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Mankiw & Turnbull on climate change compensations

Gregory Mankiw argues that President Obama should refuse to sign any version of the Waxman-Markey Bill that does not auction off carbon emission permits.  Our own Joshua Gans apparently agrees.  The opposition is based on the notion that if permits are not auctioned that the lump-sum gains received by firms who get the permits will represent a transfer of higher tax liability from consumers who must pay the higher GGE-charge-inclusive energy costs.

That US exporters are given transitional exemptions through to 2025 is consistent with the destination principal of accounting for such emissions.  It is a standard sort of policy akin to the proposal to force importers to purchase carbon quotas at the market value of such quotas under the US cap-and-trade bill.  Proposed border tax adjustments internalize the externalities of exported outputs from other countries.

The decision to exempt local electricity producers from such charges makes less sense since they provide a non-traded good. Of course local electricity used to produce alumina exports will result in a rebate to alumina producers that is part of the WMB.

Of course the first obligation of any environmental charge is environmental improvement so Mankiw is offering Obama an extreme form of advice.

Joshua Gans makes further comments today of the same type in relation to the Turnbull proposals for an improved ETS in Australia.  There are quite a few parts to this suggestion  but on the proposal of Turnbull to effectively reduce electricity costs to customers by assigning a base level of emission permits to generators I think Turnbull makes the same errors as the Rudd government.  There should be no compensation to suppliers of non-traded goods at all.  The compensation should be paid to the consumers of these goods who bear the higher prices but as income not as reduced prices.

In some respects the Turnbull proposals worsen things by reducing – or at least postponing – the price effects of an ETS.

With full auctioning of Australian carbon emission permits from 2012/13 at an estimated price of $29/tCO2 the Rudd Government estimate revenues that year of $12b. Currently more than half of these are returned to households via tax relief and as fuel excise offsets (around $7.2b).  The rest disappear as the cost of rebates to trade-exposed firms ($3.6b) with a relative trickle to electricity generators of around $0.8b.

I’d prefer to leave things this way even if customers cop a 25-30% boost in their electricity bills because they get reasonably good tax relief that should leave them not so disadvantaged. Consumers are being encouraged to cut their electricity consumption in response to climate change which is what is sought.  Leaving them with lower electricity prices by compensating suppliers means that the climate change mitigation effort will be that much less effective.

If  I can use some jargon. Turnbull’s attempt to give them more to ease electricity prices is not good economics. It is preferable to make consumers bear the higher prices and give them generalised tax relief. Capture the sought after substitution effects but offset the impoverishing income effects.   There is a PR job to sell this policy but it would be more effective and cost electricity consumers no more.

To say that electricity prices will rise more steeply in the future is unconvincing to me when the primary political pressure should be to avoid postponing things but to get them moving now.

4 comments to Mankiw & Turnbull on climate change compensations

  • Harry, I did not agree with Mankiw’s conclusion as it applied to Australia. I suggested that more compensation to generator’s would be a bad thing but I still think it is better to have what we have than give up.

    My point was that international trade was good. Let me know if you disagree.

  • hc

    Quote: “In the New York Times, Greg Mankiw provides one of his characteristically clear treatments on climate change policy. If you substitute Obama for Rudd and congress for the Coalition, it could read like the Australian debate.” Sounds like support to me although I did read this prior to your second piece.

    My view is that compensations to electricity producers is unnecessary. It is because I favour free trade that I support border tax adjustments that internalise externalities and which provide protection for competitiveness based on real resource costs.

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