Should Rudd make the floating price switch?

The Conversation

Carbon pricing has helped to destroy three political leaders – Malcolm Turnbull, Kevin Rudd and Julia Gillard – since 2009. Why would a re-minted Prime Minister Rudd want to touch such a poisoned chalice in the short time he has to recapture the hearts and minds of the Australian electorate? What are the economic and political risks of doing so?

Ratification of the Kyoto Protocol and the “Sorry” speech marked the high points of the Rudd Prime Ministership. When he baulked at taking the carbon pricing scheme through Parliament in 2010, Rudd lost many of the faithful who voted in the Labor Government in 2007. Having labelled climate change the “greatest moral, economic and environmental challenge of our time”, his fall was so much more damaging.

Many would say that Prime Minister Gillard’s tenure was doomed when she allowed the Opposition and the media to frame the fixed price of the emissions trading scheme as a carbon “tax”. What may have been a simple attempt to avoid being seen as pedantic over a definition proved to be a fatal own goal.

The problems with a fixed price

There have been three killer problems with the initial fixed price arrangement. One, it could be so easily labelled a tax – a problem at any time but worse when Gillard had ruled out a tax during the 2010 election campaign.

Two, in compensating low-income households by adjusting the tax system, the Government locked in the cost side of the ledger. Yet the revenue side is determined by the combination of the price and the volume of emissions. This is fine while the price is fixed, which it is for the first three years. It is not fine when the price is set by the emissions cap and by currently low international prices. Current expectations of the price for 2015-16 suggest there will be a hole in the budget worth many billions of dollars.

The third reason is that the current price of above $23 has never looked like being in line with international prices, most notably the European price. If it had turned out to be much lower, the Greens and others on the environmental advocacy side would have protested. Much higher, as it has turned out for now, and the business lobby and those opposed to emissions reduction in any form would have done the same.

Reasons to switch quickly…

There are three main arguments in 2013 for moving quickly from a fixed price to a market-priced mechanism with a fixed emissions cap. First, it would distinguish Rudd 13 from both old Rudd and the failures of the Gillard regime. Second, it would take the fight up to the Opposition by neutralising the “carbon tax" argument.

The members of the Government’s emerging leadership group are already consistently emphasising the use of carbon price rather than tax. It might even make climate change an election issue again. There is bipartisan support for reducing our greenhouse gas emissions by 5% below 2000 levels by 2020. What does not have bipartisan support is the path to that objective. A real debate on the merits of an emissions trading scheme against the Opposition’s Direct Action policy has been sadly lacking to date.

Third, the change would open a constructive dialogue with business. Individual companies and their industry associations such as the Business Council of Australia and the Australian Industry Group have vigorously lobbied for a move away from the current fixed price. Ironically, if tight caps more aligned with tougher global climate change commitments become a reality, business groups may just as quickly turn back to fixed – in that scenario, low – prices.

…and reasons to keep things the way they are

Why might a move from a fixed to a floating price be a bad idea? The original rationale for the fixed price, remember, was largely to provide price certainty. The business lobby wanted a fixed low price, the Greens a fixed high price. The resulting compromise, also based on forecasts of international prices, was wrong and was always going to be so.

Assuming the market-based price would be well below $20 – perhaps as low as $10 a tonne – the revenue shortfall against the fixed compensation would be revealed. Compensation might need to be adjusted, at some political cost. A low price would be likely to trigger a major disagreement with the Greens, particularly since they already see the current fixed price as too low. Also, moving from a fixed price earlier than the scheduled date of July 2015 would require the setting of emissions caps, which is both politically difficult and hard work.

On balance, there are strong arguments for committing to an early move to a market-based emissions trading scheme as the core climate change policy. The arguments against are most likely manageable. Yet such a move will force Prime Minister Rudd to create a narrative that explains how he got it wrong the first time, connects with international action now taking place in countries such as China and the US and rekindles the climate change flame of Kevin 07.

Tony Wood owns shares in Origin Energy, BHPBilliton and other ASX200 companies. He is Program Director, Energy, at the Grattan Institute.

This article was originally published at The Conversation. Republished with permission.