A Sustainable Climate Policy

In the wake of Typhoon Haiyan, one of the strongest to ever make landfall, the Philippine delegate to the climate talks in Warsaw made a desperate plea for nations to act on climate change. President Aquino when asked by CNN’s Christiane Amanpour whether he believed the warming of the planet had a direct link to the severe weather event affirmed the position. British Prime Minister David Cameron made a similar statement.

The Inter-governmental Panel on Climate Change says that severe weather events will be the consequence if carbon pollution is not abated. And yet what we find is advanced countries like Australia, Canada andJapan, that are all led by conservative governments, back-tracking or weakening their stance on the issue. 

Governments around the world from Beijing to Washington are grappling with the problem to avoid what economists call “the tragedy of the commons”. This is a situation where when a certain market activity has a negative by-product (such as emitting GHG into the atmosphere) and people are free to do (no cost is attached to it), then it will be engaged in excessively to the detriment of all. The only way to avoid this outcome is to make economic agents absorb the cost associated with abating the negative by-product.

The question that policymakers worldwide are grappling with is who should absorb the cost and what mechanisms are needed to make them absorb it? A carbon tax gives residents the right to free air and imposes the cost of abatement on the polluter. The problem is that polluters will then pass on the cost on to consumers.  An alternative would be to pay polluters to stop polluting using taxpayer’s money.

From an economic perspective, it does not matter which mechanism is used as long as no one has the ability to "game" or influence the system. From a political point of view, however, framing the policy as a tax or incentive may have enormous consequences as the Australian Labor Party painfully realised in the last election.

Beyond the theatre and drama of the climate change debate, the political players have to find some kind of common ground, though to make whichever solution is opted for credible and sustainable. One prime example of this is the climate change policy adopted by British Columbia (BC), which has been in place since 2008 and whose popularity remains intact and has even increased.

It involves a tax that puts a price on carbon that is returned to citizens and businesses through reduced income taxes and increased tax credits or benefits. The tax is broad based covering the use of fossil fuels for electricity and vehicles. The policy has reduced the consumption of taxed fuels per capita by 19 per cent in the BC relative to the rest of Canada. GHG emissions in the province fell 10 per cent between 2008 and 2011, compared to a fall of 1.1 per cent for the rest of Canada.

The carbon tax was originally set at C$10 per tonne of carbon dioxide equivalent emissions and was increased by C$5 each year until it reached C$30 in 2012, when it was subject to a review and fixed following the release of a report in 2013. The report suggested that the tax did not seem to have an impact on BC’s economy, although certain sectors such as the agri-food and agriculture sector needed additional relief, which is forthcoming.

The success of BC’s climate change policy matches that of Quebec and California, which introduced a cap on GHG and an emissions trading scheme. BC and other North American states in the Pacific coast, Oregon and Washington have been encouraged to set up similar schemes and to link their systems together. They could soon be joined by provinces along the coast of China. China is working to develop a nationwide approach after 2015.

Getting to a harmonised global scheme is quite challenging, but not impossible as the efforts of some of these jurisdictions are showing. 

"Strategic deficits" from Australia

Image credit: The Australian

The Australian Parliamentary Budget Office (or PBO), a non-partisan, government agency tasked with evaluating election promises, this week released a very interesting set of numbers in which it estimated the structural budget balance from the last two terms of the conservative government under PM Howard up to the subsequent two terms of the Labor government under PMs Rudd and Gillard.

The PBO shows that prior to the 2007 elections in which the conservatives were defeated, the Howard government was structurally in the red. Structural is the word used because if it had not been for the mining boom which had yielded a large tax bonanza, the government's expenses would have exceeded its revenues.

The reason for this deficit was Mr Howard's propensity to engage in "middle class welfare" through tax cuts and benefits such as the "baby bonus" which were not means-tested but applied to all. This was his secret to political longevity. The minerals price boom gave him the means to do it. The IMF earlier this year had called this tendency an act of "fiscal profligacy".

During the 2007 election, the conservative treasurer Peter Costello sought to lock-in the next government into a new round of tax cuts. The then opposition leader Kevin Rudd supported the tax cuts but said, "this reckless spending must stop," signalling his intention to take the mantle of fiscal responsibility from Mr Howard.

A little over a year into office though and Mr Rudd's government faced the daunting task of dealing with the effects of the global financial crisis. This forced him to commit to a large fiscal stimulus program to counter the economic downturn and guarantee the financial system. It worked. Australia avoided a recession, but something else changed. Tax revenues took a hit due to lower corporate income and consumer spending.

Mr Rudd's successor Ms Gillard succeeded in passing a carbon and minerals resource rent tax after a very contentious transition in 2010, but in order to gain the required number of votes in parliament, she had to "overcompensate" the various stakeholders affected, and as commodity prices declined, the revenues which these taxes were meant to generate failed to materialise.

This has left her government scrambling to fill this budget hole not only to regain some economic credibility but to pay for some of her government's signature programs such as school reform and disability insurance. She has sought to unwind some of the so called "middle class welfare" entitlements of the Howard era.

As polls indicate a turnover back to the conservatives in the September election this year, her treasurer Mr Swan in his latest budget sought to tie the hands of the incoming government to fund its social programs in its first term of office out to 2016-17.

This behaviour by incumbent governments to reduce the fiscal space of their successors to either increase spending for social programs (if the incumbents are conservative) or reduce the size of government (if they are progressive) is consistent with strategic budget theory which has been used to explain why governments of advanced economies have been chronically in deficit since the 1970s.

What is clear in all this is that while both sides of politics often talk of being fiscally responsible, neither one is really serious based on the evidence. Both sides play the game; and unfortunately, it is the taxpayer that eventually has to deal with the consequences.