faces is between the superiority of market-based pricing and the dinosaur of state regulation or what he brands "the Yugoslav variant of central planning". No prizes for guessing this disreputable brand hangs over the Coalition, though Garnaut avoids any direct accusation. His report only further heightens the stakes in this "fight to the political death" between Gillard and Abbott.

The effect of Garnaut's latest advice is paradoxical: advising Labor to a more reformist package ensures it will be an even harder "sell" to the public, yet if Labor legislates the Garnaut concept, it also becomes more difficult for Abbott to attack and to dismantle.

"I think there's a way through for Labor and for the multi-party committee," Garnaut tells The Australian. "The revenue raised from pricing carbon creates a nice opportunity to do what we should be doing anyway. Surprisingly little attention has been given to the opportunities carbon pricing presents for tax reform."

The point, of course, is this advantage exists only with Labor's carbon price scheme and not with Abbott's "direct action" plan. By creating a nexus between climate change reform and tax reform, Garnaut complicates Abbott's tactics and Gillard's choices.

Gillard's message to the public has been "don't worry" because the biggest share of compensation from carbon tax revenue will go to households. The Greens support this. But Garnaut has now added a new twist.

He backs Gillard's model of a two-stage fixed/flexible price. He advises the initial price needs to be about $25 a tonne, rising at 4 per cent in real terms annually, given Australia's bipartisan target of cutting emissions by 5 per cent by 2020 from 2000 levels.

After the document's release Abbott said Garnaut had confirmed the estimate the Coalition had been using to attack Labor.

Garnaut says the tax would raise $11.5 billion in its 2012-13 first year and wants the largest element (initially half but rising to a majority) devoted to productivity-raising reforms of the income tax system along the lines recommended in the Henry review.

He calls for reducing tax rates and the social security withdrawal tapers for low income earners, thereby promoting productivity and encouraging more entrants into the workforce.

"The basic ideas are in the Henry report," he says. "There are significant labour force and productivity gains if we do this."

But this poses a dilemma for Labor and its response, so far, is highly cautious. The previous idea underpinning support for households was direct compensation extending far up the income scale. For Labor, this was a political necessity. Gillard has pledged hefty compensation to stave off Abbott's attacks.

Now Garnaut has arrived with a different governing principle. There is one guarantee - Abbott's attacks will reach a new zenith if Labor retreats from wall-to-wall compensation.

Yet Garnaut's recommendation will shame Labor if it is rebutted. What credibility would Labor possess on tax reform for the rest of this term if it squandered such opportunity? It shunned the bulk of the Henry review last term. Will it repeat this decision again this term even when it has the carbon tax windfall?

Moreover, once the carbon package is legislated the dilemma becomes Abbott's: his campaign to abolish a great big carbon tax would be more complicated because the carbon tax would finance a productivity-enhancing tax reform at the lower end of the income range.

On assistance to trade-exposed industry, Garnaut's proposals are equally challenging for Labor. His philosophy is obvious.

"My main focus is getting this system right for all time, so it doesn't become a honey-pot for rent seekers," he says. "Let's get it right, let's get the principles right and stop assistance becoming a permanent cancer in the body politic." Sure. But this hardly equates with Labor's perspective.

Garnaut utterly opposes compensating industry as such for a carbon price. On the contrary, he believes in industry compensation only to the extent that because other nations have no carbon price this puts Australian industry at a cost disadvantage.

As a result, he says assistance must be transitional. He rejects any industry support arising from profit damage or asset losses, saying this is no different from seeking taxpayer support for tobacco company profit losses due to smoking restrictions. The Greens, as they have signalled, will back this Garnaut line.

Garnaut opposes the extra assistance (the "global recession buffer") offered industry in the final stage of the Rudd government's Carbon Pollution Reduction Scheme. He estimates that under the penultimate CPRS model, assuming a carbon price of $26 a tonne, trade-exposed industry would suffer only a modest carbon price ranging from $2.60 to $10.40 a tonne. In steel, for instance, the impact would be "tiny" in relation to recent price rises for iron ore and coal. The main trade-exposed sectors needing support are aluminium, alumina refining, petroleum refining, cement and iron and steel and overall. Garnaut finds CPRS levels of assistance are "generous" compared with the European Union.

Beyond this, he is determined to ensure any industry assistance is phased out. He proposes an independent regulator with "the type of constitutional protection" of the Reserve Bank to advise when global carbon prices reach a level that eliminates the economic justification for assistance. This regulator (a carbon bank) would rely upon analysis from the Productivity Commission or a similar body. All such reports would be public.

In short, Garnaut doesn't trust the politicians. He fears an extended rort and wants, as a check, to create independent institutions. "Without principles, there is no logical limit to emission-intensive trade-exposed industry assistance," he says, sounding the alarm.

This demands a purity that a pragmatic Gillard government, needing to win business support, will surely fail to match. But Garnaut offers a vital concession to Labor: because it takes time to develop such independent institutions he says that during the three years of the fixed price he would rely upon the CPRS approach. In addition, he wants transport inside the scheme but admits the problem of compensating for higher petrol prices.

As a result he suggests a one-off reduction in petrol excise and reform of the fringe benefits tax relating to private cars.

At this point the unease running through the business community is palpable. The Australian Industry Group's Heather Ridout warns that industry "has a number of concerns with [Garnaut's] proposals" as they affect business and industry.

Finally, in a move seized upon by shadow minister Greg Hunt, the Garnaut update wants to deploy 15 per cent of the revenue to purchase low-cost farm abatement. Indeed, Garnaut envisages spending up to $2.25bn on such abatement by the independent regulator in the period to 2020, a stand Hunt argues mirrors the Coalition's "direct action" policy.

There is, however, a critical optimism pervading the Garnaut updates. He is confident that other nations, notably China, are moving quickly on climate change action and that significant global progress will come in the next several years. This is a contested view.

Indeed, there is strong evidence that global political momentum for hard decisions is eroding. To the extent it erodes, then Australia's industry assistance will assume a semi-permanent status, the outcome Garnaut dreads.

Meanwhile Gillard faltered this week trying to explain her scheme, making two blunders on the ABC's Q&A program. She justified her carbon tax broken promise by claiming if she had formed a majority government she would have pressed ahead with an emissions trading scheme. Pardon? Her campaign policy, on the contrary, was for a citizens' assembly to test this issue. Gillard said in the campaign she would act only "when the Australian people are ready".

Incredibly, on China she argued it was closing down dirty coal-fired power stations at the rate of one every week or two. Pardon? Overall China is expanding its coal-based electricity generation.

The Prime Minister will need to improve upon these two efforts.

This was also the week she suddenly declared the Greens were a party representing the "extremes" of Australian politics.

It was a weak and belated effort to put distance between herself and the Greens. Everybody knew the game. A smiling Bob Brown played Gillard off a break saying she was into "product discrimination". But Abbott nailed Gillard: if the Greens were extremists, why had she entered into an alliance with them? Good question.

The lesson is that the more Gillard criticises the Greens, the more she condemns her own judgment.