environment

ETS or carbon tax? Maybe it doesn’t matter

Analysis: Prominent climate economists have called for the Emissions Trading Scheme to be scrapped in favour of a carbon tax. Marc Daalder examines the issues at play in this debate

Geoff Bertram has long been a critic of the Emissions Trading Scheme (ETS). By the time the senior associate at Victoria University of Wellington's Institute for Governance and Policy Studies sat down before three members of the Environment Select Committee to submit on the Government's new reforms to the ETS, he said he was resigned that his message wouldn't be heard.

The ETS, Bertram believes, is too little, too late. More than a decade of the scheme has seen little progress in cutting emissions. Instead, Bertram wants a flat carbon tax, applied to emitters in the same way we slap a 15 percent GST on every purchase. He said this would send a stronger price signal to the market, whereas the ETS' signal is muddied and unreliable.

Advocates of the ETS hit back, saying that there's no reason to scrap a system that's about to undergo major reforms to regain its efficacy.

Then there's a third stream of thought, which argues that whether New Zealand goes with an ETS or a carbon tax doesn't matter. The crucial factor is the country's ambition to tackle climate change. Both ETS and carbon tax can be used effectively or hamstrung into oblivion, depending on whether New Zealand has the political will to face down the climate emergency.

ETS 'a failure'?

The ETS may have been ambitious when it was first created in 2008, but it was gutted by the National Government the next year. New Zealand's emissions in 2017, the latest year for which data was available, were millions of tonnes higher than in 2009.

The original ETS, as dreamed up by then-Climate Change Minister David Parker, would have subsidised agriculture and emissions-intensive trade-exposed (EITE) industries to the tune of 90 percent until 2018, at which point the free credits would be phased out over the next twelve years, 8.3 percent a year.

But when National came to power, it exempted agriculture indefinitely and cut the 2018 deadline for EITE industry, such that the 90 percent allocations had no end-date. The Government's new reforms will begin phasing out EITE subsidies at a minimum rate of 1 percent annually for the next decade, then 2 percent until 2040 and 3 percent through 2050.

In his submission to the Waitangi Tribunal on behalf of Maori suing the Government for inaction on climate change, Bertram wrote, "the differential treatment of large industry versus small and medium enterprises in the issuing of free units remains intact, constituting a blatantly distortionary subsidy arrangement that will hinder any future attempt to bring New Zealand into trade agreements built around the carbon content of traded goods."

After National passed its changes in 2009, Bertram calculated that the full cost of ETS subsidies to the taxpayer, if left untouched until 2091, would have been $99 billion.

No cap on numbers, no cap on price

The massive subsidies for industry - and the slow scale at which they'll be phased away - isn't Bertram's only concern. At its core, the ETS doesn't work as a market, he said.

For a market to be reliable and for participants to make large investments, there needs to either be certainty of price or certainty of supply. In the case of a carbon tax, the benefit is certainty of price - carbon would be taxed at a certain amount of money per tonne and that would only be changed by Parliament.

An ETS - or cap-and-trade scheme - is meant to have certainty of supply of carbon credits, usually through the use of a cap on the total number of units in the market. However, when New Zealand's ETS joined the global carbon market set up by the Kyoto Protocol, it was exposed to nearly unlimited (and worthless) carbon credits from Russia and Ukraine. This devalued New Zealand Units (NZUs) and took away the fundamental instrument keeping the market reliable.

"If you're thinking about decarbonising the economy and you want to give an incentive to people to invest in low carbon economies, that's going to cost firms and individuals across the economy some money. Looking forward, they want some security as to what the return is going to be on their outlays," Bertram said.

The new reforms will put a soft cap on the number of units in the market, but Bertram said it's too late. The new market will grandfather in many of the bunk Kyoto units, meaning it will start off flooded, he believes.

The Government has separately proposed a price cap of $50 (which Bertram thinks is too low) and floor of $20, but this isn't enshrined in the new legislation. That cap is set at the discretion of the Climate Change Minister, which means it's vulnerable to the whims of the Government of the day.

"The Emissions Trading Scheme as it stands gives only one guarantee in a future that's full of fluctuating and uncertain prices," Bertram said.

"Nobody knows where the carbon price could go, except that the one thing you know is it's going to be capped. That's the only price controlling thing in these amendments, is that the Government can prevent the price from rising by flooding the market with NZUs" at a set price.

Carbon tax could be simpler

Instead, Bertram has put forward a proposal that is increasingly popular overseas: a carbon tax. He compares it to GST, because it would be a simple and universal price on carbon that would punish high emitters and push them to lower their emissions.

GST also accounts for some of the concerns used to justify EITE subsidies, Bertram said. "If you're an exporter and you're paying 15 percent on your value added, that would make you less competitive overseas. So what we do is we simply rebate the tax a bit at the border as the goods go out. When goods come in, we put a 15 percent GST on that as well."

"We have lots of experience with border adjustment, Inland Revenue administers it all the time. We've got the regulations in place, it's very straightforward. A carbon tax with border adjustments just modeled on GST - in fact, the entire procedure modelled on GST - is simple, clean, very effective, universal, very difficult to manipulate and very easy to harmonise with international developments."

"On all fronts, a carbon tax with border adjustments is the way to go," he said.

Carbon taxes have been implemented overseas but the results, though promising, are not conclusive. Emissions in British Columbia have dropped by as much as 8 percent since the introduction of a carbon tax in 2008. A 2011 study found that Norway's carbon tax, introduced 20 years earlier, had not mitigated the country's CO2 emissions. The same study found Finland's tax "imposes a significant and negative impact on the growth of its per capita CO2 emissions. Meanwhile, the effects of carbon tax in Denmark, Sweden and Netherlands are negative but not significant."

In the United States, the Department of the Treasury estimated that a US$49 per tonne tax on carbon introduced in 2019 would have cut emissions by a fifth over the next decade. A 2018 poll of 43 leading US university economists found that none disagreed that a carbon tax was a better way to implement climate policy than carbon trading schemes.

ETS has advantages

Ivan Diaz-Rainey, the director of the Climate and Energy Finance Group at the University of Otago, defended the ETS. It has a handful of advantages over a carbon tax that critics rarely see, he said.

For starters, it's more entrenched. When a company purchases NZU, that gives them property rights. Those are much more difficult to strip away than repealing or watering down a tax. "There is trade, there is complexity, but it also creates property rights. Once it creates property rights, it's very difficult to get rid of that market," Diaz-Rainey said.

"National didn't get rid of it [in 2009]. They tried to weaken it. Trying to get rid of it altogether would have been too complex because people had property rights."

By contrast, "tax can be repealed or zero-rated". Diaz-Rainey pointed to Australia, where a Labor Government introduced a carbon tax in 2011 but a Liberal/National Government repealed the measure in 2014.

"There's another reason to have a carbon market and that's minimising abatement costs. Let's say you have two polluters. Under a tax, they both pay the tax, even if one may find it a lot easier to cut emissions. The one that finds it easier, under a trading scheme, can cut more [than they would under a tax] and sell their certificates to the one that finds it hard."

New Zealand's ETS is flawed, Diaz-Rainey admits. Placing no cap on the number of Kyoto units that could be imported, indefinitely exempting agriculture and subsidising EITE industries, and having no price floor all contributed to a weak and confusing scheme. But the Government's new proposals address all of these concerns fairly satisfactorily, he believes.

"Certainly the announcements that have been made since the current administration came in strengthen the ETS. They're getting rid of the price cap, they're going to have a stabilisation mechanism. Compare that internationally, it's sending a reasonable signal. Compare that to what the social cost of carbon might be, there's still a ways to go."

Despite its troubles, New Zealand's ETS is also admired internationally, Diaz-Rainey said. "It's got a terrible reputation domestically, but if you go internationally, they're quite intrigued by it," he said.

Grass is greener on the other side

Defenders of the ETS also bristle at the unfair comparisons being made. It's a case of the grass being greener on the other side, they say, with an ideal carbon tax contrasted against a real world ETS. But any carbon tax would have to go through the same processes that turned the ETS from an ambitious programme into the struggling, overly-complex behemoth it is today.

"If you went for a tax, would that mean you'd get agriculture straight in? No. You have to wait until 2025 because you've got all these measurement and verification issues. That doesn't go away with a tax, it's the same blinking problem," Diaz-Rainey said.

That's what David Hall, a Senior Researcher at AUT's The Policy Observatory who specialises in environmental policy, said when asked about whether he would prefer an ETS or carbon tax.

"From political reality, we have an Emissions Trading Scheme, we have huge institutional buy-in for it, at the moment I can't see us replacing it," he said. "The game is to do the best with what we have because time is of the essence."

Diaz-Rainey agrees. "Given the history of New Zealand, where Labour spent 10 years debating a tax and then implemented an ETS in the last minute, for someone to come in and say, 'Let's have a tax', to me that would almost derail any action on climate change. It's what we have, it can be strengthened," he said.

Political ambition the key element

That's typical of the third way argument, adopted by academics and economists alike: whether New Zealand goes with an ETS or a carbon tax doesn't matter if there isn't political will or ambition for radical change. Likewise, if the Government is willing to throw everything it has at climate change - treat it like this generation's "nuclear-free moment" - it will find a way to implement effective carbon pricing.

Besides, even the most radical carbon pricing alone won't make a difference. Hall highlighted a chart in the Government's own consultation document for the ETS reforms that shows, under a $100/tonne carbon price, even the wealthiest homes would only pay an extra $12 a week. That's not enough to incentivise cutting high-emitting behaviour if the Government doesn't introduce other policies that make the transition to a low-carbon economy easier.

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Carbon pricing is a blunt instrument. In order to truly change household behaviour through pricing alone, the carbon price would have to rise to astronomical levels. "If the price is really driving people to shift out of high-emissions projects and activities, then the result is a huge amount of stranded assets," Hall said. That would hurt low-income households the most and wouldn't be the most efficient way to decarbonise the economy.

"A really strong point of difference that we're starting to see come out with the Green New Deal conversation overseas is a transition perspective on all of this. The idea there is actually the emergence and the dispersal of new innovation that drives change and not the punishment of old technologies, per se," Hall said.

"You can have [electric vehicles] but they're not taking over because we don't have the infrastructure in place to encourage that dispersal of innovation. This is where that Green New Deal approach comes, where it's talking about much more proactive, forward-looking, mission-oriented behaviour from especially the public sector but also private sector players too."

"They actually have to take a punt on the future." In other words, you need to have the political ambition to do what it takes to tackle climate change.

That requires more than just support in Government for radical measures, which already doesn't exist. It needs cross-partisan support from major and minor parties alike, such that whatever policy is implemented is guaranteed to stay in place. For an ETS, that means price signals would be reliable and companies could cut emissions or invest in forestry to the tune of millions of dollars while knowing their investment is secure.

For a carbon tax, that means companies would know the cost of not reducing emissions will only grow with the years and that decarbonising is the only way to reduce the hurt, instead of lobbying for exemptions or softer policies.

Without such political ambition, neither tax nor ETS will get New Zealand to where it needs to be in order to play our part in dealing with the climate emergency.

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