Abbott's world of pain

We are living through a period of political fantasy that for some people, especially the hugely popular Coalition, is quite pleasant. But as any psychologist will tell you, returning to reality usually involves a good deal of pain.

First the fantasy. It centres on the carbon tax and its components are these:

– Labor's carbon tax won't reduce emissions, but will hurt everyone.

– It's a market based scheme (good) but goes too far ($23/tonne, bad).

– There are cheaper ways to achieve carbon cuts than a market-based scheme, and the Coalition knows what they are (why won't silly Labor listen!).

– Carbon tax revenue isn't needed to fund Labor's program of tax cuts and pension increases, because there are massive savings lying around in the budget papers to be scooped up and redeployed.

The first three are easily dealt with, so I'll be as brief as possible.

No gain, all pain

The fixed price period of the carbon tax will substantially reduce emissions. The Coalition claims there will be an overall increase in emissions between the launch of the policy and 2020 of 8 per cent, but that figure ignores abatement purchased abroad – until 2020, companies liable for the tax can buy 50 per cent of permits abroad where, due to global economic contraction, they are currently dirt cheap.

The EU carbon price currently hovers around €8.5 (approximately $A10.50/tonne) meaning the Australian companies liable for $23/tonne permits here would be buying them by the bucketload if they could.

Treasury states that "the [50 per cent] cap may be important if world prices are much lower than expected". It expects Aussie companies to source 28 per cent of permits abroad, but when the cap is lifted in 2015 it could end up being a lot more.

As for the 'pain' bit, Sophie Mirabella summed up this common misconception on the ABC's Q&A last night, arguing that the carbon tax is 'designed to hurt your hip pocket'.

That's an attempt to elide two important, if tricksy, aspects of the government's policy: firstly, that Australians earning less than $80,000 will be better off overall due to a massive restructuring of the tax/benefits system and, secondly, that the aim of the tax is to change 'relative' prices – that is, to make cleaner products and services cheaper.

However, laws of physics demand that there is a net cost for shifting to cleaner energy (we were only burning fossil fuels because they were the cheapest option), and Treasury still thinks that will be a one-off cost to the economy of a 0.7 per cent inflation boost this year, and a smaller inflation increase when the ETS scheme starts in 2015.

So there will be pain, but not for everyone. And there will be substantial gain from an environmental perspective.

Brutal market forces

As Ross Garnaut pointed out on Lateline last night, there is no real dissent amongst economists that an economy-wide market-based approach to pricing carbon is the least-cost approach.

And wouldn't it be nice if we had one.

The reality of the Clean Energy Futures package unveiled last year is that it contains far too much 'direct action' (as the Coalition calls their all-regulation approach to pricing carbon) – the Clean Energy Finance Corporation and the Australian Renewable Energy Agency are in charge of the command-and-control parts of the scheme.

The big difference between these agencies and those that will be used by an Abbott government is that they recycle revenue raised through a tax on carbon, whereas the Coalition's direct action will be funded from consolidated revenue – that is, paid for by every tax payer.

In addition to that 'non-market' mechanism, the government's scheme distorts the 'market-based' part of package with refunds for trade-exposed industries of up to 95 per cent of permits in the fixed-price period, further diluting the notion that it's 'market-based'.

In an ideal world, therefore, the Coalition would be opposing the government's scheme on the basis that it is not market-based enough. Instead, the Coalition decided early on Tony Abbott's watch that it would exclude market-mechanisms entirely.

As for going too far with the $23/tonne price, I think that's right – as Alan Kohler pointed out yesterday, the Greens, who forced the price up to this level during the Multi-Party Climate Change Committee process, failed to take public opinion with them (Prepare for a carbon tax call back, July 2).

In a democracy, that's a massive problem. The electoral backlash that is sure to occur at the next election will take climate change policy back a decade – not the outcome the Greens were hoping for, and one they should be roundly condemned for precipitating.

A weaker starting price, to be ratcheted up in future years as voters began to understand carbon pricing, would have achieved a far better environmental outcome in the long run. But they just couldn't wait.

The Coalition's free scheme!

Labor is bandying around a figure of $1300 per household per year in direct costs to the taxpayer if the Coalition's direct action plan was working in 2020.

That might be inflated somewhat, but the fact remains that direct action is 'a big new tax on everything'. It is funded from consolidated revenue, meaning the income and corporate taxes that pay for it, could be cut by an equivalent amount if we just did nothing (as some, including Liberal Party adviser Grahame Morris on Q&A last night, seem to be suggesting is still an option).

Moreover, the science on which the Coalition's 'soil carbon' measures is based is extremely uncertain – some carbon can be sequestered in farmland, but not nearly as much as the Direct Action policy is suggesting.

In sum, therefore, the Coalition's scheme will either become much more expensive than Labor's, or will not hit the emission reduction target shared by both parties – 5 per cent below 2000 levels by 2020.

Slash and burn fantasy

Which brings us to the real fantasy – that the bribes put in place by Labor to smooth the transition to the 'Clean Energy' present (tax cuts, pension and other benefit increases), can all by paid by Tony Abbott without the carbon tax revenue Labor is raising.

Abbott and his front bench have been saying for months that they will pay for these goodies by cutting fat from the budget.

And here comes the pain.

Budget cuts do not, in this era of government, involve the firing of a few indolent public servants who will then dutifully take up productive roles in the private sector.

Labor has been trimming the fat with its 'efficiency dividend' of 2 per cent reduction in each department's funding each year – accelerated last year to 2.5 per cent.

Trimming the fat in this context means cutting frontline services. That's not going very well for the NSW Coalition government, with a growing groundswell of discontent being the obvious result.

NSW opposition leader John Robertson is running around saying "paramedics, firefighters, child protection workers, teachers' aides and physiotherapists are among the thousands of workers that could be sacked" as the O'Farrell government tries to rein in the budget.

Expect industrial action to rise and the O'Farrell government's opinion poll results to fall.

That's how our flawed, but 'least bad', system of democracy works.

At a federal level the Coalition is asking voters to believe that it can scrap the carbon tax, continue to pay for all the tax breaks and pension increases, and fund them through budget cuts that voters won't notice.

They will notice. And there will be a race against the clock for the Abbott government.

To repeal the carbon tax it will have to win a double-dissolution election (unlikely to be possible until 2015 due to pesky parliamentary checks and balances) against a backdrop of increased industrial action and the dissatisfaction that voters feel when frontline services are cut.

It's a beautiful fantasy. But there will be nothing beautiful about the pain that follows.