The emissions trading scheme (ETS) is advertised as being a "market solution to a market problem". This is a clever piece of rhetoric that has long escaped scrutiny. Many economists support the notion of emission trading on the basis that it is "market based".
It is strange that the people proposing these "market-based" solutions are so seldom free-market enthusiasts. The misuse of economic terminology is rife in the whole debate.
The Stern report makes the argument that the "climate is a public good". Indeed, climate does have the characteristics of public goods -- it is non-rivalous and non-excludable.
Yet the fundamental point is that the climate is not produced in a market, nor bought and sold in a market, nor can governments subsidise production of the climate. In other words, the "climate is a public good" argument is wrong and misleading.
Many policymakers like the market analogy because it allows them to sidestep the most obvious solution to anthropogenic (man-made) global warming (AGW) -- taxation.
ETS proponents, however, are likely to argue that market solutions are preferable to government intervention. But this market solution is just government intervention in a different format. Markets emerge through human action, not human design.
Of course free markets are preferable to government command and control intervention, but AGW proponents are not calling for free markets.
Where the economic terminology does hold up is in identifying carbon pollution as an externality. Of course, we can all agree that the polluter-pays principle should apply. Yet this begs the question: "Who is the polluter?" Surprisingly, the Victorian Government has identified the true polluters. Its black balloons advertisement has shown that households are the true polluters. Carbon pollution is a byproduct of our modern living standards. If anything should be done to counter that byproduct, an energy consumption tax is the way to go.
This type of tax has much to recommend it. For a start, it could piggyback on the GST, making use of the existing acceptance of that tax and also making use of the technology and institutions that support the GST.
This would alleviate the need to create, from scratch, a new financial product and a new trading system that will have unknown and unforeseen consequences on the economy. Governments have long experience in levying taxes. Taxpayers understand taxes and can easily determine if they are broadly revenue neutral.
Of course, the question well worth asking is why both the former Howard government and the Rudd Government favour an ETS. The answer lies in the green paper's chapter on taxation. The ETS is a non-transparent revenue raiser. The proposed ETS aims to maximise revenue flowing to government.
Each step will be taxed at the highest possible rate -- so much so that the "capital gains" will not be taxed as capital gains with a 50% discount; rather any "capital gain" will be taxed as ordinary income. The ETS is specifically not revenue neutral. All money raised will be spent on handouts and not used to reduce the overall tax burden.
One major advantage of an ETS is that it could be easily integrated into a global trading system. Yet, as Jeffrey Sachs explained, this system will not eventuate. Australia may well be investing time and effort in a complex trading system when a far easier product will suffice.