Brian Fallow: Carbon-tax demise relief may be premature

As part of the price of being returned to power, the Government is to review the case for its proposed carbon tax. Winston Peters, for one, is convinced it's a goner. Sighs of relief can already be heard from the business sector.

That may be premature.

On the parliamentary numbers, it would need the support of the Greens and the Maori Party to pass. The Maori Party has a policy of supporting the tax.

No carbon tax legislation will even be introduced before the cost/benefit analysis is completed.

Certainly, there will be no shortage of people to make the case against the tax. Alex Sundakov, author of the cogent Castalia report released on Monday, is one.

But there are also arguments for it.

Reason No 1: We need energy prices that tell us the truth.

Until the climate scientists change their collective mind and tell us otherwise, we have to accept that global warming is happening, it is a problem and to a significant degree it is our doing.

The global environmental costs of fossil fuel use need to be internalised, that is, sheeted home to the energy consumers who are, ultimately, responsible for them.

Otherwise, it is a free ride - the moral equivalent of a subsidy flowing from poor countries to rich ones and from future generations to the present. And its main effect is to protect from fair competition a bunch of incumbent technologies largely invented in the century before last.

Reason No 2: Prices work.

The purpose of a carbon tax, or of its intended more sophisticated successor, emissions trading, is to send a price signal to users of fossil fuels ranging from the individual motorist or homeowner to electricity generators and smokestack industries.

Critics of the tax point to the inelasticity of demand for petrol - the fact that people don't cut back consumption much in response to higher prices - as evidence that it would make little difference.

The architect of the Government's climate change policy, Pete Hodgson, acknowledges an extra 4c on a litre of petrol isn't going to make a lot of difference when it is already $1.50.

But he argues that, over time, price measures do influence capital decisions.

If, in the United States, a one-year-old Toyota Prius costs more than a new one, that is evidence that the uptake of hybrid vehicles is constrained by supply not demand, he says.

And a signal that tips the balance in favour of building wind farms instead of coal-fired power stations helps to future-proof the economy, given the long lives of such investments and the likelihood that in the future one way or another polluter pays will prevail.

Anti-Kyoto countries like the US and Australia still use measures like tax credits or regulatory requirements to generate some proportion of electricity from renewables to encourage the use of cleaner technologies. Either the taxpayer or the consumer still pays.

Hodgson concedes that Sundakov is right that technologies which would make a really significant difference, turning the curve from rising to falling emissions, are not yet available within reach of any price signal that would be economically tolerable.

But he does not accept that while the quest of the technological holy grail goes on we should do nothing, because there is a cost to that as well.

Incremental gains are still gains.

Reason No 3: If they don't tax carbon they will tax something else.

All else equal, like government spending and borrowing, the more revenue the Government gets from taxing fossil fuels the less it needs to get form taxing other things, like incomes or profits.

This, of course, is the basis of the Greens' approach to tax policy: tax the things you want less of like pollution instead of the things you want more of.

There is a kind of opportunity cost to consider. The revenue cost of scrapping the carbon tax would be about $400 million a year, which is just short of the cost of cutting the company tax rate by 2c in the dollar. Which would business prefer if it was one or the other?

Unless New Zealand pulls out of Kyoto, then the Government will have to meet the cost of falling short of its emissions target when the Kyoto countries square accounts in 2013. The taxpayer will still pay, whether it is through a carbon tax or another one.

To renege on the commitment made at Kyoto and, subsequently ratified, would not be costless either. It would undermine New Zealand's reputation as a country of its word and it would damage the clean, green national brand. Assuming New Zealand stays in the Kyoto club, it has to do something to reduce emissions. The carbon tax is the central plank of climate change policy.

Its effects spread beyond those who would have to pay it. Large industrial emitters are expending considerable time and money negotiating greenhouse agreements with the Climate Change Office under which they move to world's best practice in emissions for comparable plants in exchange for exemption from the carbon tax.

The decision of the Government to retain ownership of forest sink credits is having the perverse and predictable effect of drying up new plantings of Kyoto forests.

So without the carbon tax, you would be hard put to say what New Zealand was doing to honour its commitment to Kyoto.

That is why the National Party's Hamlet-worthy equivocation about withdrawing from Kyoto is seen as dishonest.

To scrap the carbon tax but stay in Kyoto until 2012 for the reputational risk reasons above would just increase, at least marginally, the excess emissions the taxpayer will have to pay for.

National is looking at the possibility of drafting a member's bill which would propose withdrawal from the protocol.

That at least is the real question, whether to keep supporting the Kyoto Protocol. To scrap the tax but stay in the protocol is just an exercise in passing the buck to another set of taxpayers.

For all its flaws, the treaty has two great merits: It is a multilateral agreement and given that it is global warming we are talking about, concerted international action is the appropriate approach.

And at its heart is a commitment to the use of market mechanisms to ensure that the cheapest options to reduce emissions are taken first.

It embodies the idea that the best way to avoid a tragedy of the commons is to ration the right to emit and create a market for those quotas. It is an approach which has worked in other areas like US sulphur dioxide emissions and, arguably, New Zealand fisheries

Kyoto may yet fail in the face of the geopolitical free-rider issues it faces.

But that would be a loss.