Monday, February 28, 2011

Carbon courage, and for Gillard, no going back

Maybe Julia Gillard will make a good prime minister after all. Her decisions of late - culminating in her commitment to impose a price on carbon from July next year - suggest she has learnt from Labor's mistakes and understands what she must do to stay in office.

Kevin Rudd's biggest mistake was to abandon his carbon-pollution reduction scheme after the going got tough, rather than seeking to get it passed after a double dissolution election. Urged on by Gillard and Wayne Swan, he thought abandoning the threat of "a great big new tax on everything" would help preserve his popularity.

Instead, it convinced voters he was lacking in courage and conviction. That was when his sharp slide in the polls began. His funk over climate change contributed to the mishandling of the resource super profits tax, while emboldening BHP Billiton and the other big miners to attempt to knock off the tax by knocking off the government. It's clear that, when Gillard replaced Rudd and rushed to an early election, she had no idea why Labor was in trouble. Rather than taking a different tack on the emissions trading scheme, she made matters worse by promising not to impose a price on carbon during her next term.

The result was that Labor voters abandoned the party in droves, while few if any swinging voters were attracted to such a chameleon party. She'd tried to "govern from the centre" and been caught between two stools. At last, however, Gillard seems to have realised leaders have to stand for something if they're to retain the loyalty of their heartland and impress the rest of the electorate.

She's starting to show signs of courage in imposing the eminently avoidable flood levy, in attacking rather than aping Tony Abbott's latest attempt to capitalise on popular resentment of boat people, and in restating Labor's support for multiculturalism.

For weeks she's been making speeches about her belief in economic reform and now she's given that some substance by announcing a firm objective of introducing a price on carbon well before the next election, not after it. No going back now.

Not long after Rudd followed John Howard's example in committing to using an emissions trading scheme as the means of imposing a cost on emissions of carbon dioxide and other greenhouse gases, many economists decided they favoured using a carbon tax.

In theory, the two are mirror images of themselves. Trading schemes limit the quantity of emissions directly, in the process pushing up their cost. Carbon taxes raise the cost of emissions directly, in the process discouraging people from emitting them. In practice, the two approaches have differing practical and political pros and cons. And now Gillard's agreement with the Greens commits her to a hybrid of the two. An emissions trading scheme will be established, but for the first three to five years the price of permits will be fixed and no trading allowed. After that trading will be permitted and this will cause the price of permits to vary with the balance of supply and demand.

This idea was originally proposed by Professor Ross Garnaut and later taken up by the Greens. Of course, most of the details of how the scheme would work remain to be negotiated with the Greens and sufficient independents in the House of Representatives.

But in his review of Gillard's statement, Dr Richard Denniss, the director of the Australia Institute, says the initial price is unlikely to be lower than the $26 a tonne initially used by Treasury in its modelling of the carbon pollution reduction scheme. The annual increase in the price is likely to be the inflation rate plus a few percentage points. Denniss says that if the eventual move to a trading scheme led to a rapid fall in the carbon price this would harm many businesses. So he suggests setting a price floor to prevent that from happening (as it did happen in the European Union's trading scheme).

Perhaps the greatest area of political vulnerability is the scheme's addition to households' electricity bills, given these have already risen by 40 per cent or so in recent times for other reasons. Here Denniss has an unorthodox and second-best suggestion.

Since it's all higher prices rather than just higher carbon prices that are expected to change our habits in the use of power, why not shield consumers from any further price increases?

The power generators could be made to pay for their emissions, but the higher costs could be offset by direct payments to the retail distributors. This would leave the price incentive for generators to invest in less emissions-intensive production methods, while removing the need to raise household electricity costs but then compensate people for the rise in their cost of living.

As Denniss reminds us, behavioural economics explains why the punters hate being taxed with one hand and compensated with the other. Partly it's distrust - the pollies may welsh on the deal - but mainly it's because most people are "loss averse": they dislike losing money more than they enjoy receiving money.

The very use of the word "compensation" is a reminder to people there must be pain involved.

Because it's so hard to adequately compensate every last person with unusual circumstances, governments commonly end up overcompensating a lot of people. So if you sent the compensation direct to the electricity retailers you could avoid wasting the proceeds from the tax on overcompensation, leaving more available for subsidising research and development of alternative energy sources.