Are Carbon Taxes Worth It? Australia Says No

July 22, 2014

Australia is the first developed country to both institute and repeal a tax on carbon. On Thursday, July 17, the Australian Senate repealed its carbon tax with a 39 to 32 vote.

After the repeal, Prime Minister Tony Abbot characterized the tax as destructive to jobs, families and the economy, without actually helping the environment. “The Carbon Tax was a $9 billion a year hit on the Australian economy,” he said, and stated that the repeal would “save the average Australian household $550 a year.”

Under the repealed law, liable Australian entities had just began paying the top rate of 25.4 Australian dollars per ton of carbon pollution emitted. Liable entities were mostly large emitters (25,000 tons of carbon dioxide per year), who cumulatively produced about 60 percent of the country’s emissions.

Australia implemented its carbon tax in July of 2012 with a tax of A$23 per ton of carbon. The tax was set to rise 2.5 percent each year until 2015 when a cap and trade system would be implemented.

Australia’s attempt to tax carbon indicates that raising the price of energy consumption is difficult to implement properly and can be politically unpopular. 

Why is Taxing Pollution so Difficult?

Setting aside the politics for a second, a carbon tax can make theoretic sense as a way to charge people for the social costs of their pollution. Economist call these uncompensated damages negative externalities. To offset these externalities, some economists recommend a tax on carbon emissions that is equal to the social cost of the pollution. These are known as Pigovian taxes, after the late British economist Arthur Pigou.

The problem is, such tax schemes must overcome two hurdles to be sound tax policy. First, the collected tax must go to remitting the damage caused by the externality. And second, policymakers must be able to know the uncompensated cost of carbon emission.

Additionally, regulators often lack sufficient knowledge or correct incentives to estimate and implement efficient carbon taxes. It is not an easy task to set a tax equal to the cost of the externality and distribute the revenue to compensate the appropriate individuals.

Why is Australia’s Experience Important to the United States? 

Australia has been called an important laboratory for U.S. energy policy because of the similarities between the two countries. The continental U.S. is roughly the same size as Australia, both countries are heavily reliant on carbon producing fossil fuels, and the distribution of emissions by industry are similar. Both Australia and the U.S. are among the top per capita carbon dioxide producers in the world.

The Australian laboratory for U.S. carbon tax policy seems to have demonstrated that politically, the costs of taxing carbon are prohibitively unpopular. The high social and economic costs of transforming an economy away from carbon emission are mostly borne by ordinary citizens. The first lesson in tax economics is: when people cannot quickly change their demand (as is the case with energy usage), most of the tax cost will be passed along to the consumer through higher prices.

A tax on carbon is, by extension, a tax on energy. Taxing energy raises the price of transportation, heating, cooling, manufacturing, and everything else that uses electricity, gas, oil, or plastic.

A tax on energy is a tax on growth and innovation. Historically, economic growth has been fueled by low energy prices and hampered by high energy prices. The Australian carbon tax has enforced this narrative by exacerbating the 2008 recession and handicapping its economic recovery.

Most of the revenue generated from Australia’s carbon tax went to tax breaks for low income taxpayers and subsidies to power plants and aluminum manufactures. In theory a carbon tax is intended to place upward price pressure on carbon emitting activities, forcing emissions to decrease. However, the revenue from the Australian tax was redistributed in the form of subsidies to low income energy consumers and to some of the largest polluters.

These two policies are fundamentally at odds. With one hand the government raised the price of energy, and with the other hand subsidized the use of carbon emitting energy to the tune of one billion Australian dollars.

The carbon tax did provide some funding for alternative and green energy projects, but again this use is not supported by sound tax theory. The increased price of energy under the tax regime would theoretically incentivize private actors to develop new technologies – allowing the market to decide what the most efficient alternative technologies are.

Instead, Australia invested much of the tax revenue into government research initiatives and subsidies for politically favored alternatives, displacing private investment. Well-structured tax policy would have used the tax revenue to mitigate climate related damage, not dictate future energy production.

While carbon taxes can be alluring on the pages of a text book, in practice they fail to become good tax policy. The laboratory results are in and Australia says they are done with the experiment.

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