Stuck in a policy of odd origins

WITH more compensation packages than boat arrivals, the carbon tax is a policy at war with itself.

And barely a week after the tax came into effect, the government, having boasted about its careful design, is reportedly canvassing changes that further undermine its rationale.

Those changes are to the floor price, which sets the threshold below which permit prices cannot fall once the emissions trading scheme comes into place. The legislation creating the scheme specifies that the floor price in 2015-16 will be $15, increasing at 4 per cent a year in real terms.

But $15 now seems absurdly high. Where permits are traded internationally, or emissions credits sold, prices are less than half that level. Given that difference, the current floor price not only risks imposing crippling losses on Australian producers but also looks bad, starkly revealing the chasm between Australian and world carbon prices. The government is consequently said to be considering options that would allow closer alignment between Australian charges and at least those in the EU.

Unfortunately, the high floor price is the effect, rather than the cause, of the problem. The fundamental issue is that both the level of the carbon tax and that of the subsequent floor price in the ETS were set on false premises.

Those premises were that the world would move, surely if unevenly, to economy-wide emissions trading. The prices that emerged as that occurred would, in the first instance, reflect the commitments countries had made at the 2010 Cancun climate change conference. Over time, those prices would increase steadily, with that predictable price path encouraging firms to make expensive up-front investments in low-emissions technologies. As a result, Australia could fix its carbon price trajectory on the basis of the Cancun commitments without seriously damaging our competitiveness.

Those assumptions underpinned Treasury's carbon tax modelling, with its unified international price for carbon in 2016. But anyone in Treasury who still believes that fantasy should be transferred to the safety of a home for the bewildered.

For not only is global agreement more remote than ever, it is also clear that the markets in which permits are traded attach little credibility to the Cancun commitments. Moreover, markets know that if those commitments are met, it will not be because of governments tightening the screws on emissions. Rather, it will be thanks to depressed demand, reflecting a prolonged European recession and plentiful natural gas and slower than expected economic recovery in the US. As a result, permit prices will remain low.

As for the developing countries, some will indeed act to slow the growth of emissions. But those actions will be limited in scope and effectiveness, especially as they are offset by substantial subsidies to energy use that increases emissions. Cheap abatement credits in developing economies will therefore be abundant.

That leaves the Australian scheme swinging in the breeze, imposing costs for no environmental benefits. The sensible response would be to scrap it altogether, along with the renewable energy targets, and start again, referring the whole issue to the Productivity Commission for the rigorous, independent inquiry it has never received. Instead, the government seems intent on fiddling at the edges, first by ad hoc compensation measures and now by tinkering with the floor price. But even that is likely to prove highly costly.

To begin with, the Greens would hardly accept a reduction in the floor price without a struggle. After all, they could argue, Climate Change Minister Greg Combet has repeatedly stressed the goal is to provide a "predictable, long-term price signal" whose steady rise investors in renewables and other low-emissions technologies can rely on, with the high floor price underpinning their confidence.

How could that goal be served by first setting the tax at $23 and then allowing permit prices to collapse to less than half that?

Fair point. But the reality is that a high floor price could never eliminate the risks associated with global climate change policy: it only shifted those risks from investors in renewables on to other industries and consumers, adding waste along the way.

That was always inefficient; that the government thought it could endure was hubris.

Now, doubtless, it will pay for that hubris in striking a deal with the Greens. And that deal will doubtless involve further costly gifts from taxpayers and the community to the Greens' supporters in the renewable energy lobby.

But the difficulties the government faces don't end there. The problem is that the spending the scheme's proceeds are to fund has been largely locked in. As a result, lowering the floor price reduces revenues far more than it reduces outlays, degrading the budget bottom line.

In fact, if the floor price is lowered to $10, rising from then on by 4 per cent in real terms annually, and that floor price prevails, the $7.5 billion 2015-16 commonwealth surplus assumed in the 2012-13 budget shrinks to $3.5bn. Moreover, taking the whole period from 2015-16 to 2019-20, the fiscal position worsens by $25bn. To leave budget outcomes unchanged, the government would therefore need an additional $25bn in revenues, spending cuts or both.

That seems wildly unrealistic. Rather, the fiscal position the government leaves its successors is likely to be even more precarious than the most recent budget suggests, with even greater burdens shifted on to future taxpayers. But that begs an important question. The government would not consider reducing the floor price unless it thought there was a material likelihood of the current $15 floor being unsustainably high. Yet merely weeks ago Wayne Swan announced a surplus predicated on a 2015-16 permit price of $29. What has changed since then? Nothing.

So much for budget honesty. But this government would scarcely worry about such intellectual niceties. Instead, it pins its hopes on the carbon tax, like the GST, rapidly fading from public consciousness.

Yet the opposite seems more probable. The closest parallel is Work Choices. Imposed without a clear electoral mandate and out of step with the public mood, it proved politically poisonous, generating a bad news story virtually every day. Constantly on the back foot, the Howard government's tinkering then rendered an already complex scheme increasingly impenetrable. Far from fulfilling the original vision, each concession only made its ultimate frustration all the more certain.

That is the syndrome in which this government is caught. Trapped in a policy whose foundations were flawed from the start, the symptoms of morbidity abound. If it continues this way, all that remains is the fall.