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Is there a more effective way to reduce carbon emissions? An alternative to emissions trading and carbon taxation

15 December 2010

This paper considers a new scheme, the Tender-Price Allocation Mechanism, which focuses carbon factor cost expenditure on abatement rather than just revenue transfers.

In Australia and internationally, we have witnessed intense discussions concerning the best policy to reduce greenhouse gas emissions. The two main proposals are a carbon tax (CT) and an emissions trading system (ETS). The latter is favoured over the former mainly because, first, it can set a reduction target and, second, because increasing taxation is never palatable politically. The debate concerning the relative merits of these policies has tended to crowd out discussions about alternative schemes.

This is surprising because both policies have potential problems, both in implementation and in achieving their goals. The ETS is a ‘quota’ policy which deviates from economists’ preference for ‘tariff’ schemes, particularly in the context of international trade. Also, since both are ‘stick’ rather than ‘carrot’ policies that raise prices that are passed on to consumers, they depend upon there being a high enough price elasticity of demand to achieve significant reductions in demand. If demand is price inelastic then little will be achieved without very high increases in a carbon price with serious consequences for low income consumers. In particular, neither scheme addresses the consequences of increased cost or decreased emission reduction as a result of uncertainty.

This paper considers a new scheme, the Tender-Price Allocation Mechanism, which focuses carbon factor cost expenditure on abatement rather than just revenue transfers. It is a scheme that reduces uncertainty and the costs of uncertainty for both firms and regulators. It also incorporates a suite of incentives that compensates for the externalities associated with abatement investment.