Why household assistance doesn’t undo carbon pricing
My AFR op-ed today explains why providing household assistance doesn’t undermine the effect of introducing a carbon price.
The price is right for consumer shift, Australian Financial Review, 12 July 2011
One of the most persistent myths in Australian politics has been that providing household assistance undermines the effect of imposing a carbon price. If the prices of carbon-intensive products rise by $10 and you give me $10 in assistance, aren’t we back where we started?
If there was only one product in the world, the answer would be yes. If there’s only one thing I can buy, you can be sure that’s where every dollar in my wallet is going to go. So if you put the price of that product up and increase my income, I’ll carry on exactly as before.
Yet the one-product world is a far cry from the vast plethora of options facing modern consumers, who can spend on anything from a ballet lesson to a bunch of bananas, a train fare to a television. And here’s the insight from modern economics: when you have choices, changing relative prices changes behaviour.
While we’re sometimes coy about it, government policies change relative prices all the time. When we raise the first homeowner grant, house sales go up. When we cut tax rates on superannuation contributions, more people put money into their retirement accounts. When we raise cigarette taxes, fewer young people take up the habit. And when we tax alcohol, fewer people buy it.
Yet here’s the other thing: all these taxes and subsidies also affect government revenue. All taxpayers help subsidise homeowner grants and superannuation, and all of us share the revenue from alcohol and cigarette taxes. But the revenue impacts don’t undermine the price changes.
In understanding how carbon pricing works, there’s no more critical distinction than the difference between prices and incomes. Indeed, it’s this distinction that should make us optimistic about moving to a low-carbon economy. If some supermarket prices rise, but you have more money in your wallet, you have a choice: you can either buy the same amount of the high-carbon products, or make a switch to a low-carbon product.
One of the great things about a market economy is that we can leave it up to people to decide what’s best for themselves. For example, some might decide to turn off the beer fridge, so they can spend the household assistance on a new surfboard instead.
This will parallel the choices being made inside the 500 largest emitters, where managers will look for creative ways to cut CO2 emissions in order to save money for the company. Indeed, when the US introduced an emissions trading regime in the 1990s to tackle acid rain, firms found so many innovative ways of reducing emissions that the eventual cost was just one-third of what the boffins originally anticipated. Anyone who thinks companies will shut up shop rather than find creative ways of reducing carbon emissions underrates the ingenuity of Australian businesses.
To see the fallacy in the ‘money-go-round’ argument, just think back to recent increases in households’ disposable incomes. When economic stimulus cheques were sent to millions of households during the global downturn, did families spend it all on high-carbon products? When the single pension was raised by $65 a fortnight in 2009, did pensioners put it all towards goods that produced carbon pollution? And when tax rates were cut in recent budgets, did taxpayers spend all the money on carbon-intensive commodities?
In each case, the answer is no. If you increase disposable incomes, we spent the money on the next thing we’re hankering after: a nicer brand of coffee, a new book, a visit to the cousins. The same principle holds for tax cuts and pension increases that will be delivered as part of the clean energy future plan.
By pricing carbon, we’re encouraging a shift to a cleaner economy. But assistance offers a simple guarantee to most Australian households: if you want to keep buying the same things, you’ll be able to do so. Indeed, some groups will receive a buffer – such as full rate pensioners, who will get a 1.7 percent increase in their pensions to compensate for a 0.7 percent price rise.
Since Tony Abbott has called economics ‘boring’, it’s perhaps not surprising that he is in complete misinformation mode on this point, describing tax cuts to assist households as ‘a con’. Yet language sometimes reveals. When universal superannuation was introduced in the 1990s, Abbott told parliament that it was ‘a con’. Let’s see how long he’s able to rage against good economic policy this time around.
Andrew Leigh is the federal member for Fraser.
Andrew, there is little price incentive in switching to a low-carbon product. These products will not be cheaper than a high-carbon product under your carbon price; they will be the same price at best, or simply less expensive at worst.
Turning off the beer fridge is an examlpe of energy saving. People will save money on this right now, if they so want to. All benefits from energy saving and energy efficiency measures – carbon price or not – go to the person or organisation implementing them. There are no spillovers warranting price signals or government intervention (through the announced grants scheme).
Richard, if the carbon component of a good or service now attracts a price, then carbon-intensive things will be relatively more expensive, and less of it will be consumed.
Andrew,
This article has made the compensation argument a lot clearer to me.
However, would this mean that compensating industry like we are compensating consumers still lift the relative price of carbon (reducing emissions) but give something back to industry so that it is less painful (and thus easier to persuade the Top 500)?
But what happens if you don’t have a choice? I have to buy electricity from the one provider. What incentive do they have?
Sheena, there are two things at work here. First, your electricity provider will have a stronger incentive to buy green power than they currently do. Second, you’ll have an incentive to use less electricity. The expected price impact is $3.30 per week (with average household compensation for that and other price changes of $10.10 per week). So you can either spend the money on the electricity bill, or consider ways of reducing power use (for my own part, my household will be focusing on getting the most energy-efficient appliances).
This whole argument is fatuous to say the least . You assume people have the capital to replace their appliances etc. Those who are affected most by the Labour Party’s surrender to Brown and the greens I would suggest many have not . Once again the lowest ends of the economic stratum are attacked by the party that is supposed to be their champion -what hypocricy . Take a look at the Planned commisioning of coal fired power stations (and existing) in India and China and tell me that a country that emits about 1 per cent of the world total CO2 is going to make any difference even if we reduced our output to zero . You people need to take a good look at how the population is being manipulated by a bunch of far left zealots seeking to impose their”religion ” on everyone -tkae o look at the background of some of the latest crop entering the senate – a former Marxist or Maoist or Trotskyite ( not sure which) and a few others at the exteeme of the political spectrum . Someone once wrote ” never put zealots and statitcians in charge of anything they make poor managers ” I would suggest also that appeasing the greens this time round will help your party retain power is a poor strategic choice – all you have done is embolden them to pursue even more exteme components of their agenda as t {much of which is an unstated agenda publicly) and to wrest control of the political process from Labour.
Just take a while and have a look at (past and current) Brown with Milne and co on TV. They are preening themselves and uttering a torrent of self congraltulatory statements and “save the the world” edicts.
What sort of a message do you think that conveys to the great unwashed out here about the labour party.
What sort of credibility do you think is attached to statements from politicians that ” no one will be worse off” and no one will lose their jobs ‘ and no increase on petrol prices” About as much as “No child will live in poverty” and ” there will be no carbon tax under my government”
Andrew, a problem with buying more energy-efficient appliances to replace less efficient appliances that still work is that one should really take into account the amount of emissions required to produce the new, more energy-efficient device. Does one really reduce greenhouse emissions when that is taken into account? Of course, if the old device doesn’t work any more, then it is undoubtedly a good idea to get a more energy efficient device.
Phew, I thought you were going to ask me about the Jevons Paradox. The short answer is that it depends on the appliance and how old it is. In the case of lightbulbs, it’s efficient to replace incandescents immediately and throw the old bulbs away. But this won’t always be true. The neat thing about a carbon price is that it encourages people to make the right decision, and allows time for transition – so we don’t have to trash the existing capital stock.
Andrew, just a quick point about the cost-effectiveness of replacing incandescent lighbulbs –
I am glad you stopped short of recommending Compact Flourescent bulbs… Experience shows these are
LESS efficient from a whole-of-life perspective, AND a lot more environmentally hazzardous when
“thrown away” (to paraphrase your reply above).
The average effective life of CF bulbs in my home is 6 months. Then it’s brightness has reduced to
unacceptable levels. (Who mandated their use anyway? oh that’s right, the “Green” Malcolm
Turnbull…