Why cap-and-trade beats a tax

In the heat of the debate over the merits of various carbon reduction plans, it's too easy to forget what the argument is fundamentally about: this is an environmental policy that should be designed to achieve an environmental outcome.

The fact that the policy debate has been diluted and detoured towards fiscal and political solutions is a sad inevitability. After all, of all the great technological transformations – from cow dung to coal, from typewriters to computers, and from analog to digital – this is the first one we get to vote on. And, of course, the debate is coloured by the fact that the science of climate change and the contribution of man-made greenhouse emissions is still loudly, but not widely, contested.

Perhaps this explains the renewed call for a carbon tax, a mechanism that can be here today, gone tomorrow. A tax has a superficial attraction because it appears a blunt instrument that is easy to administer, but if it were there to achieve an environmental outcome, it would be dreadfully hard to impose.

Cap-and-trade schemes have been favoured – after more than a decade of vigorous debate – because they set an environmental target and let the market decide the price, markets being a favoured tool of the capitalist world.

A carbon tax simply sets a price, and a fiscal and financial outcome, but it is pretty much guesswork as to what the environmental outcome might be.

One thing is for certain, it would condemn successive governments to announce further and regular and quite significant increases in a carbon tax in an effort to meet the environmental goals – if not, what would be the point of even a small tax. It would be about as regular as an election cycle.

This is not an attractive scenario for any politician, and it simply recycles the issue as a lobbyist playground. Yes, a cap-and-trade scheme might deliver an avalanche of fees to traders and bankers, but a carbon tax would simply deliver that money to lobbyists and consultants with their endless economic models.

(Judging by the hundreds of millions spent on lobbyists on Capitol Hill this past six months, that would be one hell of an annuity. Little wonder they are pushing it so hard.)

But a carbon tax also holds little attraction for the owners of our businesses – the superannuation and pension funds here and overseas – who generally favour a cap-and-trade scheme because they want it to drive the investment opportunities of the future. And with a $6 trillion global clean energy industry and growing, that is considerable.

As Nathan Fabian, the head of the Investor Group on Climate Change, which represents Australian investors with some $500 billion of investments, says, the prospect of financing of new technologies under a cap-and-trade scheme is one of the few bright lights on the current economic horizon. You don't get that kind of response from a tax.

"Portfolio investors want a range of opportunities to invest in,” he says. "You can't assume that all the incumbents are going to make that transition.”

Carbon reduction schemes must be designed to encourage a significant change of behaviour from high emitters, so they must encourage a flow of capital. And they must take into account the enormous potential of energy efficiency, or even the huge potential of sequestration in soils and plants. This will allow for greater ambition.

And they should drop the dubious assumption that only established utilities can lead the charge into new technology. The world's investment funds would beg to differ, and so would the huge specialist renewable energy companies that have and will emerge here and overseas.

By omitting some industries from the scheme, fully compensating others, and putting sectors such as energy into a completely different system simply switches the burden to the rest of the economy.

Investors may not like some of the detail of the package, but they realise that they will incur a cost whichever way the policy turns. They just want to get on with being able to seize the opportunity, and so do those companies that have already begun to make that transition.

And is it really going to be that bad? Does the CPRS, for all its imperfections, really amount to the most terrible crisis ever to face the country? Analysts at Goldman Sachs and Citi quantify the impact at between 1 per cent and 2 per cent of earnings. If that's a national catastrophe then someone save us from this year's earnings season.