Why the carbon price has not caused inflation

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In June 2011, IA managing editor David Donovan – a former finance analyst – made the economic case for pricing carbon, explaining why it would have virtually no effect on inflation. With the inflation numbers proving him right, IA republishes his argument.

SOME PEOPLE might say, worrying about the future is all very well, but the future is far away — yet implementing a carbon tax will increase the cost of living for Australians now, in the immediate future, as soon as it comes in. And, in its zealously effective scaremongering, the Coalition has greatly encouraged this perception. As a former accountant, and one that has worked in the mining industry, I feel assured that a carbon tax – especially one set at the relatively modest level of between $20-$30 a tonne that has been widely mooted by the Government as being the likely entry-point – will have negligible or no impact on the cost of living of ordinary Australians, especially given the tax breaks the Government has presaged.

The reasons for this are twofold.

Firstly, under the National Greenhouse Energy Reporting Act 2007, major Australian polluters have been required to account for their carbon emissions and report to the Government since 2008. Consequently, the future cost of compliance for any carbon tax should be negligible. In addition, the companies that have been reporting under this scheme for the last few years – which would include all of the 1,000 major polluters covered by the carbon tax – will almost certainly all have already implemented a “shadow carbon price” as part of a prudent risk management strategy. In other words, since they will have been expecting a carbon price since at least 2010 (the timing for the Rudd Government's planned, but then scrapped, ETS) these companies will have already priced in an internal price for their carbon emissions that would feed into the prices they sell for their products. Any gains they have made since 2010 as a result of the Government not yet acting would simply be regarded by them as a windfall. This conclusion is supported by Tony Wood from the Grattan Institute who, on ABC’s 7.30 last night, said energy companies would have been factoring in a cost for carbon “...for 10 years at least”.

Secondly, since the cost of carbon has already been factored in and a price on carbon already passed on to consumers, at least in demand inelastic industries, the actual implementation of a carbon price should cause no increase in prices for consumers (unless, that is, particular companies decide to opportunistically price gouge customers). Indeed, since the likely carbon price will almost certainly be lower than the internal marginal cost – which, in my experience, most companies will have placed at somewhere between $40 and $60 a tonne – any lower price for carbon imposed by the Federal Government would be regarded by these polluters as a windfall in and of itself. Prices are unlikely to come down, but unless operators are unscrupulous, they should not go up. And if they do go up, the Government can mitigate any cost of living pressures through tax cuts, which will be funded through the carbon tax itself. And there should still be enough carbon tax revenue left over to fund further Government programs to find new renewable energy solutions.


I should speak briefly about the Coalition’s “direct action” policy. In short, this policy is simply not economically feasible. It is a Clayton’s policy, as Malcolm Turnbull alluded to some weeks ago, that provides an illusion of progress while actually achieving very little. Whilst direct action on climate change might help mitigate climate change in the short term by targeting the “low hanging fruit”, or the worst sources of carbon emissions in our economy – maybe even limiting our emissions beneath the modest targets set at Kyoto, as is the Coalition’s goal — once these easy-fixes disappear and harder structural changes are required, the cost to the taxpayer would almost certainly become prohibitively expensive.

Only by a market mechanism that encourages innovation, investment and responsible behaviour will the cost to consumers be able to be shared and minimised throughout the economy. A direct action, or command, mechanism is inherently inefficient. In fact, it is the sort of policy you can imagine being suggested by a socialist or a Communist command economy, not a modern liberal free-market democracy. The Coalition’s solution is not a long, or even a medium, term approach, unless they are advocating the taxpayer paying two or three times as much tax in the future than they do at present.

Climate change is real and the science is persuasive. But even if you personally don’t believe it’s real, the world is moving in only one direction — towards limiting carbon emissions via a market based approach. Direct government action on climate change is not economically sustainable beyond the short-term — only a market based approach can stimulate investment and innovation in renewable energy and encourage pollution mitigation widely throughout our society. The increase in cost of living pressures from a carbon price is not only greatly exaggerated, but almost certainly non-existent. Moreover, certainty about a carbon price will encourage investment and provide cheaper funding sources for the business community, providing a fillip for the economy as a whole. Our economy must begin to make the transition to a renewable future as soon as possible before such a future is imposed upon us to our massive financial detriment.

Australia should seek to develop a value-adding first world, rather than a "quarry", economy.

(David Donovan has worked as a financial accountant and finance analyst for some of the world's major investment banks, commercial organisations and mining companies in Australia and the UK, including Merrill-Lynch, Barclays Capital, NatWest Global Markets, Mizuho, Viacom, UBS and Downer EDI Mining.)  
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