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SELECT COMMITTEE ON CLIMATE POLICY
15/04/2009
Emissions trading and reducing carbon pollution

CHAIR —Welcome to our roundtable on key design features of the CPRS. I propose to ask each of you to make a five-minute opening statement, and I am going to be relatively brutal on time. As I said, it is important for you to get your points across and for us to get our questions asked and answered. Dr Denniss, I invite you to make a five-minute statement regarding your perspective.

Dr Denniss —Thanks for the invitation to attend. There is a lot that needs to be talked about—it is a big piece of legislation—but I will try to prioritise things and try to make some guesses about what other people will bring up. The main problem with the CPRS is that the targets bear no relationship to the problem that is trying to be solved. Emissions trading is not good or bad; it is a mechanism for solving a problem. The problem is to reduce greenhouse gas emissions, and the selection of targets in the CPRS is entirely disconnected from the scientific problem of reducing greenhouse gas emissions. Having an emissions trading scheme which bears no relationship to that problem is an expensive exercise in failure. That is not an underlying critique of an ETS; that is a design feature of this one. If you want to have a politically acceptable one that does not disrupt polluters, that is okay, but it is then a job creation strategy, not a climate strategy.

The next problem I want to talk about is the interaction between the Australian CPRS and our international obligations. I think there is a lot of misunderstanding about that interaction. If we participate in an international scheme, we accept international obligations to achieve a particular emission reduction. We do not make commitments to other countries about how those reductions will be achieved and, frankly, other countries do not really care how they are achieved as long as they are certifiably achieved. There is a lot of conversation about the need for the CPRS, as our version of emissions trading, because we need to be joined up with the rest of the world. I think that is a misunderstanding, and I am happy to take questions on that.

In a nutshell, whether we have the CPRS as currently proposed, an amended version of the CPRS, a carbon tax or a whole suite of domestic emission reduction policies, as long as we achieve the targets that we have agreed to in the international community, that is great. And if we do not achieve those targets—which, under the modelling in the CPRS, we do not attend to achieve—we will import credits from other countries. We can import credits from other countries regardless of whether or not we have the CPRS. So, to restate: under the modelling for the CPRS, we are not intending to even meet the CPRS targets let alone our international obligations. The shortfall will be made up via the importation of permits. That avenue is available to us regardless of whether or not we have the CPRS, whether it is introduced in the timeline and whether it is introduced in the form proposed by the government. So, regardless of whether the CPRS is passed or passed in its current form, if we sign an international obligation, it is our international obligation that will determine our 2020 emissions, not the CPRS. The CPRS is a means to an end. The end is our international obligation. The analogy that I would give you is if we made an international undertaking to spend $10 billion a year on foreign aid, it does not matter whether we raise the $10 billion a year through an income tax, through a lottery or through a payroll tax—it is irrelevant. All that matters is that we hand over the money that we promised to hand over. The same is true for our international obligations under emissions trading.

There are other points that I would quickly like to make. The proposed emissions trading scheme, the CPRS, sets not only a cap above which emissions cannot rise but also a floor below which emissions cannot fall. There seems to be some dispute from the government on this point, but there is no dispute from the department or from other experts in this area. Once we have set a target under the CPRS, if households, local government, state governments or the federal government itself attempt to reduce emissions further—for example, by spending $4 billion on insulation—we do not reduce the level of emissions; we simply reduce the level of emissions from a particular sector, like the household sector, thereby freeing up permits for polluters in other sectors.

Some people will rightly argue that that is a design feature of the current proposal. I think the question for this committee and for the parliament is whether that is a good design feature and whether you would like to change it. The advantages of changing it are that, in addition to giving motivation and equity for people who are trying to do their bit, if we do fix the system in that way, if state governments spend billions of dollars trying to reduce emissions, regardless of the target set—no matter how timid the target set at the Commonwealth level—we leave the flexibility to go further through individual and state and local government actions. Most people would argue that a design strength of emissions trading is what we all quantitative certainty—the certainty that we will hit the target. That is a design feature if the target is a good target. But, as I said at the beginning, if you have selected a target that is entirely unrelated to the scientific problem you are trying to solve, that certainty of hitting the target is actually a weakness, not a strength. So including flexibility to go further is, I think, a good improvement.

The last point I make is that the assertion that the CPRS will deliver least cost abatement is repeated again and again. I just do not see any evidence that has been put up to back that up. The exclusion of agriculture is, I would argue, proof that it is not a least cost abatement process. The fact that the government is spending $4 billion to put insulation in people’s roofs is proof that it is not least cost abatement. If the CPRS was going to drive the kind of investment in energy efficiency that we need, you would not need the $4 billion for insulation. The fact that we are spending $4 billion on insulation is proof that the CPRS does not drive least cost investment. I think that is my five minutes.

CHAIR —Thank you very much, Dr Denniss. Mr Mazouz.

Mr Mazouz —I am the Director of EcoPerspectives, but I am here today in a personal capacity. I have a lot of sympathy for those who feel that the CPRS needs to be changed fundamentally. It does have many flaws, and some of them have been picked up. Others I might disagree with—there are lots of opinions out there. To my mind, a fundamental change to the climate change mitigation response in Australia right now is only likely to lead to a delay in the increasingly necessary coordinated, economy wide action on climate change.

The Carbon Pollution Reduction Scheme has many problems that arise out of political pressures and implementation issues. Those same pressures will apply whether you have a carbon tax, an emissions trading scheme, different forms of emissions trading schemes and so forth. It is important to pass the CPRS—potentially with amendments—in order to get that broadbased price mechanism into the system and allow the economy to start getting that price signal. The more broadly based that price signal is—for instance, including agriculture—the better it is. At the same time it is very hard to see that this could be done in one go. The problems in implementing the Carbon Pollution Reduction Scheme to include agriculture are that much more complex. Getting a start on an as broad as possible price mechanism is to my mind a worthwhile thing to do.

I believe there are three main amendments that should be pursued now and in the future. Even if they cannot be passed as part of the implementation of the CPRS now, it is going to be worth pushing for them later. One is tighter targets and greater flexibility to achieve those targets. Another is the policy design features relating to industry assistance, especially with respect to trade-exposed emissions-intensive industries. Finally, I think it is worth reviewing how the CPRS deals with international permits. By the way, my position is that I do not believe that we do need to worry about the issues around voluntary action. I will quickly outline each of those.

The proposed targets are not high enough for Australia to play its proportionate role in reaching a global target of 450 parts per million. By the way, science is increasingly telling us that that may be too high. There is strong evidence that deferring action will cost more rather than less. In that light, the 10 to 25 per cent target suggested by Garnaut, aside from sending a stronger signal to the international community about Australia’s willingness to participate in more ambitious global action, may turn out to be cheaper than the five to 15 per cent range that the government is proposing.

In relation to assistance to emissions-intensive trade-exposed industries, the current proposal is to commit in the order of $40 billion or more to a very small proportion of the economy. But the evidence for leakage, which is the main reason for this assistance package, is actually very weak—as is the case for the policy interventions themselves, by the way. The other thing, of course, is that this assistance package has the side effect of increasing the cost of the scheme to the remainder of the economy and reducing the ease with which the emissions target can be tightened over the next decade.

In respect of international permits, I think that the current regime’s restriction on exports is somewhat peculiar. I know that the modelling says that we are unlikely to become net exporters of permits any time soon, but to put the restriction on it is somewhat peculiar. We do not do that for any other aspect of economic activity. Very few people would advocate having export restrictions on goods to avoid the prices rising domestically, which is essentially what we are saying with respect to carbon permits.

In relation to import of permits, I think that further consideration needs to be given to the effect of purchasing the cheapest abatement opportunities that are available in developing countries. I think that that would affect their ability to then agree to targets later on. Of course, I think we need to bear in mind the quality of the targets that we are importing.

Briefly, on voluntary action: in my opinion it is simply not accurate to assert that voluntary action does not contribute to abatement in the scheme as currently proposed. Obviously, I am happy to elaborate on that or any other aspect.

CHAIR —Thanks, Mr Mazouz. Mr Hitchens.

Mr Hitchens —AIGN endorses the CPRS white paper test for setting Australia’s emission budget at a level that is commensurate with advanced economies taking on reductions comparable to Australia. However, the minus five per cent target, which represents a 25 per cent reduction in emissions relative to expected trends and a 34 per cent reduction relative to per capita emissions, is some three to four times stronger than those proposed by other, wealthier countries such as the USA and countries of the EU, as measured by an impact on gross national product. AIGN advocates that Australians shoulder a fair share of the global burden—no more and no less.

AIGN also advocates that an efficient response to the challenge of reducing human-induced greenhouse gas emissions must involve pricing emissions and offsets in a coherent way. A carefully designed emissions trading scheme probably has better potential to meet these requirements in an economically efficient and equitable way than do other policy instruments; however, the design of the CPRS fails both the environmental effectiveness and economic efficiency tests. In AIGN’s view, in the context of a limited global agreement the CPRS legislation will need to be amended. I have a list of amendments here, which I will not read; they are in our executive summary to the submission. What I would like to end on, though, is one of those items, which is:

The objective of developing a coherent and streamlined set of climate change measures across jurisdictions has long been requested by industry.

That has been for 20 years. There are over 140 Commonwealth and state (and territory) measures that claim to be in place in order to address climate change. Industry has not yet seen one of these measures replaced. Indeed, we see jurisdictions continuing to impose additional measures. Until the situation is rectified, any claims that the CPRS can be economically efficient are hollow.

CHAIR —Thank you, Mr Hitchens. Mr Pearce.

Mr Pearce —The Centre for International Economics is a private economic research and consulting firm. We work at various times for state, Commonwealth and international governments and peak bodies, usually on some form of modelling of greenhouse related issues. I will be speaking to you tomorrow also, so I will be brief here. With regard to some of the questions raised in the previous session about the costs on agriculture, I note that we are currently engaged by a number of clients, R&D corporations within government, to address some of those questions, and hopefully that information will be available in time for this committee. Other than that, however, I appear on behalf of my own organisation and not on behalf of any of our clients. I do not speak for them.

On the CPRS and the economics of mitigation, I agree with previous comments that establishing a price of carbon is fundamentally important. It really cannot be underestimated how important that is and the effect that it is likely to have—to significantly change people’s perceptions, to internalise the currently externalised cost of carbon. It is a very important policy change to adopt. The CPRS is one way of configuring a traditional cap and trade emissions trading scheme. There are many other ways of configuring such a scheme. What has particularly concerned me is that we do not have a very good quantitative understanding of the trade-offs that are made in choosing the particular configurations under the CPRS. Dr Denniss referred to the claim in the white paper that the CPRS will achieve abatement at lowest possible cost. That is possible but, as he pointed out, that claim is nowhere tested or demonstrated. It is a very important claim. If it is true, it is fundamentally important. It is fundamentally important that the abatement measures we adopt are in fact least cost, because that will mean we can afford to do more. I would like to see some explicit modelling to test that claim—that is, to test whether it really is the least possible cost of abatement.

I come at this largely from a regulatory impact perspective. We are engaged on many occasions to do regulatory impact analyses for government. As you are probably aware, major regulations require a regulatory impact statement, and an important component of that statement is often a quantitative comparison of the proposed regulation against other alternatives to demonstrate that that is the best way of achieving the objectives of the regulation. I think it is very important that such a regulatory impact statement or process is undertaken for the CPRS and that it is undertaken by an independent organisation that has a transparency role. I am thinking of the Productivity Commission or other organisations like that, which are used to the process of doing the analysis and making all of the results of the analysis transparent and publicly available. To me it is very important to consider the demonstration that the CPRS really is achieving its objectives at lowest possible cost. Thank you.

CHAIR —Thanks, Mr Pearce. Mr Carmody?

Mr Carmody —Thank you, Mr Chairman. I was a co-founder of Access Economics. I currently am Director of Geoff Carmody and Associates. I have had 15 years economic policy experience in Treasury and subsequent to that 25 years economic policy consulting experience. I appear today in a personal capacity.

I accept the majority scientific opinion that global warming is happening and that we need policies to reduce greenhouse gas emissions. I am not here to debate the science. I will leave that to the experts. I also accept that this is a global problem and that therefore it requires a global policy response. Let me sharpen that point. I believe it is crucial to adopt a policy model that maximises chances of getting a truly comprehensive, truly global policy response. I am concerned that the current policy model chosen by Europe, Australia and New Zealand is wrong. Specifically, this model maximises impediments to securing a global policy response rather than minimises them. Indeed, it is arguable that if Australia adopts the CPRS as currently structured it will increase incentives for our trading partners in Asia and America not to act on climate change. In my opinion the CPRS as presently proposed is not a means to a carbon reduction end. Perversely, it is more likely to hamper global efforts to achieve that outcome and quite possibly—in terms of global emissions—take us backwards.

Let me briefly go back in history. In 1992, when we got the United Nations Framework Convention on Climate Change, the original vision was for a policy model that made sense and would have worked. That model targeted national production of emissions based on the harmonised introduction of a carbon tax—that is, a global carbon tax. That made sense. Immediately you had thrown out all concerns about competitiveness, carbon leakage and job losses due to one country acting before another. By the time we got to 1997 and the Kyoto protocol, two changes had been made to that original vision. The first and less important one was that we moved to an emissions trading scheme. I personally think that emissions trading equals emissions shuffling and that the word ‘scheme’ is highly appropriate to describe that arrangement. The most important thing, however, was that the Kyoto protocol broke that production model’s viability by ratifying the notion that countries would act at different times. As soon as that happened, individual countries faced trade incentive considerations that dominated their concern about environmental policy initiatives. That is the fundamental problem that has caused what we have seen since. We have now had nearly 12 years of evidence of how a national production model in a non-harmonised context will work. The short answer is: it will not.

Kyoto has failed. As Elizabeth Barrett Browning might say, ‘Let me count the ways.’ Not all countries have ratified the protocol. For those that have, observation of the targets they have signed onto has been observed far more in the breach than in the observance. As I said, the protocol mandates non-harmonised action. That immediately destroys the viability of a national production based model as a way forward for individual countries. Let us look at Europe, the home of the ETS. As I understand it, policy coverage there is about 50 per cent of CO2 emissions and maybe 40 per cent of total greenhouse gas emissions. Even if the world signed on to that model, with that sort of carve-out, where would we have got? We would still be left with half of the emissions not covered. On current flows of anthropogenic emissions, the primary variable I assume intended to be targeted by this policy, the major absolute emitters, the USA, China, India et cetera, have not come on board—not yet, anyway. In some instances there are indications that they are unlikely to do so in the foreseeable future and in others there is a revived debate about the best way to act.

Even if we look at the countries that have ‘come on board’, we should look at the way they have done so. To pick up a point that Mr Mazouz made earlier: there is not much evidence of leakage. Why would there be when carve-outs have been so extensive? Countries that have come on board have carved out large slabs of emissions because they have been worried about trade competitiveness. That is the thing we are worried about here; that is what every country is worried about. That is why you do not get a comprehensive policy nationally when all countries do not act together. Even those that have come on board have mostly missed their targets. The fact is that those countries that have come on board have tried to move from this national production model to something else. Without specifying what it is, they have tried to move to something else. They have tried to say, in a ham-fisted way, ‘Let’s look after some of our exports at least, the emissions intensive ones, and maybe let’s have a bit of border protection for the import side as well.’ That is a recognition that we have to go to a different model, and that model would be focused on national consumption of emissions. That is what China actually wants. That is what the United States is effectively talking about when it talks about border protection for import-competing industries. That is effectively what the carve-outs—in their own ham-fisted way—that we are adopting or proposing to adopt and which Europe has adopted are groping towards as well.

We need to move in a non-harmonised world away from a production orientation to a consumption orientation. This is not protectionist. I am against export subsidies and import tariffs. But equally I am against export taxes and import subsidies. Export taxes and import subsidies are what the CPRS, as currently structured, is all about. Thank you.

CHAIR —Who wants to start?

Senator MILNE —I will.

CHAIR —Do you want to start, Senator Milne?

Senator MILNE —Thank you very much for your contributions. I am interested to hear from all of you about the extent to which the current scheme as it is designed will drive transformation in the Australian economy and the extent to which it is designed to protect the existing industry mix and the existing energy production. It is a key issue for me because, if we are going to get to a low-carbon economy, we have to drive transformation. I am interested to know whether you think the scheme will do that and what the problems are.

Dr Denniss —I would say the scheme has been designed to prevent transformation. The very small targets are explicitly based on the fact that, if we had more ambitious targets, there would be more transformation. The assistance packages have been designed not just to provide assistance to the status quo; if big emitters increase their emissions over time, the amount of free permits they get increases. So not just in a static sense but in a dynamic sense the scheme prevents transformation.

Again, the design feature of a fixed number of permits being shuffled around means that, if the household sector or state governments or others seek to undertake a lot of transformation, given that the number of permits remains the same, the transformation of one sector is a substitute for the transformation of the other, which is one of the main reasons I keep bringing this point up. If we transform household energy use, we have reduced the transformation of the big polluters.

Mr Mazouz —My view is that the scheme indeed has a number of problems in the way that it encourages transformation—so I agree with much of what Dr Denniss said. Yet I think the question is: what is the alternative right now? We have been talking about various schemes and scheme designs for a very long time. The CPRS does provide a price mechanism that is as broad as we could get it, in a sense, given the political pressures that are around. Perhaps not—I just wonder whether, for instance, Mr Carmody’s scheme would be implementable in its theoretical beauty or whether, in implementing it, one would end up with very similar carve-outs that come from the pressure applied by particular groups. Those pressures in part may be self-serving but in part also serve to ease the transition to an economy that is able to reduce emissions more efficiently over time.

So I think the introduction of the CPRS has the advantage of allowing economic actors to get used to a carbon price, albeit low. I would advocate a more stringent target and I think it is worth fighting for and so forth, but I do not believe that it is worth throwing out the baby with the bathwater to seek to completely change the scheme. That said, there are a number of design features that could be changed. For instance, emissions-intensive trade-exposed industry assistance is one of those where essentially there is a carve-out that means that those industries are not facing the full abatement incentives. They are facing technology based abatement incentives—that is, incentives to change the technologies they use in production—but they have no incentive at all to change production levels, and that is a real problem in terms of the operation of the price system.

Mr Hitchens —I will try to make about four points. The first is that the scheme covers roughly 75 per cent of Australia’s emissions, so clearly 25 per cent of emissions are not in the game yet. We heard from the NFF this morning. They are a major part of the 25 per cent that is not in. So there has to be something more comprehensive than what we have. The second thing is that that 75 per cent is not a true 75 per cent. For example, you and I as motorists are going to be fully protected, at least until 2013, and then partially protected forever, apparently. That does not seem to make a whole lot of sense to me. Either we are going to have a price on this or we are not.

Let me now just pick up the two industry sides, if I may, and state quite clearly that nothing in the current design—apart from something that Salim just said, and I will come to that—stops the price signal getting through to industry in the way the CPRS is designed. If we take electricity generation, what is proposed there is one-off, upfront, single, ‘don’t come back any more’ asset value loss compensation. It is a straight equity deal. It will have no impact in their day-to-day decisions on how much electricity is produced, what price they should put on that electricity—that is, the compensation is unrelated to the production.

For trade exposed industry, I think it is pretty clear that you are wrong that production decisions will not be changed, because what is being offered is a long way short of a trade neutral outcome. I think we have seen eight activities determined so far. I may be wrong; I have not looked at the website in the last couple of days. The minister announced the first eight last week. Nearly all of those eight fall into the 90 per cent category, and they will get very close to a 90 per cent allocation, but they are probably the only ones. For most of the others the effective rate of allocation will vary. We have a couple of cases in the 90 per cent category that look like an effective rate of allocation of 70 per cent. We have one in the 60 per cent category that has an effective rate of about 20 per cent. Of course, there is a whole lot of trade exposed industry; some were mentioned here this morning, particularly in food processing, that do not come into the scheme at all. They will get zero allocation.

There is a great deal of incentive in here that will reduce production in Australia—no doubt about it. It will reduce investment in these sorts of industries. Even if there were 100 per cent allocation for trade exposed industries, the design that the government has—and we agree with this—is based on a benchmarked emission intensity. That design automatically gives an incentive—and this was your first point, Salim—for reducing your emissions compared to that baseline, and so a great deal of investment will take place in that. But, importantly, we do not want production to decline in Australia in any of these trade exposed industries at this point in time. That is the problem we face at the moment. We are in this transition between a partial global agreement and a full global agreement. If we had a full global agreement this would not be an issue.

Mr Pearce —It is quite a hard question, Senator. First of all, I think that ultimately transformation of our economic structure from carbon intensive to less carbon intensive has to be led by consumers. I am concerned by the proposition, which is sometimes explicit and sometimes more subtle, that this transformation can happen without imposing any cost on consumers, that consumers can somehow themselves be protected. At the end of the day, all of the economic activities which generate emissions do so in order to ultimately deliver a product to some consumer, whether it is a flat screen television, a steak—whatever it is. It is very important that the price mechanism is allowed to work so that the full price impacts move all the way up the chain to the consumer so that, when consumers go to Harvey Norman or another superstore to buy a particular product that is energy intensive or emissions intensive, they can see which product they should buy. Because there will be a price difference. Some will be less emissions intensive than others.

I agree with Michael’s point about fuels. I think it is a mistake to carve out any aspect of the consumption bundle from the price effects. I understand that the politics of fuel prices in Australia are such that it is not a good idea to recommend a fuel price increase. However, I think we already started to see the sorts of long-term adjustments that happen when you have a higher fuel price. It does not happen immediately. People do not stop driving the next day. But over time you see a smaller proportion of big cars being purchased and you see slow and steady changes in behaviour. I think, with the transformation notion, it is very important that the price signals are allowed to move up to the consumer and that the consumer, which is all of us—the household; everybody—is fully aware that this is a price they are going to pay in order to transform the economy, rather than trying to pretend, in sense, that you can do it for nothing. That is my bit on transformation.

On the issue of protection, I think it is important to point out that the proposed allocation to emissions intensive industries is not really a form of protection; it is an attempt to correct a distortion that is created by the fact that there is an Australian carbon price ahead of the rest of the world carbon price—or, in Mr Carmody’s way of phrasing it: to correct the fact that we have a partial production base system rather than a global production base system. This is a fundamental problem. The CPRS, as proposed, is not trade neutral and there are no benefits from that non-trade neutrality. You could accept non-trade neutrality if there were some benefits associated with it, but in this case there is not. So that protection to emissions intensive industries is really an imperfect attempt to correct that distortion. Unfortunately, while the ultimate cause of the distortion remains in place, you cannot actually correct it. So whatever measures are proposed in order to correct it will ultimately be imperfect. That is just a note on the notion of protection.

A third point I would make is that, in order to fund a transformation—to change technologies, to find the new technologies that are lower emitting—we are going to need some investment funds. Somebody is going to have to invest. Somebody is going to have to take a risk. It is an interesting question as to who is best placed to take that risk. As it is proposed in the CPRS, with almost full auctioning, firms will be paying more money than they are actually spending on their abatement. For the abatement, they need only to spend on the margin, but they will in fact be paying for the full amount that they are emitting. That is a big transfer of funds from the private sector firms to government—which, under the CPRS, the government is proposed to hand out in a variety of different ways. That is one way of doing it. An alternative is to structure initial allocation differently so that the funds remain with industry so industry have those funds to then invest in the kinds of abatement technologies that may be necessary. I cannot tell you for sure which of those two will deliver the best outcomes for Australia, because it has not actually been modelled yet. But I believe that has to be an important part of this transformation issue.

Mr Carmody —I pretty much agree with everything that David said, so I will not repeat most of that. But I do want to talk about price and the transformation, because I think that is a crucial question. It is the reason that we are doing this in the first place. Before I do, I will offer some homework to Mr Mazouz and invite him to read my policy note No. 2, which explains how a piggy-backing off the GST consumption approach is eminently practical.

On price, I guess we could consider price in the following way. Let us suppose we have effectively a low-carbon price in Australia. If that is the result of a CPRS, given the rationale for a CPRS—which is to send a price signal—then we can expect transformation responses to that to be lower. That is not rocket science. If we have a higher carbon price in Australia, where Australia is acting unilaterally, we can expect significant transformation. But it is probably not the transformation we want. We will see a significant transformation in the location of production to other countries that do not have such a policy. The result of that may well be—contrary to Minister Wong’s repeated assertions—an emissions trading scheme that does not give us global emission certainty. It might give us emission certainty in terms of a reduction in national emissions, but only because they have been shuffled offshore. In fact, it is even conceivable that that sort of transformation might increase emissions globally rather than reducing them. And, if you are just shuffling emissions through trading rather than capping them and reducing them, that is just churning. The financial community will love it. They would make a margin on the coupon every time it goes around.

Finally, let us look at the transformation we really want. The transformation we really want is driven by a strong, predictably rising, not volatile carbon price signal that investors can respond to. But it has to be done in a way that does not visit upon Australia concerns about carbon leakage or shuffling of permits. That is what we want to effect transformation. A consumption based model which ultimately flows the price signal from high up the supply chain right through to the consumer—as David was describing—is what we want. That will generate at all points in the supply chain, including at the consumer end, a transformation in the way Australia produces its goods and services. And if we act unilaterally and it is done in a way that prevents carbon leakage, we can go forward knowing that any reduction in emissions that we make as a result of that transformation is equally a reduction in global emissions—it is not just a shuffling of those emissions offshore.

Senator BOSWELL —Mr Carmody, what chance do you believe there is in getting a universal carbon trading system throughout the world? Is it feasible? I know it is laudable to look for it, but can it be achieved?

Mr Carmody —Again, you can look at this from two perspectives. If we had that original vision of a national production based scheme or policy which involved application of either emissions capping and trading or a carbon tax where all countries move together, that would work. Then we would have everybody in the boat. We would get a similar price signal all around the world—there would be no way to escape it—and there would be no need for carve-outs. Everything is covered. That would work. We did not get that in 1997. It is not that; it is this. What we have now is a fragmented policy response where there are strong quasi-moral arguments that say that developed countries have got to go first and developing countries go second.

In that sort of environment, I still think it is possible relatively quickly to get a deal if we move from a national production based approach to a national consumption based approach. You immediately take away the carbon leakage/job losses concern. Remember: Ross Garnaut said ‘this is a diabolical problem because of the prisoner’s dilemma’. That title is not quite accurate, but let us call it ‘I’ll cut my emissions after you cut yours’. That is what we are facing at the moment. Everyone is doing this. That is why nothing gets done. This is not some sort of out of the ether market failure problem that we have just got to live with. This is a government policy failure. It is a failure of national governments to choose a policy model appropriate to an environment where countries are acting at different times. That is the bad news. The good news is that this model can be changed with the stroke of a pen if governments want to. If governments move to a consumption based approach, the prisoner’s dilemma problem disappears. China have already indicated quite clearly through the climate change department there that they think a consumption based approach is the way to go. America is already talking about border protection on the import side. ‘Protection’ is the wrong word there; it is trade neutrality.

Senator BOSWELL —What does that mean—a tariff?

Mr Carmody —Yes. The biggest irony in my mind is that the three countries that have got a policy of this sort or are about to embark on a policy of this sort are Europe, Australia and New Zealand—and guess what? All of those countries have a GST—and the GST is the mechanism already in place on which you can piggy-back a consumption based approach. If that was the model that was taken to Copenhagen, far from delaying the process—as Mr Mazouz asserted—I would argue that that would accelerate the process to a genuinely global deal.

Senator BOSWELL —I have another question.

CHAIR —Could we hear Dr Denniss’s response to that, Senator Boswell.

Senator BOSWELL —Yes. Anyone who would like to respond is welcome. I asked you about the practicality of it. You gave me the reasons why we should do it, but you did not tell me about the practicality. But maybe Dr Denniss can help there.

Dr Denniss —Yes. I support virtually everything Geoff just said. There is a question that I think needs to be asked, and this appears to be the context to ask it in: why is Australia rushing in to have our CPRS legislation passed before we have an international agreement at Copenhagen or beyond? A lot of the uncertainty that we are talking about here is about what is possible, what is going to be agreed to et cetera. The simple question is: where is the argument, policy or otherwise, for saying that, if Australia locks into a particular scheme with particular domestic targets right now, that somehow facilitates rather than, as I would think, prevents or certainly reduces the chance of coming up with an optimal global solution? I support what Geoff is saying, but I think that raises the question. One way to get around a lot of this uncertainty about what the world will and will not agree to is to wait until they do or do not agree to it.

Mr Carmody —But it is worse than that.

Dr Denniss —Yes, I agree.

Mr Carmody —It is worse than that, because if we act now then we actually send a signal to those who have not acted up to now not to act.

Dr Denniss —I agree.

Mr Carmody —If we want to act now, do something unilaterally and take a chance, I do not mind doing that. I do not mind accepting the moral argument that we were first to industrialise and that therefore we put a lot of stuff in the atmosphere first, but if we are going to do that then let us do it on a consumption base. That minimises the trade and job losses and carbon leakage risks and allows us to lead by example—‘This is the way we can all go without a trade risk.’ Then you get a global deal faster.

Senator CASH —Mr Carmody, could I ask you—

CHAIR —Before we go to that, I would like to go to Mr Mazouz, because I think this is exactly what we wanted to get to: some interaction at this level and discussion of ideas, which is really good. I will come back to you in a minute, Senator Cash.

Mr Mazouz —I would like to say that in fact, in terms of implementation, my view is that it is much more difficult to get a consumption based system going. I did read your note when it came out a while back.

Senator CAMERON —What mark did you get for that?

Mr Mazouz —One of the key problems with something like carbon emissions as compared with a GST—where essentially it is very easy to do your border tax adjustments because you just take out whatever margin there is on the price of the good—is that the carbon emissions are embodied in the good and it is not quite clear how many of them are in there. Suppose I import an ingot of aluminium from somewhere. Say it comes from China. How much do I slap on it? You could say, ‘Just take the average,’ but the Chinese firm may say, ‘No, we have a hydro-electricity generation plant that is feeding my production, so you should slap zero on it.’ Someone else might say, ‘No, actually that comes from coal fired generation,’ or something like that. So the amount of carbon impost that should be imposed at the border to equalise this is rather problematic. It is much, much harder than with something like a GST.

People have looked at this for a long time. I agree that if it were possible to implement it—if one could overcome all the hurdles of essentially generating a completely new international architecture—that might be a way forward. But we have been at this for about 20 years internationally. People have been discussing the various options for a long time, and many of these options are still out there and floating about. Someone will tell you you ought to have an international tax, and people are still advocating that. Others may say, ‘Let’s go for something completely different, such as a demand side based scheme.’ Emissions trading is still very firmly on the table. Although Mr Carmody was saying that, for instance, in the US there are some proposals for taxes out there as well, there are proposals before the US Senate that are emissions trading based. Ultimately, my view is that the reason we can get a benefit, to answer David’s question and perhaps yours as well—the implicit questions in the answers—is that to get an international scheme up and wait for the whole thing to happen is a fiction, in a sense. What do we do in the meantime?

Just as, with respect to adaptation, there is a need to manage the risk around either higher than expected climate change impacts or lower than expected climate change impacts, we need to do the same with mitigation. If the international community does manage to agree to something more significant over the next 10 to 20 years or whatever it is so that we end up with, say, international targets that may be as low as 350 parts per million, then the Australian economy will need to do a lot to reduce its emissions. On the other hand, if we do not get an agreement, then anything we do early is just a cost imposed without much benefit in terms of not really having been part of an international agreement. So, ultimately, I believe it is important to start implementing a price mechanism right now, rather than continuing to wait for the next international convention and then the next and the next, so as to impose the price so that the economy can start transitioning. Again, it is not perfect, and some sectors are carved out and so forth, but we ought to get as ubiquitous a priced mechanism as we can in order to avoid the very hight costs of continuing to wait until action becomes so necessary that we have to reduce emissions extremely drastically.

Mr Carmody —Salim, if you have read my papers I am going to give you an F for comprehension. I am serious about this. That was the breakthrough in paper No. 2. The concern with exactly the complaint you are making is that we cannot measure embodied emissions in imports. The other concern related to that was whether we are going to fall foul of WTO rules. My whole point in paper No. 2 was to apply Occam’s razor and say: you don’t need to know what emissions embedded in imports are; all you need to know is the carbon price in Australia, the emissions intensity of the product in question in Australia, and convert that to an ad valorem equivalent adjustment and make sure that same percentage adjustment applies to imports from wherever they come. That actually is WTO-compliant in exactly the same way as the GST is. Sure, it is rough justice but, at the end of the day, keep your eye on the main game. The main game is not for Australia to be hairy-chested about this if all we do is encourage other countries not to act. The main game is putting in place a policy that other countries can also adopt so you get a global deal, and my paper No. 2 explains precisely the way a GST is WTO-compliant. This consumption approach will be WTO-compliant as well, and it does not require the information you are asserting it requires.

Dr Denniss —I am frustrated that, for the last 15 years, we have not managed to get a carbon price in. I am pretty loud and proud on the record saying we need to do this urgently, so it gives me no pleasure to sit here and say, ‘Let’s not rush into this,’ because, frankly, I think we have needed to rush into it for quite some time. But, as to the proposal that we should support whatever the government of the day dishes up because this is urgent, don’t you know?—well, I do know that it is urgent and my considered opinion is that what we are proposing to do has so many flaws and in fact is so inflexible that, if we introduce it, depending on what the world does or depending on the scientific need to get to 350, what we would be doing is locking in a very inflexible, long-term scheme to solve a problem that has both an international uncertainty to it and a scientific uncertainty to it. You have no idea the frustration that it causes me to suggest we should not rush in, because I am one person among many who for a very long time have said we need to hurry up and do something about this. But, to suggest that, because this is an urgent problem, we should settle for a suboptimal proposal that locks us in until 2020, when there is both a rapidly changing international debate and a rapidly changing scientific debate, is a logical leap I cannot follow.

Senator CASH —I have two questions. I am flagging one for Mr Pearce in relation to transitional costs but, in relation to what we are talking about currently, Mr Carmody, could I get a better understanding from you in relation to a target based on production or a target based on consumption? In relation to research modelling analysis—you name it—which one is better at delivering emissions reductions and better at minimising job losses and job costs, and why?

Mr Carmody —I will come to modelling. Make sure I do not forget it. In terms of consumption versus production, let us start with the world. We can measure economic activity through a production approach—gross domestic product added up nationally and you get a global gross domestic product. Emissions are embedded in that GDP of goods and services. National accounts frameworks tell us that we can also measure that same activity through expenditure in each country—gross national expenditure. When we add that up, there are emissions embedded in that too. I use the shorthand ‘consumption’ for that. Technically, consumption means something else. You have two paths, if you like, to the same global quantum of emissions. One path is the national production route; the other path is the national consumption route. Either of those paths followed fully to the end gets you to the same point. So you are reducing the same emissions. You are covering global emissions in both cases. Either path followed through to the end would get you to the same answer. So they are equal in that sense. If we all acted at the same time, it would not matter which of those you chose. There would be no issue about loss of competitiveness or carbon leakage or anything else.

But when countries start acting at different times, there is a world of difference because while globally GDP, add emissions in it, equals GNE, add emissions in it; nationally, GNE and GDP are very different. GDP includes your exports but it does not include your imports. GNE does not include your exports but it does include your imports. The first approach for a country acting by itself means that you put a tax on your exports and you subsidise imports—that is negative protectionism. With a consumption approach, you do not tax your exports at all—that is for the importing country to do. And you make sure that your imports are subject to the same price increase as your locally produced substitutes—that is trade neutral. That is why of the two paths, given the real world with which we are now faced—let us not continue to be mugged by reality; countries are going to act at different times—the consumption path is more likely to get you to the end point that you want to get to and get you there faster. The production path—

—Are you saying with less carbon leakage and less impact on jobs?

Mr Carmody —With no carbon leakage and no loss of jobs. Because of that, it gives countries confidence to act even unilaterally or even going a little bit ahead of other countries. It gives them confidence that they can do that. If there is this moral argument that developed countries have to go first, this is the way that they can go. It seems on to me that this is a no-brainer. If that is where you want to go and there are two baths to get you there but one is more likely to get you there than the other, then the fundamental architecture of your policy response should be ‘Let’s pick the consumption path.’

On the issue of modelling, I would love Treasury to model a consumption based approach. I am not a modeller. I have used models all my life, but I am willing to lay you bet right now that the adjustment cost of any given assumed carbon price in Australia consequent on an ETS or a carbon tax, the adjustment cost will be much, much lower in the consumption case than in the production case. In fact, as I recall, there was a very cryptic reference to this in the Treasury report that was done. Page 84 is in my mind but I do not know whether that is the right page reference. There is a cryptic reference that went something like this: ‘The economic cost to the Australian community of a production based allocation of emissions would be higher than a consumption based allocation of emissions.’ I do not know what lay behind that, but I would actually like to see a full-fledged independent modelling of a consumption approach stacked up against a production approach.

Senator BOSWELL —I will direct my question to Mr Hitchens. We are looking forward and projecting 'What would happen if?’. But, in real terms, what will happen in two months time is that a piece of legislation will go before this parliament and it will be either rejected or accepted. As the legislation stands, what will be the impact on people in the food industry? Let us take Golden Circle as a case in point. How will that company be affected? How will this legislation affect industries, whether they are protected like the cement industry or non- protected like Golden Circle? Golden Circle is not protected but it is always on the margin. It was a cooperative. It has now been sold out, which just got it out of trouble. How is this legislation going to affect the protected industries and the non-protected industries?

Mr Hitchens —As I said earlier, even with the allocation proposed for some trade exposed industry, nobody is so-called fully protected. As Mr Pearce said, it is always going to be an imperfect design job to try and overcome a fundamental problem. AIGN itself does not do any of this sort of modelling to be able to give you those sorts of answers, but its members do. I understand that quite a few of its members are going to appear before the committee over the next few weeks that it is having hearings, and I will leave it to them to answer those questions about how much investment or how many jobs or where these impacts are going to be felt. What I would generally say is that, while we are in this period of time when we have uneven responses from different countries around the world, wherever we put a cost impost on our trade exposed industries, they are going to be worse off. I do not think any of them are going to close down tomorrow, and I do not know of any who have claimed that.

What happens is far more insidious in a way. What people in existing businesses stop doing is investing in those businesses. Whether it is an upgrade of Golden Circle, a cement factory or whatever it is, you stop investing. That does not mean that the Australian people are going to eat any less canned soup or use any less cement. We are just going to import it. That will be the result. In the case of exports, we will lose trade share. We will export less. That is what will happen. We will just have lower investment in those industries.

Senator BOSWELL —This will be my final question, which I will put to all of you. How will the RET impact on the ETS? Are we going to get a double whammy? That will put up the price of electricity by 20 per cent or whatever. How will that impact on the ETS?

Mr Hitchens —Our view has been fairly straightforward for a very long time. The idea of having an emissions trading scheme—and I mentioned it in my last comments at the opening—is that it actually gives you the price that you want to see in the economy. To then start imposing other market mechanisms on top of that—be it for renewables or energy efficiency or any other scheme you want to think of that you think is not going to respond in the way in which you want it to respond to the price—really just defeats the purpose. What does the MRET or the proposed RET do? Again, I think you will hear from some of my members who have done some work on that, particularly the electricity intensive ones. Their calculations suggest that in the range of permit prices for the emissions trading scheme, which, let us say, is $20 to $40, the RET scheme is likely to impose just as big an increase on electricity prices on them. So, you are right: it is a double imposition of the same price.

Dr Denniss —I am a big supporter of the RET but I agree entirely with those comments. Because the CPRS is so flawed, because the targets are so low and because the carbon price will be both so low and so volatile, the CPRS will not drive any investment in renewable energy. So we have had to have a second measure such as the RET, which I support and which will certainly provide for a substantial investment in renewable energy. It will do so at additional cost but, again, that comes back to my assertion that the CPRS clearly does not deliver least-cost abatement. That is why we are spending $4 billion on insulation and that is why we have a 20 per cent MRET. So, while I think it is a good idea in terms of driving investment in renewables, the interconnection between the two is evidence of how flawed the CPRS is.

Mr Mazouz —To answer the question about the RET, I think it is not quite right to suggest that the additive, in a sense, is the impact, because if you have got a particular emissions abatement target and you say that you will achieve your target with a price of, say, $20 to $40 a ton, having taken into account the effect of the RET, if you were remove the RET, the carbon price would have to be a lot higher to achieve that same abatement. In respect of whether that means that the CPRS is flawed, one of the big problems is that the market failures that affect the economy in respect of climate change are not just related to the emissions themselves—that the emissions are unpriced. There are all sorts of other market failures in there that result when you try to price carbon. They include very strong transitional problems, they include information failures and they include investment failures—R&D, for instance, is likely to be underinvested in by the market if you leave it on its own. So there are all sorts of complementary measures that need to be built around it as well.

Ultimately, it gets back to the point that I have been trying to make throughout, which is that, if you try to implement a real scheme, with all the warts that exist in implementing real systems, you end up with a system that has many dimensions to it. If, for instance, you run a comparison between what we think the CPRS looks like in a model with a consumption based system, you can get the results by the assumptions you make about what the respective schemes look like. The variations in that modelling are so large that you are unlikely to get your answer to that. Let me add that I would perhaps encourage you to be cautious about the sorts of results that you will be getting from people over time or, if you have already looked at it, the claims about the sorts of costs that people will be facing.

In Australia, for instance, there has been a report by the National Emissions Trading Taskforce, there has been a report by the Task Group on Emissions Trading, we have had the Garnaut review and we have had the green paper work. All of this work has said, ‘Let’s go for emissions trading.’ I am by no means saying that it is flawless or that other schemes could not be potentially better—or indeed that we could not design a much better emissions trading scheme. But, ultimately, for instance, the consumption based—

Senator BOSWELL —You are debating the rights and the wrongs and the merits of this ETS. The question I asked was: how will a RET impact on the ETS? Will it double it? Will it halve it? I am not interested in the rights and wrongs of which scheme is the best. I am asking a really specific question about how it will impact. Are you going to have two hits at this to drive the price up?

Mr Mazouz —Sorry. I thought I had answered that question first and then moved on. My apologies. The answer to that question is that the RET itself is one of the design elements that will increase the price of electricity. If you did not have the RET, and you just had the emissions trading scheme to reach the same overall abatement target, then the price of carbon would be higher in that emissions trading scheme. Hence, you would have a higher hit from the carbon emissions trading scheme.

Senator BOSWELL —Thank you very much. I ask the same question of Mr Carmody and Mr Pearce.

Mr Carmody —If you have an ineffective CPRS, the RET is not going to have much impact on the CPRS. It is ineffective. If you have a genuinely effective CPRS—

Senator BOSWELL —Will a RET put the price of electricity up?

Mr Carmody —This is a very tricky question. Mr Mazouz has suggested that if you impose a particular form of energy generation, as opposed to raising the price of energy generation and letting that signal flow through the economy, and let the innovation flow from that, that somehow you can get a free lunch. The fact is that if you impose a certain proportion of energy generation to be in a particular form, and that form in a free market happens to be far more expensive than other forms of energy generation at the time, then I think in the long run, or even the medium run or in the very short run, you might find that there is not much difference in the price increase that you face. That is, if the RET is going to work by forcing you to use higher-cost energy sources of supply then there will be a price consequence of that. It is a bit like saying with the ETS that the government does not control the price; it is set by the market—it is the government that sets the cap, and that determines the price.

Mr Pearce —I have a couple of comments. Salim is probably much more sceptical about modelling than I am. I think there is a lot more we can learn from the modelling that could be done or is available. If you look carefully at the Treasury modelling, there is a very strong hint there if you look at numbers that the RET increases the unit cost of abatement. The Treasury modelling looked at four scenarios, effectively: two so-called Garnaut scenarios and two CPRS scenarios. The CPRS scenarios include the RET; the Garnaut scenarios do not. If you put them on a common basis—and our ability to do that is imperfect because we have limited published information from the Treasury—you can see that the per-unit costs are much lower in the Garnaut scenarios than in the CPRS scenarios, and my suspicion—and I do not know this for sure—is that a big proportion of that is due to the effect of the RET. A lot of modelling has been done that shows that renewable energy targets are inefficient as a means of reducing emissions. However, Salim also made a very important point. That is that there may be a secondary objective that the RET is targeting. It is a fundamental principle of policy making that you clearly establish targets and instruments. The target for the CPRS—

Senator BOSWELL —The question was not how much it would reduce emissions; it was: how much would it increase the cost of electricity?

Mr Pearce —I do not have that exact number. I am not actually a supporter of the RET, so I am not about to defend it. However, you would not necessarily reject it simply because it increases the cost of abatement—that is, it further increases electricity costs—because there may a secondary market failure that the RET is attempting to correct. I think that was Salim’s point. I believe that it is very important to much more clearly set out what that secondary market failure is and then do a cost-benefit analysis of that in its own right. However, I agree, Senator Boswell, that the interaction of the RET with the CPRS with emissions trading creates a lot of confusing signals. It tends to encourage some things that would not otherwise have been encouraged simply under a CPRS, and it tends to discourage some things that might otherwise have been encouraged under a CPRS.

Senator BOSWELL —But will it put the price of electricity up or not?

Mr Pearce —Yes. By itself, it will put the price of electricity up, yes.

Mr Hitchens —Just to help, within the report on the Treasury modelling that Mr Pearce was referring to there is a sentence that says that per ton of emissions saved the RET costs three times more than the CPRS.

CHAIR —Are you gentlemen prepared to take questions on notice from the committee?

Mr Carmody —Yes.

Dr Denniss —Yes.

Mr Hitchens —Yes.

Mr Mazouz —Yes.

Mr Pearce —Yes.

CHAIR —Okay. That might help us.

Senator CAMERON —First of all, Mr Pearce, I notice that both you and Mr Carmody were in furious agreement about passing on the cost of the scheme to the consumer, and that to ensure this the market price ought to be sent out. I understand that you are doing a response to the white paper for the Liberal Party.

Mr Pearce —That is correct. We are currently—

Senator CAMERON —Will one of your recommendations to the Liberal Party be that the full cost of the scheme should be passed on, or will your economic purity give way to some political pragmatism?

Mr Pearce —With respect, Senator, political pragmatism is your job, not mine. The point I wanted to make about cost to consumers is that, essentially, to me it is not an issue of passing on cost; it is an issue of revealing the true cost of carbon to everyone who is engaged in consumption activities. The policy proposition underlying mitigation policy is that the true cost of carbon is currently hidden; we do not know what it is. That is the externality.

Senator CAMERON —I think you have made that point. I will just interrupt you, and you can answer however you like on this issue. What do you do to try to protect the consumer in this situation? You have a Qantas worker who loses their job—a typical Qantas worker, driving a pretty polluting 20-year-old car—not state of the art. They are really battling. Are you saying that you simply do not do anything, even in an interim period, to try and assist these poor, unfortunate people who are losing their jobs and facing costs that they cannot meet? It would be okay for you and me—we would probably be able to meet the costs—but these are workers who have been earning $30,000 or $40,000 a year and are just not going to be able to handle it. What do you do for them?

Mr Pearce —I am not saying that we do not have a social security system that picks up costs for low-income people or that manages the transition of workers in carbon intensive industries who will be put out of their jobs. We are familiar with managing these sorts of traditions in Australia. Typically, we have done it by having a good social security system so that low-income earners are captured in a safety net. The other way that we manage the transition is as we did, for example, in tariff reductions, that is, to have advanced announcements of what those reductions would be and to give people a lot of time to prepare.

I agree with you that many transitional issues will need to be captured. Some of them may be effects on low-income earners and I agree that they should be captured and dealt with appropriately in a social security system that should come into play for all kinds of economic shocks that affect low-income earners and not just the CPRS.

Senator CAMERON —Before other people answer that question I would like to ask two other questions. The economics committee’s inquiry into the bill received evidence from some superannuation fund investors and from Colonial First State that revealed that they needed certainty. We have not heard much about certainty and confidence. If we further delay this issue certainty and confidence will go down the tube. Their argument was that it might not be the perfect scheme but we should implement the scheme and give them some certainty and confidence because they have people waiting to invest in green jobs.

We have not heard much about the other side of the equation—about business certainty or the prospect of green jobs. All the feedback that we have had has been negative. We heard evidence from Tim Flannery and from James Cameron, Vice Chairman of Climate Change Capital, a merchant banking group in the United Kingdom. They are also saying that we should implement a scheme even if it is flawed. We should implement a scheme, get some certainty and start moving forward. Cameron is also arguing that if Australia adopts the scheme it would have a significant impact on the leadership at Copenhagen. That is the argument that he is putting forward. Those are some of the issues on which I would like to hear some comment.

CHAIR —Members should bear in mind that we are running short of time. Senator Xenophon, do you have any questions?

Senator XENOPHON —I can place my questions on notice. One question relates to the asymmetry in the CPRS on the quantity of abatement. Could I get some comments on notice from the panel? At the moment with the CPRS it seems that the cap loosens after a certain point in the upside when demand for abatement exceeds projections, but it does not tighten when the demand for abatement undershoots projections. There is an argument that is in contrasts to the CPRS proposal. If there is an intensity-based measure would carbon taxes lead to a tightening of the cap when emissions undershoot expectations? Could I get the panel to comment on that on notice? Could panel members also comment generally on the issue of modelling? Do they consider that the CGE is unduly optimistic in the transition that the economy will make with respect to the CPRS as modelled by Treasury?

CHAIR —Senator Feeney, is your question in any way complementary to this?

Senator FEENEY —No, but it is a short one.

CHAIR —Let us deal with the questions that we have in front of us. We can continue so long as you do not want to break for lunch. I am relatively flexible on that issue. However, we have to be back by 1.30 pm for a teleconference with the next witness. Mr Carmody, you appear to be anxious to start?

Mr Carmody —Let me respond to Senator Cameron’s questions. I refer, first, to the low-income groups and to the effect that they might have. I refer, next, to a consumption model. I agree with everything that David said. A signal has to flow through the economy but let us not mistake this as a policy designed to reduce real incomes. This policy is designed to change relative prices. For example, if you had a carbon tax and you had a serious carbon price it would raise a serious amount of revenue. A serious amount of that serious amount of revenue could be used to change other taxes—to change social security payments and the like. The intent of the CPRS, an ETS or a carbon tax would be not to increase the tax burden on the economy but to change relative prices away from carbon intensive to less intensive.

On your certainty point I heard that exact mantra when I was doing the Energy Reform Implementation Group exercise a couple of years back. Business wants certainty. But let us think about what the CPRS will deliver. Will it deliver emissions reduction certainty? No, because we do not know what will happen in relation to carbon leakage, and we do not know what will happen in relation to more emissions overseas verses fewer emissions here. Will it deliver price certainty? Let us look at the history of the ETS in Europe. It is a joke. You could not make investment plans on the basis of the carbon price in Europe. At the moment emissions permits in Europe are a sub-prime asset because they are being unloaded.

Senator CAMERON —That scheme is not the same as the scheme in Europe and it will not deliver the same outcome.

Mr Carmody —I hope it does not. All I am saying is that with an emissions trading scheme even if you ignore the incorrect assertion that we are delivering emission certainty, the design of an emissions trading scheme is to let the price float. The government and Garnaut are sufficiently concerned about that anyway to argue, at least in the initial period, that we will not have an emissions trading cap; we will have a reasonably stable price. That means that the government will stand in the market at that price and issue as many permits as business requires, at that price. That is starting as a carbon price rather than an emissions cap.

CHAIR —Mr Hitchens?

Mr Hitchens —I would like to respond quickly to Senator Cameron’s question on protecting the poor. The AIGN has supported that for a long time. As has been said by the other two speakers, there is a lot of revenue. We have done a calculation to show that between 2010 and 2020 about $25 billion to $30 billion worth of permits will be unaccounted for in Treasury’s budgeting. At the moment the biggest rent seeker in this calculation is Treasury. There are plenty of permits to go around.

Senator CAMERON —Some big rent seekers have approached me in the past few weeks.

Mr Hitchens —I am just pointing you to another one. There are enough permits to get the trade-exposed companies right, and there are enough permits to ensure that low-income earners do not shoulder this cost.

Dr Denniss —I share your concern about the impact of any policy change on low-income earners, and I have done so for a long time. It is interesting to look at how people queue up in this debate verses how they queued up in previous debates. I was around for national competition policy debates which saw tens of thousands of electricity and transport workers lose their jobs. I did not hear the people who are currently concerned about jobs expressing that concern. I heard national interest—

Senator BOSWELL —That does not include me. I was one person who expressed concern.

Dr Denniss —I am not referring to people in this room. I am saying that industry groups loudly and proudly suggested that if it was in the national interest some people would just have to suck it up. There is rank hypocrisy—let us call it what it is—in the way that different groups are queuing up behind protecting jobs in this debate. The secondary issue is how we go about assisting people who are adversely affected by the transition. I think I have been on the generous side of that debate for a long time. Frankly, the billions of dollars that we are giving to some of those industry groups get in the way of providing even more generous assistance to those people.

On the final issue of certainty, there is no certainty about exchange rates, about interest rates, or about China’s GDP growth. There is no certainty about anything in this big wide world of international trade. I find bizarre the idea that these big enterprises cannot get out of bed and do their job unless we tell them what will be the level of pollution permits until 2020. However, as Geoff said, we are not talking about certainty around price. If people want certainty surely they would want a carbon tax? Do you want to give certainty to other investors? I do not think a carbon tax is without its flaws.

But let us be clear: if you are concerned about giving big investors a certain investment climate, especially potential new industries that are offering green jobs, one thing those people need is certainty around price. The only beneficiaries that would have certainty about the number of pollution permits would be a small number of large polluters. It has been suggested that we have to work backwards in order to provide certainty which I believe to be a misunderstanding of a modern capitalist economy. They will never achieve certainty. Some people have said that the ETS or the CPRS will drive them out of business. The exchange rate has fallen very quickly from 90¢ to 70¢. Anyone in Australia who is profitable at 90¢ is doing pretty well at today’s exchange rate. The trivially small increase associated with the CPRS will not go within cooee of driving those people out of business, if they could export profitably at 90¢.

Senator CAMERON —Could you take on notice the issue relating to green jobs?

CHAIR —Very quickly, Mr Mazouz, and we will then go to Senator Feeney and Senator Pratt.

Mr Mazouz —In the interests of time I will concentrate on the questions relating to jobs, and I will refer briefly to certainty and confidence. I agree with most of what Richard said about certainty. An additional point I would like to make is that risk premiums that avoid investment can also be efficient. When you have an investor making a decision to invest in a particular theme, let us say in this case less emissions-intensive production activity, it is beneficial for them to second guess where emissions will need to be and for them to bear that cost. If they do not they are liable to make the wrong decision. In a sense, the risk premiums that are associated with having some uncertainty around price and quantities potentially is inefficient.

On the question of green jobs I agree that today we have talked mainly about the downside. Indeed, there are real questions about this issue. If we need to achieve emissions abatement—and that is the assumption—getting in a price mechanism is likely to deliver you more prosperity over time than not getting in a price mechanism. Ultimately, that is because it is costly to remove emissions from the system. If you commit for free you have a form of free ride, but it creates costs elsewhere and that is why the intervention is there. That intervention in itself will lead to losses—an issue that has been discussed and a point that people make strongly. At the same time changing relative prices opens up opportunities in the green industries and frees up investment in green industries which can then generate jobs.

Another element that is quite interesting in this context is that a lot of ‘green jobs’ tend to be less capital intensive. Overall, one would not expect net job losses in the long run. Transition is another issue and that is the issue that is at the heart of the question relating to the sort of assistance that one might give to low-income earners and those that lose as part of the transition. Again I agree that the proposed systems are not ideal. There is benefit in seeking to improve some of them but I would not see that as sufficient.

CHAIR —Senator Feeney? I will have to limit you to about five minutes.

Senator FEENEY —In the first instance I direct this question to Mr Carmody. Mr Mazouz referred in his opening remarks to three amendments that he would love to make in a perfect world. One of them was removing the restrictions on trading in permits internationally. I was interested in hearing your response to that proposition.

Mr Carmody —Trading in permits is shuffling emissions. In my view, increased ability to import emissions permits from offshore presumably would be taken up only if the price of those permits was lower than the prices in Australia. That leaves us with a CPRS that in practice simultaneously might generate carbon leakage because of a loss of competitiveness when shifting emissions offshore. At the same time it would allow an importation of emissions permits undermining the emissions cap even in Australia. It seems to me to be bizarre. I think that emissions trading is emissions shuffling. I would much rather see a single, simple price signal such as a carbon tax that everyone understands and to which everyone has to respond.

Senator CAMERON —So the market does not work?

Mr Carmody —The whole policy issue here relates to market failure.

Senator FEENEY —Sticking to the point of the contemporary system, do you have a response to that question?

Mr Mazouz —If one allows international trade the idea of emissions trading is that essentially you are unable to get the abatement where it is cheapest. Generally that is what international trade gives you by allowing the production system and consumption to use the cheapest available production opportunities, as it were. My point at the beginning was about restrictions to exports of permits. On the import side I am concerned that it allows too much. In part that again is a complicated discussion. Ultimately, the credits that we get from overseas—clean mechanisms from developing countries—in part suffer from the fact that it is difficult to ensure additionality. Additionality relates to ensuring that they deliver the abatement that is promised.

You have to have a baseline and then say, ‘The difference from that baseline is what we will call a credit that you can then purchase.’ If these baselines are not set properly potentially you are buying a fraction of a tonne of abatement for the price of a full tonne of abatement. That is one issue in that context. The other issue is that as you buy cheap abatement opportunities from developing countries, essentially you are removing the cheapest part of their abatement cost curve. In Australia there is a reluctance to impose high costs with the targets that we are imposing.

Those developing countries will do the same maths. Having sold the cheapest abatement opportunities they are therefore unlikely to agree to similarly stringent targets that they may have agreed to had one not done that transfer. I said in my opening remarks that I believe restrictions should be imposed on the import of permits from countries that have not agreed to targets themselves but that are in for free trade in permits from countries that have agreed and also for free exports to countries.

Senator FEENEY —I understand that but it sounds different to what I first understood you to be saying.

Mr Mazouz —I am sorry about that.

Dr Denniss —It is bizarre to be saying that we need the CPRS because it links us seamlessly with the rest of the world. In being linked seamlessly we should be allowed to import as many permits as we want but we cannot export any. The only beneficiary of that would be the domestic polluters who have monopoly access to cheap domestic abatement. I have heard no argument as to why, if I generated cheap abatement in Australia, I should not be able to sell that for the highest price I can get in the world. It is not how we deal with commodities generally; clearly, it has been designed to assist domestic polluters.

Salim made a point about the imprecise measurement and low quality of credits that we are likely to import. I think there are real problems there, especially with the voided deforestation. Coming back to my earlier point about measuring voluntary action, it shows how intellectually inconsistent the proposed CPRS is. When it comes to importing permits we are drawing baselines, measuring additionality, crediting that additionality, and using that to make credits in Australia. I have suggested doing that domestically. Do we say, ‘Here are household emissions. If we do better than that we can capture the benefits for the atmosphere.’

I have been told that domestically that would be impossible to achieve because of administrative costs and uncertainty. I do not believe the arguments for a second but that is the intellectual foundation for the permits that we plan to import. Frankly, it is far easier to measure an account for them domestically where I think we have good greenhouse accounting and it is unlikely that we can do it well internationally. I again say that we have the worst of both worlds.

Senator PRATT —I am sure that you all like to push and peddle your ideas, get other people to subscribe to them and adopt them, and then push your reform agenda. I am sure you all appreciate how difficult it is to create a policy such as this, push it through, get everyone to subscribe to it and to move it along. Mr Carmody, you said earlier that such a policy could be changed with the stroke of a pen. Mr Mazouz, you said that we should not throw out the baby with the bath water. Dr Denniss referred to critiquing the model but his primary objection seemed to be around too many free permits and the nature of the target. I note that we have started work on an ETS.

Mr Pearce, back in 1998 you would have been familiar with the work that was being done. I want to know from you how we should move forward from this point. I do not think we want to throw out the baby with the bath water. How many years would it take to come up with a new model and to get stakeholders to buy in, having regard to the time it has taken to get as far as we have? Ross Garnaut started his work before the Labor government took office. How should we build our agenda and how should we move forward from this point?

Dr Denniss —There is no doubt that it is hard. If the argument ‘Let us go with whatever we have’ is ever applicable it would not be applicable to something like the CPRS. As we keep hearing the purpose of the CPRS is to provide certainty. The purpose of the CPRS is to lock in certain structures for a long period. It is designed not to be tinkered with. Unfortunately, it is not a first step; it is the only step that we will make between now and 2020. I do not want to critique the policy development process or its politics, but if you were trying to take a first step I think the CPRS would be a risky one to take.

Senator PRATT —Are you arguing for it to be rejected or changed?

Dr Denniss —If the government will not change it in any substantial way I recommend that it be rejected and that we go back and make modifications. I do not understand why the government is so determined not to take other ideas on board. I do not understand why the government is running the argument that it is not a Ferrari. We all agree that it is not very good but it is the best we can do so let us do it. That argument is hardly likely to bring people on board. That argument denies how the whole scheme is designed not to be fixed after it is introduced. I think the argument also ignores substantial questions such as those that I asked before. Why not wait until we find out what are our Copenhagen targets?

There will be an open-ended financial liability for Australian taxpayers. This parliament will be signing an open-ended, blank cheque if we pass the CPRS with very low targets and then agree to more ambitious targets at Copenhagen. Taxpayers will have to pick up the difference. We will have to import an unknown quantity of permits from other countries, so we are locking in very timid targets. We are about to go into an international agreement where we do not know what will be the targets, and any shortfall will be made up by taxpayers, of which I am one, so I have a vested interest. If we are to have an emissions trading scheme that is designed to send strong price signals to the people who are polluting I would rather wait to find out exactly what will be our international obligation.

I will make one last point as I know we are short of time. In 2020 Australia’s emissions will be exactly equal to our international obligations. Whether or not the CPRS is passed, all we are talking about is how many permits we will be importing. We will not be personally responsible for killing the polar bears if we do not support the CPRS. The CPRS is a means to achieve some domestic emission reduction—I would argue a very flawed means—but the CPRS envisages failing to meet its own timid targets domestically, and the CPRS anticipates a substantial importation of permits. If the CPRS is delayed or it is not even introduced we will be importing more permits in 2020. The climate does not rest on this decision. I think that is good politics but bad framing.

CHAIR —A quick final question from Senator Cash.

Senator PRATT —That question was directed to the panel and so far I have had only one response.

Mr Carmody —I will split my answer into two. I refer, first, to a production approach verses a consumption approach. We do not have a production approach in a pure sense and we do not have a consumption approach in a pure sense. We have this bastard approach with selective temporary partial carve-outs, which puts us somewhere in between. This is one area where I would agree with Ross Garnaut. We want a principled approach to the trade-exposed sector. A consumption models gives you that. It is not throwing out the baby with the bath water; it would start with the same emissions production data and all the things that are generated as a result of the CPRS model.

The difference would be instead of the compensation and carving up that you have now you would have an approach that was based on using the GST system to ensure that exports were zero rated and imports were treated like local production. Your next question referred to the ETS verses carbon tax. I think that is a no brainer. It will be quite easy to dump the ETS and introduce a carbon tax, but there is one problem. That comes back to people like you. It will probably require a degree of political courage.

Senator CAMERON —It was not there for 11½ years under the previous government.

Mr Carmody —Political courage?

Senator CAMERON —Yes, on this issue. Nothing was done.

Mr Carmody —I was not saying you did not have it.

CHAIR —Suck it up, Senator Cameron; suck it up. Mr Mazouz?

Mr Mazouz —In addition to the one year of Garnaut’s research that underlies this we have had many reviews. As early as 2003 there was a proposal before cabinet to do emissions trading. A lot of work has gone into this. A lot of the ideas that are around about what could be done have been around for many years. A decade ago when I was at the Australian Greenhouse Office I remember discussing the consumption-based approach. Ultimately, the government has to deal with many interests and a difficult policy problem that has many nooks and crannies to be explored and to be sorted out.

I have a number of reservations about the design of the scheme which I believe can be improved, but I assure you that when I talk about emissions-intensive trade-exposed assistance and how I believe that is badly designed, I am sure Mr Hitchens would say, ‘Yes, it is badly designed but in the opposite direction.’ We have many views about what ought to be done and we have many views about the architecture of the scheme. There is nothing different to what occurred a decade ago. It is not the case that the Senate is facing a choice between the CPRS and an alternative proposal that might be superior.

The Senate is facing the same choice as governments have been facing for a long time. There are many schemes, all of which work differently and which are extremely difficult to comprehend. Ultimately, I believe we are better off sticking with what we have developed over the past few years to start getting a ubiquitous price and a signal out there. To the extent that that price signal is held back by all sorts of design features, work hard at developing the scheme over time to ensure that it becomes the theoretical equivalent that we would like it to be.

CHAIR —Mr Hitchens?

Mr Hitchens —The government and the opposition should go back to their pre-election positions relating to trade-exposed industries. At that stage they were unanimous that trade-exposed industries should be fully offset for the costs that they incur in this period of transition where we have uncertainty about the global agreement. If you both went back to those positions I think you would find that the amendments to the current CPRS bill are pretty straightforward.

Senator CAMERON —Where will the money come from?

Mr Hitchens —As I said earlier, there are plenty of permits. We outlined in our submission where all those permits are and a hell of a lot of them are still in Treasury. If that is not possible the AIGN recommends that you ought to give serious consideration to what Mr Carmody is saying.

CHAIR —Mr Pearce?

Mr Pearce —How do we move forward? My simple answer is that despite the fact that there has been a lot of modelling over the past decade or so it has been fairly narrow and it has focused mostly on one or two policies. In fact, the modelling done to date does not really distinguish it. You cannot tell from the modelling that Treasury has done whether it is an emissions trading scheme or a carbon tax because they are modelled in the same way. I think there is a lot more to be learned from some more transparent modelling. I do not say this for the sake of modelling; I say this as a practical way forward. We should establish an independent modelling forum like the Productivity Commission to test all the different propositions that have been put before you today. This morning you had a remarkable amount of agreement, which is embarrassing.

Senator BOSWELL —You must be wrong.

Mr Hitchens —I perceive it as people pointing out a series of trade-offs in how you design the scheme. Some trade-offs are important and others are not so important. But until we do a bit more modelling of those trade-offs we do not know how much is at stake. Look at any of the ideas that have been put forward. It could be $1 million at stake or it could be $1 billion. In practice there could be no difference between different propositions. Until we test it in an empirical way—we can never get that close to empirics because we are talking about the future and we are talking about something we have never done before—we will continue to grapple in the dark.

People like you, who ultimately have to make a decision, do not have much to hang onto and say, ‘How do we tell the difference between X and Y—between Geoff’s proposition and somebody else’s proposition?’ I think there is scope for further evidence-based policy analysis that will help you with this process. I put that forward because in my experience of doing regulatory impact assessments the process generally produces something that many more people agree with than agreed at the start. I am optimistic that the same sort of thing could happen in this case.

CHAIR —Thank you for your indulgence, in particular, with respect to time constraints. Your evidence has been highly stimulating for all members. Thank you for appearing before the committee this morning.

Proceedings suspended from 1.08 pm to 1.34 pm