Wednesday, July 16, 2008

GST points the way for carbon tax

Ross Garnaut describes the dilemma of imposing a carbon tax on the trade-exposed emission-intensive industries as "truly dreadful problem".  His phrase is less catchy than Gore's "inconvenient truth" but is evocative enough.  Garnaut realises that energy intensive industries would depart our shores once they are hit with a tax which makes them internationally uncompetitive with rivals in countries without a carbon tax.

His solution is to exempt industries facing a "material" increase in costs from the tax by recycling back to them 30% of the revenues the tax gathers.  He speculates that "materiality" and its associated free credits might extend to aluminium smelting, sheep and cattle, cement and some aspects of steel manufacturing.

But this misunderstands the drivers of industry location.  Globalisation has created footloose firms.  Manufacturing everything from aircraft parts to zircon jewellery, these firms will switch location in response to very small cost differentials.  The logic of such decision-making is clear:  the impetus is profit maximisation from meeting consumer needs most cheaply.  If a firm obtains a profit equivalent to 10% of the costs of a good, a cost saving as small as 2% is material since it increases profits by 20%

Any firm that turned its back on such an improved return would pretty soon find itself out of business.  That's why Adidas scours Asia for the best wage and tax deals in setting up clothing and shoe facilities, why Lufthansa does its aircraft servicing in China, why Billabong sources from the Philippines and elsewhere in Asia.

The aim of taxation is to avoid "economic distortion", economists' jargon for needless and wasteful costs.  This is true whether the measures are for revenue gathering or, as is the case with emission taxes, to promote particular forms of production and consumption.

All imposts create incentives for their avoidance and shifting location is a proven means of accomplishing this.  It will remain so unless those like WTO chief Pascal Lamy have their way and the entire trading system is remodelled to incorporate a carbon tax levied at a common rate on every good and service sold.  At the very least, that prospect is a couple of world economic depressions away and, in the interim, firms will continue locating oblivious to its possibilities.

But the international dimension does point to a way ahead for political action on carbon emissions.  All taxes fall not on "business" but on individuals -- the customers, workers and shareholders of the firm and their suppliers.  The business entity is simply a vehicle through which income flows.  It cannot be sustainably milked.

The aim of the proposed carbon tax is to incentivise everyone to use less carbon dioxide emitting fuel.  The introduction of the GST brought a strong consensus among policymakers that a consumption tax levied at a constant rate was more efficient than the mix of measures we previously had.  Levied at a constant rate, a consumption tax was to end the discriminative imposts levied on goods rather than services.  It also avoided placing an impost on exports of goods and services.

In practice, the GST's principles were adulterated from the outset.  What we actually have is a consumption tax at several effective rates -- zero for food and much more than 10% for petrol, cars, alcohol and gambling.  Nonetheless, the GST recognises the short-sightedness of levying taxes on business -- as did the Commonwealth/state agreements to eliminate various state-based business taxes as part of the GST deal.

If we extended the GST principle to carbon, should a tax be put in place, we could apply a small surcharge on electricity and gas sales to the final consumer without this impacting upon business.  The surcharge would be passed on and reclaimed by businesses in exactly the same way as the GST is passed through.  That way it would have a neutral effect not only in terms of the tip of the iceberg that is Garnaut's "truly dreadful problem" but on the impacts that a tax would have on all productive sectors of the economy.

We are already levying quite a high additional tax on petrol, and it might be argued that we already have a tax on carbon with various regulatory and tax imposts like the Mandatory Renewal Energy Target.  These equate to something like a $10 a tonne tax on carbon dioxide, a level that some have suggested as being a sensible starting rate.

A tax approach that is modelled on the GST is of proven workability.  It would also facilitate the removal of the taxes if (some say when) catastrophic global warming turns out to be a myth.  It would also allow for the taxes to be ratcheted up if the evidence about global warming becomes more persuasive.  And, contrary to Garnaut's assertions, there is more to be gained by waiting than by precipitous early action.  As Garnaut argues, technology will improve and material wellbeing will be higher in future years, phenomena that suggest merit in delaying draconian measures.


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