John Quiggin does a sound job demolishing Tony Abbott’s claim that a $40 per ton carbon tax will double the price of electricity. It won’t – the increase John calculates at about 20%. I have been equally puzzled by people’s assumption that a $40 carbon tax on fuels would increase petrol prices dramatically. Again it won’t – the increase is about 10 cents per litre or less than 9%. Most of the political speeches in this campaign have been evasive/irrelevant and of the “he said/she said” character with very limited policy analysis. It is annoying that when a political leader like Abbott does get specific he gets it wrong. I guess if Abbott can get away with this that he will get away with the more complex idea that direct interventions in the energy sector will outperform imposing a price on carbon.
Of course the implication of this findings is that carbon price taxes need to be fairly hefty to have any significant effect. Both fuel and electricity demands are very price inelastic of the order -0.2 to -0.3 as suggested by the Garnaut Review. This means that large carbon taxes are needed to have much of an effect on emissions. Hefty taxes need to be accompanied by income redistributions to low income households in order to prevent serious disadvantages as, again, was suggested by Garnaut.
[...] This post was mentioned on Twitter by Denyse Skipper – RSS, denyse skipper. denyse skipper said: Abbott fork tongues on carbon tax effects: John Quiggin does a sound job demolishing Tony Abbott’s claim that a $4… http://bit.ly/9OQHLu [...]
I think there are two corollaries of those price elasticities, Harry:
1) that fuel switching is going to be relatively more important, and efficiency relatively less important, in the transition to a low/no carbon society than is often assumed.
2) The transport sector will decarbonize only after the stationary energy sector is pretty much completely decarbonized.
Maybe but I can’t see that from these elasticities. I suppose people will switch to cheaper alternative fuels if these are close substitutes – they might drive a bit further. As for switching to more fuel efficient vehicles the problem is that they may they will drive further.
The issue is not so much how far a $40/tC carbon tax raises the price of electricity, but how high it needs to raise the price to ensure turning off lights or finding a cheaper source. Electricity demand is fairly price inelastic, and the Quiggin piece totally fails to assess elasticity both of generators vis a vis relative prices of wind/solar and coal, and of consumers vis a vis reative prices of electricity and other goods.
Tony Abbott is right that the cost of coal-fired electricity needs at least to double to make non-coal viable, and that will indeed raise consumer prices pro rata.
Strange to find an economist like JQ who unlike hc appears to be innocent of the concept of price elasticity!
Hc: you are therefore spot on when you said “carbon price taxes need to be fairly hefty to have any significant effect” -but quite wrong when you add “Hefty taxes need to be accompanied by income redistributions to low income households in order to prevent serious disadvantages as, again, was suggested by Garnaut”.
There used to be a rule in economics that each policy objective requires its own policy instrument.
Using revenue from an ETS or carbon tax aimed at reducing carbon consumption as a redistributive measure that is then used to allow “low income households” to consume as much if not more carbon than before is self-defeating in terms of reducing carbon usage. Recall that in aggregate there are many more “low income households” than there are rich, and that electricity is something of a Giffen good.
Tim, This is buffoonery. John was questioning Abbott’s claim that a $40/ton carbon tax would double electricity prices and he is 100% correct in rejecting this.
Elasticities were not raised by John – he wasn’t concerned with the effects of price on demand but with the easier question of the effects of the tax on price. What’s got into you?
If prices are much higher than they are at present then elasticities are likely to increase.
Your claim about rebating income to low income households is just wrong. Even if they were rebated the full value of the tax they paid they would still face the higher price and cut their consumption. The rebate negates the income effect of the price change but not the substitution effect which will still reduce quantities demanded. Its first-year microeconomics and you must know that.
It gets silly if you oppose everything that John Quiggin says because of his stand on climate change. Among other things John is a very good practical economist – he wouldn’t make the silly sorts of errors Tony Abbott did. You need to nuance your opposition to certain ideas.
Quite apart from electricity being nothing like a Giffen good. How many people would increase their consumption of electricity when the price goes up?
[...] Harry Clarke points out, the demand for petrol is ‘inelastic’ with respect to price – consumption doesn’t go down [...]
hc: You need to read Garnaut Chap.16, there you will find no rebate of the ETS, how could there be, as the poor are not buying the permits?
Mark: check out Wiki – In economics and consumer theory, a Giffen good is one which people consume more of as price rises, violating the law of demand. In normal situations, as the price of a good rises, the substitution effect causes consumers to purchase less of it and more of substitute goods. In the Giffen good situation, cheaper close substitutes are not available. Because of the lack of substitutes, the income effect dominates, leading people to buy more of the good, even as its price rises.
The classic example given by Marshall is of inferior quality staple foods, whose demand is driven by poverty that makes their purchasers unable to afford superior foodstuffs. As the price of the cheap staple rises, they can no longer afford to supplement their diet with better foods, and must consume more of the staple food.
“As Mr.Giffen has pointed out, a rise in the price of bread makes so large a drain on the resources of the poorer labouring families and raises so much the marginal utility of money to them, that they are forced to curtail their consumption of meat and the more expensive farinaceous foods: and, bread being still the cheapest food which they can get and will take, they consume more, and not less of it”.
—Alfred Marshall, Principles of Economics (1895 ed.)
If you check Garnaut Fig. 16.2 and text, there will be a general increase in the prices of all necessities impinging most heavily on the poor. Food accounts for 20% of their disposable income, and electricity for c.4%; in cold places and elsewhere food and electricity are substitutes, eat less, you feel colder, and desire more heating. The ETS will have a large impact on food prices, especially when agriculture and livestock are included (BTW, Garnaut wants all ruminants liquidated), so at the margin given the relative disproportion in shares of disposable income it is possible that electricity consumption of the poor could increase. The actual transfers of income proposed by Garnaut will further increase the tendency for the poor at least to maintain their real spending on the items that are both most CO2 intensive (as measured by their relative price increases) and most income inelastic.
The thing about elasticities of goods that can be substituted only over a long time period is that their long-run elasticities are generally far higher than their short-run ones. And given the time frames we’re talking about with AGW it’s the long run ones that are relevant to carbon reduction. Its the shorter run ones, though, that matter to immediate distributional effects and hence to the politics.
So I’m not as pessimistic as you or Garnaut about the effectiveness of even a moderate carbon price in mitigating climate change, but I am pessimistic about the political prospects of such a price.
you may have an incredible weblog here! would you prefer to make some invite posts on my blog?