A More Appealing and Effective Price on Carbon

In 2016 a large group of international economists including four former Federal Reserve Chairs and 27 Nobel laureates made a number of recommendations on climate policy, including that a carbon tax offers the most cost-effective lever to reduce carbon emissions at the scale and speed that is necessary, that such a tax should rise over time to encourage innovation, that it should be revenue neutral to avoid debates over the size of government, and that to maximize the fairness and political viability of a rising carbon tax, all the revenue should be returned directly to citizens through equal lump-sum rebates.

New Zealand currently has an emissions trading scheme (ETS), but it has no cap on emissions, so it works more like a tax. Agricultural emissions of methane and nitrous oxide are exempt, and many industries receive free allocation of emission permits. In addition, the price of carbon has been capped at NZ$25. Unsurprisingly the scheme has had a negligible impact on emissions.

At Infometrics we have explored the effects of a ‘tax and rebate’ policy with a detailed model of the New Zealand economy. In our modelling we look at an additional carbon tax (that is, over and above the ETS carbon price) that rises to $450/tonne by 2050 – admittedly a much higher number than is commonly discussed. [1]

We retain some free allocation for emissions-intensive, trade-exposed industries, but set it at 75% of their emissions. We redirect the other 25% into a reduction in the effective company tax rate for all companies. This could be in the form of a lower statutory rate or as some sort of credit for research and development linked to reducing emissions. As under the current ETS agricultural emissions of methane and nitrous oxide are exempt from the tax, though this is probably over-generous.

Revenue from the tax is used to pay a lump sum per capita dividend, with dependent children receiving half of the adult amount.

The results reveal that by 2050 New Zealand’s emissions decline by 20Mt or 26% relative to a ‘business as usual’ scenario, excluding the effects of any additional absorption by forests. There is widespread adoption of electric vehicles, efficiency gains in space and water heating, as well as substitution of energy in favour of more home insulation. Electricity generation is 98% renewable. A small amount gas fired generation remains to cover adverse climate events.

Real private consumption is 2.3% higher and each adult receives a carbon dividend of more than NZ$1000 per year. Thus, a family of two adults and two children (with a 50% weighting per child) would receive over $3000/year or about $60/week.

In addition, a disproportionate share of the benefits goes to lower income households. Those in the lowest income quintile would see an increase of 3.2% compared to 1.1% for those in the top quintile (see Chart 1).

As economists we acknowledge that the above tax and rebate policy may not be the most economically efficient option for reducing emissions, but we also recognise political realities. We have seen many cases around the world in recent years where the removal of subsidies on fossil fuels or food has led to riots, as well as industry lobbyists and politicians in Europe, Canada, USA and Australia loudly expressing their resistance to carbon pricing. These attitudes will change only when the wider public demands it. And for that to happen the public needs to be assured that a price on carbon will not make them economically worse off, notwithstanding the seemingly more widespread support for the associated environmental benefits. A tax and rebate policy merits further consideration.

[1] This research was supported by Citizens’ Climate Lobby New Zealand.

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