Why the Government’s Emissions Trading Scheme is not a good idea
Responsible politicians and policymakers should baulk at legislative proposals which are likely to have significant and widespread economic consequences, but whose net benefits they have not rigorously assessed or had carefully explained to them.
What are the expected net economic benefits to Australia of the Government’s proposed emissions trading scheme? After numerous government reports comprising several thousand pages, the Government has yet to answer this question.
None of the official studies (including the Garnaut Report, Treasury’s modelling, the Green Paper, the White Paper, or the Regulation Impact Statement that accompanies the CPRS legislation) have assessed the Government’s actual policy, which aims for a minimum 5 per cent unilateral reduction in emissions on 2000 levels by 2020. This unilateral policy scenario was not even considered, let alone modelled in detail, in any of the aforementioned publications.
It is not as if the tools to undertake such an analysis do not exist. Cost benefit analysis is a collection of analytical methods that the economics profession has developed over a period of more than 70 years to examine precisely these kinds of policies. The Department of Finance’s Handbook of Cost-Benefit Analysis provides a great deal of guidance on when and how those tools should be used, and the Office of Best Practice Regulation’s Best Practice Regulation Handbook sets out an analytical framework for assessing regulations like the proposed emissions trading scheme.
These publications, together with many others, outline the basic methodology of cost benefit analysis: (i) set out the broad range of policy options; (ii) assess and set out, to the greatest extent possible, the present value of the full expected incremental economic costs and benefits of each policy option (that is, costs and benefits relative to a baseline of no policy change), (iii) examine the risks and sensitivities involved in these costs and benefits, and (iv) recommend the policy option that has the greatest expected net benefit in present value terms. None of the aforementioned studies followed this basic methodology, and thus none of them comply with basic standards of cost benefit analysis that are widely practiced throughout the economics profession.
So what are the incremental costs and benefits of the Government’s policy? The incremental economic costs are likely to be non-trivial. For example, Treasury’s modelling, which examined various scenarios including a 5 per cent cut (but only in the context of similar action taken by developed countries, with developing economies coming on board between 2015 and 2025), shows that Australian living standards (as measured by GDP) will be lower than they otherwise would be for every year that the emissions trading scheme is in place. That is, the incremental effect of the CPRS will be to reduce our living standards below what they would otherwise be for each and every year into the future.
If these future costs are discounted back to today’s dollars and added up over all the years of the scheme, they represent a sizeable cost – they are of the order of the value of our entire current GDP. Table 1 below presents a range of discounted present values of the GDP costs, where the range varies according to the discount rate chosen (between 5 and 0 per cent in Table 1 –note the Garnaut Report uses discount rates of 1.35 and 2.65 per cent). The Government’s planned unilateral emissions reductions (which Treasury has not costed) will likely have much greater incremental costs. Thus, the costs in Table 1 are likely to represent a lower bound on the incremental costs of the Government’s proposed scheme.
Table 1: Ranges of present value of Australia’s GDP loss (relative to baseline) under each mitigation scenario
5 per cent emissions reduction
15 per cent emissions reduction
Range of Present Value of Economic Costs
$0.5 trillion to $1.9 trillion
$0.67 trillion to $2.47 trillion
Data Sources: Commonwealth of Australia (2008a) and Concept Economics (2009), Table 4, page 56.
Treasury’s modelling also shows that if the rest of the world reduces its emissions whilst Australia does not, by 2050 our Gross National Product (GNP) will be only 0.6 per cent lower than the baseline scenario, which is far less than the estimated 3.2-5.2 per cent annual GNP costs under the Government’s policies. In other words, Treasury’s analysis shows that Australia will be better off not reducing emissions, even if the rest of the world does.
What about the other side of the cost-benefit ledger? Avoiding any costs of climate change that can be demonstrated would certainly count as an economic benefit to Australia, but the key point is that these benefits will not be achieved by the Government’s emissions trading scheme. Australia’s emissions reductions can have no significant impact on global emissions or global climate. Therefore, the incremental benefits to Australia of the Government’s policy are zero.
The Government’s policy will have large incremental costs and negligible incremental benefits for Australia. This means that the expected net incremental benefits of the Government’s policy are negative, and from a cost-benefit point of view, the Government’s policy should be rejected.
Australian Government (2007) Best Practice Regulation Handbook, Canberra.
Commonwealth of Australia (2006) Handbook of Cost Benefit Analysis, January 2006.
Commonwealth of Australia (2008a) Australia’s Low Pollution Future: The Economics of Climate Change Mitigation, Canberra.
Commonwealth of Australia (2008b) Carbon Pollution Reduction Scheme: Green Paper, Canberra.
Commonwealth of Australia (2008c) Carbon Pollution Reduction Scheme: Australia’s Low Pollution Future (White Paper), Canberra.
Concept Economics (2009) Peer Review of the Treasury Modelling of the Economic Impacts of Reducing Emissions
Garnaut, R. (2008) The Garnaut Climate Change Review, Cambridge: Cambridge University Press.
Parliament of the Commonwealth of Australia (2009) Carbon Pollution Reduction Scheme Bill 2009: Regulation Impact Statement, Canberra.
Dr Alex Robson is a Senior Economist at Concept Economics in Canberra, and is a Visiting Fellow at the Crawford School of Economics and Government at the Australian National University. He holds a PhD in Economics from the University of California, Irvine.
 See Commonwealth of Australia (2008a), page 154.