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4.2.3 Alternatives – a modified carbon tax

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4.2.3 Alternatives – a modified carbon tax

Summary

This section:

  • describes two broad approaches to primary price-based measures that could be adopted as alternatives to the announced carbon tax
  • describes four possible modified carbon taxes and assesses them against each other and the announced carbon tax.

There are two main alternative approaches to the current carbon tax/NGA policy:

  1. change current policy settings to a policy package that, in the short term, does not require or expect significant slowing of the rate of growth of domestic emissions, but that best positions New Zealand to significantly reduce the rate of growth of, or reduce in absolute terms, domestic emissions over the long term without requiring further substantial policy change for, say, the next 10 years. This approach avoids commitments now that might be regretted later, but is sustainable; or
  2. change current policy settings to some other “holding pattern” policy package that, in the short term, does not require or expect significant slowing of the rate of growth of domestic emissions. Then, at an appropriate time in the future when there is adequate information about international regimes and their implications for New Zealand and the cost of emissions reductions in New Zealand, develop appropriate domestic mitigation objectives and adopt a policy package consistent with these. This approach avoids commitments now that might be regretted later by adopting a policy that is explicitly temporary.

The key differences between the two approaches are:

  • the sustainability of the initial policy settings
  • short-term messages given to investors and consumers about what might occur over the longer term.

Sustainability

Sustainability has three main aspects:

  • the impact of the policy settings on the Government’s objectives for economic growth and social cohesion
  • the need to adjust, and the ease or difficulty of adjusting, the policy settings in the future in response to new information about, eg, post-2012 international regimes and the cost of mitigating emissions in New Zealand or elsewhere
  • the costs of administering and complying with the policy settings once they are in place, including the opportunities for lobbying or gaming behaviour by firms and the ongoing time and effort this would entail for Ministers, officials and the private sector.

Messages about the longer term

Messages about the longer term contribute to the formation of expectations about the longer term. Those expectations influence investment decisions made in the shorter term and the strategies of businesses, government and households for the medium and longer term.

The Government’s commitment to slowing the rate of growth of, or reducing, domestic emissions is an important driver of decisions about whether to invest now in research aimed at reducing the emissions intensity of economic activity or the consumption of emissions-intensive goods and services. A lack of tangible commitment by the Government to such objectives is generally interpreted by both private and public sector research-investment managers as a signal that investment to find ways of reducing domestic emissions is not a high priority. One effect of the Government ratifying the Kyoto Protocol was that it provided a clear signal to research-investment managers that the Government was serious about greenhouse gas emissions, at least until 2012.

Similarly, decisions made in the short term about long-lived, emission-intensive investments will have an important effect on the level of New Zealand’s emissions in the medium to longer term and on the cost of slowing the rate of growth of, or reducing, these emissions over the longer term. Such investments include power stations, transmission lines, roads and railway lines, airports, ports, houses and urban development.

The message regarding the medium and longer term that is given by the first modified carbon tax approach (and the announced carbon tax) is: “It is quite possible that New Zealand will want to use a carbon tax to help significantly slow the rate of growth of, or reduce in absolute terms, domestic emissions in the medium and longer term.”

In contrast, the message given by the second approach is: “We do not know, and do not think it is appropriate to give any indications now, about whether New Zealand will want to use a carbon tax as part of the policy response designed to significantly slow the rate of growth of, or reduce in absolute terms, domestic emissions in the medium and longer term.”

For each of the two approaches, the review considers two options. The four variants (three are a modified carbon tax and one is a defer option) are summarised in Table 12.

Table 12 - Modified Carbon Taxes

Once implemented, the measure is likely to remain in place beyond the short term; the measure signals that there is likely to be a price on all domestic greenhouse gas emissions over the longer term

The measure is short term, with the expectation that it will be reviewed within a few years; the measure does not signal that there is likely to be a price on all domestic greenhouse gas emissions over the longer term

Option 1a

low-level, broad-based tax

A low-level, broad-based greenhouse gas tax that is implemented in the near future and gradually increased over time

Option 2a

defer a decision on price-based measures

Do not proceed with the announced carbon tax/NGA policy; give a commitment that there will be no decision on a primary price-based measure for at least five years (ie, until 2011); defer implementation of a primary price-based measure until at least 2013

Option 1b

broad-based tax (world price), targeted recycling

A greenhouse gas tax (approximating the international price) with no exemptions, implemented in the near future, with the revenue used for targeted government assistance (energy efficiency and structural adjustment in the economy)

Option 2b

tax industrial emissions above world’s best practice

A tax on large final emitters of CO2 where the intensity of their direct emissions exceeds world’s best practice for the industry; the tax would apply only to emissions above world’s-best-practice levels

Assessment criteria

To assess each option, a number of criteria need to be considered. These criteria reflect the overall objective of significantly slowing the rate of growth of, or reducing in absolute terms, domestic emissions in the medium and longer term. These criteria are outlined below:

  • a key criterion is the effect on domestic emissions in the medium and longer term (ie, beyond CP1), as this is ultimately the measure of success or failure. The messages about long-term policy directions and settings are likely to form a key part of this effect. However, it is important to recognise that any carbon tax is only one of a number of complementary policy measures that will be needed to meet this overall objective
  • the effect on domestic emissions in CP1 is not a key criterion. New Zealand does not have to reduce its emissions to meet its Kyoto commitments – it can cover any excess of emissions over 1990 levels by purchasing emission units on the international market. None of the options for a modified carbon tax considered in this section will have a large effect on domestic emissions in CP1. Section 4.9 addresses alternative approaches to meeting our commitments in CP1
  • the economic impact of the different carbon taxes includes their coverage, the initial direct price impact, the longer-term impact on the economy (including dynamic effects), the effect on international competitiveness, the level of regulatory certainty, the administrative and compliance costs, and the fiscal impact, including their consistency with good tax-policy design
  • the sustainability, flexibility and feasibility of the different carbon taxes will be heavily driven by their degree of broad political acceptance. Other aspects of this assessment include the ease of changing the policy settings once they are in place, whether some change of settings is necessary (or likely) and the ease of transition to an emissions trading system.
The effect on domestic emissions

None of the options considered will result in a large reduction in domestic emissions in the short term. No option would produce much response in the transport sector – demand for transport fuels is unresponsive to small changes in price and even the announced carbon tax (or the world price of carbon) would have only a small effect on the price of fuels compared with factors such as the price of oil or exchange rates. The low-level, broad-based tax and the tax on industrial emissions above world’s best-practice options are likely to have an effect broadly similar to that of the announced tax on the emissions of NGA firms in CP1; the impact of the broad-based (world price), targeted recycling option would depend on the nature of the targeted government assistance. It is unlikely that any option would include agriculture or forestry in the short term (for the reasons below), so again, the effect will be the same as for the announced carbon tax, which also does not include these sectors.

The low-level, broad-based tax (Option 1a) and the broad-based tax (international price) with targeted recycling (Option 1b) have the potential to significantly reduce, or slow the growth of, domestic emissions in the medium and longer term.

Option 2a (deferring the decision on a price-based measure) and Option 2b (taxing industrial emissions above world’s best practice) will not significantly reduce (or slow) domestic emissions in the medium and longer term. However, if the Government chose one of these options now, it could replace that option in due course with a price-based measure designed to achieve significant reductions in domestic emissions. It is not clear whether such a delay would make it more costly to achieve a given reduction in emissions in the future.

Any quantitative estimate of the extent of emissions reductions over the long term would depend critically on the assumptions made about emission-reducing technological development and up-take. Such assumptions would be arbitrary. The best that can be said is that a credible, consistent and gradually increasing price signal would provide an incentive for emission-reducing technological development in New Zealand and for the up-take of emission-reducing technologies from New Zealand or overseas.

Economic impact
Coverage

In general, a broad coverage is likely to be more efficient and effective in reducing greenhouse gas emissions, as it minimises the scope for substitution between emitting activities on the basis of their tax treatment. The credibility of the policy implemented – in particular, over time – will also be important, as the effect on long-lived investment decisions will be a key channel through which the different options will affect the level of emissions. The overall size of the options – the level of the tax and its coverage – will also influence their likely impact.

 
Initial price impact

The initial price impact (eg, the amount by which the tax would increase the cost of coal or gas or petrol) is an indication of the magnitude of the initial shock to the economy. Over time, this impact will change as businesses and households respond to the higher cost. The low-level, broad-based tax (Option 1a), the taxing of large industrial emissions above world’s best practice (Option 2b) and the deferral of a decision on a primary price-based instrument (Option 2a) would all have very modest, or zero, direct price impacts. The initial price impacts of the broad-based (world price) tax with targeted recycling (Option 1b) would depend on the nature and level of the targeted assistance and who received it.

Long-term economic impact

In the longer term, economies are dynamic, with continual expansion and contraction of individual businesses and of economic sectors. This change is driven by the ability to create new goods and services, by access to new markets (or loss of access to old markets) and by changes in the mix of goods and services that consumers purchase, which in turn is driven by changes in preferences, relative prices and incomes. Because New Zealand has an open economy, much of our economic activity faces international competition.

The pricing of greenhouse gas emissions adds a new price to the economic environment. The nature, mix and level of economic activity (as well as the level of greenhouse gas emissions) within all countries that price greenhouse gas emissions will change as a result. Those countries that can produce particular goods and services with a lower greenhouse gas emission intensity will have a comparative advantage and will tend to expand their production of those goods and services.

The most important measure of the economic cost to New Zealand of policies to slow the growth of, or reduce, global emissions is the impact on GDP per capita. The problem with focusing on the impact on particular firms or particular sectors is that that tells only part of the story. To get an accurate overall picture, we need to know where the resources that are no longer being used for one particular type of activity have gone, what they are now being used for and what value that is adding to our economic welfare.

However, the movement of resources between sectors can be costly. Adjustment that is forced to take place too fast has costs, such as increased unemployment and the scrapping of assets before the end of their economic life. Because such costs can constrain economic growth, it is important to assess the adjustment impacts and costs that would be associated with different rates of the greenhouse gas taxes over time.

Economic modelling of taxes on CO2 was done in 2001 (Infometrics 2001) and 2003 (ABARE 2003).

In the work by Infometrics, three rates of tax were examined ($NZ2.73 per tonne of CO2, $NZ8.19 per tonne of CO2 and $NZ13.65 per tonne of CO2), together with five different ways of recycling the revenue (repayment of debt and four tax-reduction options). In each case, there was no price on carbon in the rest of the world. This work did not include a tax on agricultural emissions of methane or nitrous oxide.

The macroeconomic results were that when the revenue was used to repay debt, the aggregate impact on GDP was small: of the order of -0.1% for the tax at $8.19 and $13.65 per tonne, and less than that for the tax at $2.73 per tonne. When the revenue from the tax was recycled through reductions in other taxes, GDP showed at least a small increase in every case.

At the sectoral level, the model contained 32 industry groups and gave changes in industry gross output ($m) for each. The results indicated that the tax represented a small shock to most industries, with changes well under ±1%. The eight industries with the largest changes are detailed in Table 13.

Table 13 – Sectoral Effects of a Tax (Percentage Change from Business-as-usual)

  $2.73/t CO2 $8.19/t CO2 $13.65/t CO2
Gas and oil exploration and production -0.26 -0.91 -1.64
Electricity distribution and transmission -0.35 -1.07 -1.75
Aluminium and other metals -0.43 -1.28 -2.10
Other mining -0.51 -1.51 -2.44
Petroleum -0.53 -1.59 -2.61
Electricity generation – fossil fuels -0.87 -2.54 -4.09
Iron and steel -1.48 -4.36 -7.07
Coal mining -2.64 -7.00 -10.46

Source: Infometrics (2001)

In the work by ABARE, it was assumed that New Zealand applied a carbon tax of $NZ15 per tonne of CO2; the international price of carbon (determined by the model) was about $NZ20 per tonne of CO2. As with the Infometrics work, this work did not include a tax on agricultural emissions of methane or nitrous oxide. The results were similar to those from Infometrics. GDP in 2010 was 0.03 percentage points lower than it otherwise would have been and sectors with a reduction in output of more than 1% were coal, gas, petroleum and coal products, electricity, iron and steel, and non-ferrous metals.

Comparable investigations of changes in agricultural output in response to a carbon tax do not appear to have been undertaken.

The possible constraints (stemming from a diversity of domestic policies in the countries that are New Zealand’s competitors) on the initial level and the scope to increase any carbon tax raise issues about its efficiency over time (dynamic efficiency). These issues are particularly important in relation to decisions on long-lived assets such as houses, other buildings, power stations, transmission lines and transport infrastructure.

Power stations typically have an economic life of at least 30 years and often longer; houses and transport infrastructure such as roads, railways, ports and airports typically have an economic life of closer to 100 years. Decisions made about these assets in the short and medium term will have a major influence on New Zealand’s greenhouse gas emissions for many decades to come.

As New Zealand’s emissions are such a small part of global emissions, the emissions intensity of our assets will not actually make any difference to whether greenhouse gas emissions are still a serious global problem in the long term. However, at any point in time, the emissions intensity of our assets affects the level of domestic emissions and the cost of reducing those emissions by any given amount.

Learning by experience

It is likely that international carbon markets will continue to develop and that it would be desirable for New Zealand firms to learn about these markets by participating in them. None of the four options would provide incentives and opportunities for New Zealand firms to gain valuable experience in these markets. However, by improving the economics of some projects and having them implemented earlier than would otherwise be the case, Option 1b (broad-based (world price) tax, targeted recycling) in particular, but also Options 1a and 2b, have the potential to enhance learning by experience with technology that is not well-established in New Zealand.

International competitiveness

Overall, as Section 2 of the review has shown, different countries are taking a variety of responses to the challenges of climate change. Firms in many countries do not currently (and are unlikely to) face greenhouse gas taxes on their emissions. This potentially puts New Zealand firms at a disadvantage as a result of any greenhouse gas tax introduced here. However, these international competitiveness issues should not be overstated, as there are many factors that affect competitiveness and the balance of international trade in different goods and services. The overall level and design of taxation is only one of these factors, and the effects of greenhouse gas taxes within this will typically be small.

It is very unlikely that the great majority of New Zealand’s agricultural competitors will face a price on their agricultural emissions within the next decade or two. There are proposals internationally to develop global agreements for industrial sectors that are large emitters of CO2 and that would involve both developed and developing countries. Sectors proposed include cement, steel, electricity and pulp and paper. But even if these agreements eventuated and removed the international competitiveness issue for these industries in New Zealand, there are several other industries in New Zealand (apart from agriculture) for which international competitiveness might still be an issue (eg, wood processing, food processing, basic metals, non-metallic industries, paper and paper products, tourism transport, glasshouse crops, fishing, irrigated dairying and irrigated arable crops).

For these reasons, the nature of the post-2012 regimes that emerge internationally, together with the Government’s desire to achieve its economic and social objectives, may constrain the longer-term settings and likelihood of reform of any of the four options (all of which are designed to address international competitiveness issues in at least the short term). Whether, or when, such a constraint might bite would depend on the level of the carbon tax, how long it had been in effect and what degree of adjustment had already taken place in these industries.

Another perspective on the effect of any carbon tax is that some New Zealand export industries may be able to use the tax as a point of differentiation in their marketing.

Regulatory certainty

In general, higher levels of regulatory uncertainty are more likely to be damaging to investment (and hence economic growth) than are lower levels of regulatory uncertainty.

With any carbon tax, there would be lobbying activities by firms around international competitiveness issues. If, as is expected, many of the foreign competitors of New Zealand firms will not face equivalent costs of greenhouse gas emissions for many years, this lobbying would be expected to increase as the level of the tax was increased.

Compliance, administration and lobbying costs

In general, it is desirable to minimise the compliance and administration costs associated with any tax. The design of the announced carbon tax has shown that compliance and administration costs for a tax that is imposed early in the supply chain are small. Moving the point of obligation downstream (eg, to provide for an easier transition to emissions trading) is expected to result in a modest increase in compliance and administration costs.

Options 1b (broad-based (world price) tax, targeted recycling) and 2b (tax on industrial emissions above world’s best practice) are expected to involve higher compliance and administrative costs than the other two options.

There are also costs to government and business around lobbying to influence any change in the regime. These costs are likely to be higher if the policy adopted is unpopular, lacks widespread support and/or anticipates further changes in treatment over time (eg, further policy reforms, and/or changes in rates). Good design would also minimise the scope for gaming behaviour by firms to exploit the regime.

Fiscal impact

The fiscal impact includes the net revenue raised by the different options, which could, in theory, be used to reduce the costs of other taxes so that revenue overall is raised at a lower cost. In this respect, there are benefits from not returning a significant element of the tax collected as rebates. The announced carbon tax is expected to give $360 million per year net revenue, Option 1a (low-level, broad-based tax) is expected to give about $225 million (inc GST) per year in the short term but approximately double that if coverage is extended to agriculture, Option 1b (broad-based (world price) tax, targeted recycling) about $600 million (inc GST) if its coverage excludes both agriculture and forestry, Option 2b (tax industrial emissions above world’s best practice) is expected to provide very little revenue (less than $10 million per year) and Option 2a (defer decision on price-based measure), no revenue.

Options 1a and 1b would contribute significantly to a move to greater reliance in the tax system on taxing “bads”, should this be an objective of the Government.

Another factor to consider is the general principles of good tax-policy design, and the way the carbon tax options relate to the wider approach to tax policy. The aim is to raise the required amount of revenue at the lowest cost. In New Zealand, this is achieved with a broad-based tax regime with few exemptions or concessions, and with much the same relatively low tax rates applying across different activities.

Sustainability and flexibility
Impact on achieving economic and social objectives

It will be important to minimise any adverse impact of the carbon taxes on the Government’s objectives for economic growth and social cohesion.

In general, the impact on domestic emissions and on domestic economic and social objectives could be managed through the rate of the tax (and the breadth of its coverage). The low-level, broad-based tax (Option 1a) is designed to ensure a low impact on these objectives in the short term. However, the flexibility of the tax to achieve a particular outcome for domestic emissions may be constrained by the nature of the international regimes that emerge. As long as there are major foreign competitors who do not face an equivalent cost of greenhouse gas emissions, there is the possibility that the Government would find it difficult to reach a high rate for the tax (say, the world price of carbon) because to do so would create unacceptable international competitiveness issues for some New Zealand firms, and/or have unacceptable adverse affects on economic growth or social cohesion.

The tax on large industrial emissions above world’s best practice (Option 2b) is designed to have minimal effect on the Government’s objectives for economic growth and social cohesion. The major effect of this option and the “defer decision on a price-based measure” (Option 2a) on the Government’s economic and social objectives is expected to be from deterred or delayed investment.

The issue is different, and the risk greater, for Option 1b (broad-based (world price) tax, targeted recycling), which starts with a high rate for the tax. Its impact on economic growth or social cohesion would depend critically on the nature of the targeted assistance measures.

Need to, and ease of, changing policy settings

Once a primary price-based measure has been implemented, it would be a major undertaking, involving significant legislative change, for the Government to change to another primary price-based measure.

For all four options, it may be desirable in the medium term to change to emissions trading. There is a higher probability with Option 2a (defer decision on price-based measure) and Option 2b (tax industrial emissions above world’s best practice ) than with the other two options that they would become unsustainable and require significant change before conditions were favourable for a change to emissions trading.

Transition to emissions trading

Potentially, there are three main issues around the transition from a tax to an emissions trading regime: points of obligation, discontinuities in the price of marginal carbon emissions and the allocation of permits.

There appears to be no reason why entities that were a point of obligation for the tax could not also be the points of obligation for an emissions trading regime. Indeed, if it were judged that a transition to emissions trading was a possibility within, say, the next 10 years, it would be desirable when designing the tax to decide what the best points of obligation for emissions trading would be and then make those entities the points of obligation for the tax. For greenhouse gas emissions from energy, this approach might lead to more points of obligation than is proposed with the announced carbon tax (eg, adding large end users of gas, coal and petroleum products, namely electricity generators and some industrials). Option 2b (tax industrial emissions above world’s best practice) is not consistent with setting points of obligation for the tax according to likely points of obligation in an emissions trading scheme.

If, at the time of the change to emissions trading, the level of the tax were close to the international price of carbon, the change could be made relatively simply by replacing the obligation to pay the tax with the obligation to surrender an emission permit. However, if the level of the tax were significantly below the price in the international market, it would raise other issues, because moving to an emissions trading regime would mean that the price of greenhouse gas emissions in New Zealand would move towards the international price. Options to address this would include increasing the level of the tax in the run up to the change so that it was close to the international price at the time of the change, or giving free permits to at-risk firms.

Feasibility

Further work would need to be done on how best to apply any greenhouse gas tax in the near future to agricultural emissions of nitrous oxide. Application of the tax to agricultural emissions of methane, and an extension of any tax to include forestry, would not be practical in the near future.

If a transition to a lower carbon economy in the longer term is likely, it is possible that the transition can be achieved at lower cost if it is started earlier (say, 2007 rather than 2012) and is undertaken more gradually. In this case, the benefits of introducing some carbon tax quickly, rather than maintaining a “holding pattern” for any length of time, may be significant. On the other hand, if a transition to a lower carbon economy in the longer term is unlikely, or if the costs of delay by New Zealand are small, there may be benefits (or only small costs) from maintaining a holding pattern for a number of years.

One source of significant costs may be long-lived, emission-intensive investments on which decisions to proceed are made while any “holding pattern” tax is in place and there is no guidance for decision-makers about the likely future value of carbon emissions in New Zealand. The emissions associated with such investments are likely to contribute to New Zealand’s emissions for many decades and will constrain the extent to which (or the cost at which) New Zealand would be able to reduce its emissions in the medium and longer term.

Conclusion

A credible, consistent price signal is expected to result in significant reductions in domestic emissions in the longer term, say 2020 and beyond, principally through the implementation of new ways of reducing the emissions intensity of production and consumption. Such a tax would have negligible effect on domestic emissions in the short term and only a modest effect in the medium term. Any quantitative estimate of the extent of emissions reductions over the long term would depend critically on the assumptions made about emission-reducing technological development and up-take. Such assumptions would require further work before they could be made with any confidence.

The assessment of the different options is set out in the rest of this section. Table 14 summarises the results of this assessment for the longer term.

Table 14 – Summary Assessment of Carbon Tax Options (longer term effects)

Schematic Comparison of Carbon Tax Models against Assessment Criteria

KEY

Tick. Positive impact on emission reduction goal, or growth, or sustainability

X Negative or negligible impact

? Unknown impact

  Effect on domestic emissions in CP1 Effect on domestic emissions beyond CP1 Impacts on medium term economic growth Sustainability, flexibility and feasibility
Announced carbon tax Tick. 13 Mt reduction ? Depends on whether policy survives “overheads” of negotiating NGAs X Negligible   X Large overheads of NGAs means sustainability questionable
Option 1a: low-level broad-based tax, rising over time X Negligible in CP1 Tick. Tick. Tick. (With agriculture in.) Tick. Tick. (With agriculture out.) Potentially substantial to 2020 (Depends on the level to which the tax can be raised) ? Tick. Tick. Provided community buy-in  
Option 1b: broad-based tax at world price, targeted recycling Tick. Tick. ? Depends on the nature of the targeted assistance ?   ? This option would face major sustainability barriers – fiscal pressures
Option 2a: defer decision on primary price based measure X   X   X This option would create substantial regulatory uncertainty. X Unlikely to be sustainable to 2020
Option 2b: tax on large industrial emitters that do not meet world best practice emissions intensity X Negligible emission reductions X   X This option would create substantial regulatory uncertainty X Unlikely to be sustainable to 2020
Coverage of any carbon tax – agriculture and forestry
Agriculture

About 80% of agricultural emissions of methane and nitrous oxide are either directly emitted by the belching of ruminant animals – cattle, deer and sheep – or come from the excreta of these animals. Different types of ruminant livestock emit different levels of greenhouse gases (ranging on average from about 2.5t CO2e per year for a dairy cow to 0.3t CO2e per year for sheep) and within each type, different animals have different emission levels depending on factors such as their age, size, genetics, and feed.

If any carbon tax were simply applied at a standard rate for each type of animal, it would create incentives for farmers to change their stocking levels and the mix of their livestock in order to reduce the tax paid but would not create incentives to investigate, or apply, other methods of reducing emissions (animal breeding, vaccines, feeding regimes, etc).

More sophisticated but low-cost, on-farm measurement and monitoring is needed if a carbon tax is to be applied to emissions from ruminant animals.

Use of nitrogenous fertiliser releases nitrous oxide to the atmosphere: each tonne of nitrogen in nitrogenous fertiliser ends up as 6.8 tonnes of CO2e in the atmosphere. This suggests that one small first step to including agricultural emissions within the scope of the tax could be to tax these emissions from nitrogenous fertiliser. The point of obligation for the tax could perhaps be the manufacturers and importers of the fertiliser. Nitrate loads in ground water and lakes are a serious problem associated with pastoral farming in several parts of New Zealand. A greenhouse gas tax that reduced the use of nitrogenous fertilisers would also have water-quality benefits.

At farm level, average, annual per animal emissions of methane and nitrous oxide (from excreta) are 2.5t CO2e for a dairy cow, 1.7t CO 2e for beef cattle, 0.7t CO2e for deer and 0.3t CO2e for sheep (Ministry for the Environment 2005b). On this basis, a tax of $5 per tonne of CO2e would be equivalent to $12.50 a head per year for dairy cows, $8.50 for beef cattle, $3.50 for deer and $1.50 for sheep.

Each tonne of nitrogen applied in the form of fertilisers produces, on average, about 6.8 tonnes of CO2-equivalent nitrous oxide emissions. At a cost of $5 per tonne of CO2e, this would increase the average price of urea fertiliser (which is the main fertiliser used in the dairy sector) by about 3%. The proportional price increase would be less for other fertilisers such as ammonia sulphate or diammonium phosphate.

Sin et al (2005) have estimated total agricultural emissions per hectare of methane and nitrous oxide for dairy farming and for sheep/beef farming: 7.6 tonnes per hectare per year and 3 tonnes per hectare per year respectively. For a tax of $5 per tonne of CO2e, the increased costs would be $38 per hectare per year and $15 per hectare per year respectively.

These issues are discussed in more detail in Section 4.7 on agriculture.

Forestry

Forestry has an important role in our climate change policies, as planting forests absorbs carbon, while felling forests releases carbon. In theory, a carbon tax that included tax rebates to forest owners while the forest is growing and carbon liabilities on the felling of forests could be more efficient than a carbon tax that excluded forestry.

However, if tax rebates were given to forest owners who had already planted their forests, they would be rewarded for decisions made some time ago. In these cases, the payment would simply be a deadweight expenditure. In addition, such a tax potentially introduces a liability on the deforestation of non-Kyoto forests, which raises distributional and equity issues. A simple carbon tax would not create incentives to investigate, or apply, other methods of reducing emissions within the forestry process (eg, the types of trees developed and planted, growing regimes, etc). Finally, there are fiscal risks to the Crown, as forest owners may not be in a position to pay the large carbon tax liabilities on felling. These expected liabilities may also distort the behaviour of forest owners.

Overall, it is unclear that the exclusion of forestry would reduce the impact or economic efficiency of any greenhouse gas tax. It is likely that a more sophisticated policy response will be needed to secure real climate change benefits from the forestry sector.

Option 1a: A broad-based tax on greenhouse gas emissions that starts at a low level and is gradually increased over time

Specification

The tax would apply to CO2 and CH 4 from fossil energy sources and process emissions from the industrial sector, and ideally, eventually to CH 4 and N 2O emissions from the agriculture sector and to CH 4 from the waste sector as well.

It would be introduced at a level at which the effect on New Zealand’s objectives for economic growth and social cohesion was minimal, possibly around $5 per tonne of CO2e. It would be increased over time, say at the rate of $2 every two years, to a level judged to be appropriate to achieve whatever medium- and long-term emissions reductions New Zealand commits to in the future or to the level of the relevant international price of carbon. The level of the tax would never exceed the international price of carbon. Using this example, a tax of $5 per tonne of CO2e introduced in 2007 would increase to $11 per tonne in 2013 and $19 per tonne in 2021 (provided the relevant international price in 2021 is greater than $NZ19 per tonne).

For emissions from the use of fossil fuels, the points of obligation for the tax could be the same as those for the announced carbon tax (generally, as early in the supply chain as possible). Alternatively, the points of obligation could be fixed by considering what the best points of obligation for an emissions trading regime would be and making the points of obligation for the tax the same as the optimal points of obligation for emissions trading.

If a low-level, broad-based tax were largely removed from the political arena (eg, if sufficient cross-party political support could be secured for it), the Government would be able to use the tax to indicate a forward price path for carbon in the New Zealand economy for perhaps up to 10 years ahead. If the Government’s adherence to such a price path was considered credible, it would provide considerable stability, consistency and certainty for those making decisions about investment in New Zealand. For example, the Government could regularly specify (say, every five years) what the level of the tax would be for each year for some future period (say, 10 years). The future increases could be specified in legislation. This would assist the formation of stable and consistent expectations about the future price of greenhouse gases in the New Zealand economy.

While there would be advantages if increases in a low-level, broad-based tax could be credibly signalled in advance, the assessment of this option does not assume that that would necessarily be possible in practice.

Effect on domestic emissions

A credible, consistent and gradually increasing price signal is expected to contribute to significant reductions in domestic emissions in the longer term, say 2020 and beyond, principally through the development and uptake of emission-reducing technology. The tax is expected to have negligible effect on domestic emissions in the short term and probably only a modest effect in the medium term.

At $5 per tonne, this tax would increase energy users’ costs by about $200 million per year (and pastoral farming emitters’ costs by about the same amount when/if its scope was extended to them). The full effects of this measure will be driven primarily by the expected profile and coverage of the tax over time, when/whether the rate reached the world price of carbon, and the credibility of this profile and coverage.

Economic impact
Coverage

A low-level, broad-based carbon tax is expected to be economically efficient (in the sense that emitters would have an equal incentive to find and apply the lowest-cost methods for reducing their emissions), especially if the intention to apply the tax to agricultural emissions is credible and eventually becomes reality. The number of emitters facing the incentive would be greater than with the announced carbon tax, the “defer a decision on price-based measures” option or the “industrial emissions above world’s best practice” option, but similar to the broad-based, targeted recycling option.

Initial direct price impact

At the level of businesses and households, a tax of $5 per tonne of CO2e would lead to price increases (including GST) of about $7 a tonne for sub-bituminous coal, about 20c a GJ for reticulated gas, and about 1 cent a litre for diesel and petrol. The increase in electricity prices is not straightforward to estimate but, based on an extrapolation of modelling of the electricity market done for a $15 per tonne tax, would be likely to be below 0.2 cents a kWh.

Longer-term economic impact

The longer-term impacts depend on the anticipated path of the level of the tax and the extent to which it is perceived to be credible. If the tax can be increased over time towards the world price of carbon and there is widespread support for it and these increases in its level, it is likely to have a growing impact on investment decisions over time. Modelling (Infometrics 2001) suggests that the longer-term impact on GDP of carbon taxes in the $3 to $13 range would be small (this work did not include a tax on agricultural emissions).

Learning by experience

It is likely that international carbon markets will continue to develop and that it would be desirable for New Zealand firms to learn about these markets by participating in them. This tax would not provide incentives and opportunities for New Zealand firms to gain experience in these markets. It would, however, improve the economics of some emission-reducing projects and may provide some opportunities for learning by doing with respect to technologies that are not well-established in New Zealand.

International competitiveness

A tax of $5 per tonne of CO2e would pose a serious risk to the international competitiveness of very few, if any, New Zealand businesses. The low-level, broad-based tax option allows the Government to manage the risk posed by the tax to the international competitiveness of New Zealand businesses by managing the level of the tax and its rate of increase.

Regulatory certainty

To the extent that the long-term profile for the level of the tax is credible, a low-level, broad-based tax would provide more certainty that all greenhouse gas emissions in New Zealand are likely to be of continuing concern to the Government than would the “defer a decision on price-based measures” option, the “tax on industrial emissions above world’s best practice” option or the announced carbon tax/NGA policy. It would provide much the same level of certainty on this as the broad-based tax, targeted recycling option.

To the extent that it is credible, this option provides more certainty about how firms within the same industry will be treated in the short term, and are likely to be treated in the longer term, than does the announced carbon tax/NGA policy or the three other modified tax options considered by the review.

To the extent it is credible, this option also provides more certainty about both the form and price level of the primary price-based policy instrument that is likely to be used over the medium term than does the announced carbon tax/NGA policy or the three other modified tax options considered by the review.

However, if the Government seeks to manage the risk posed by the tax to the international competitiveness of New Zealand businesses by managing the level of the tax and its rate of increase (as above), then this certainty will be reduced.

Compliance, administration and lobbying costs

The design of the announced carbon tax has shown that compliance and administration costs for a tax that is imposed early in the supply chain are small. Moving the point of obligation downstream (eg, to provide for an easier transition to emissions trading) is expected to result in a modest increase in compliance and administration costs.

A low-level, broad-based tax provides little opportunity for gaming behaviour by firms.

Fiscal impact

Based on the draft New Zealand fourth national communication under the UNFCCC projection of gross emissions of 81Mt in 2010 and a tax of $5 per tonne, annual gross revenue would be about $225 million (inc GST) if applied to all emissions other than agricultural emissions and $450 million (inc GST) if also applied to agricultural emissions. The former is about 60 percent of the net revenue from the announced carbon tax.

As the effect on domestic emissions during CP1 is expected to be broadly similar to the effect of the announced carbon tax, the low-level, broad-based tax option is not expected to significantly change the fiscal cost of meeting our CP1 obligations under the Kyoto Protocol.

This tax is compatible with good tax-policy design, as it is applied widely at a common rate, with few exclusions.

Sustainability and flexibility
Impact on achieving economic and social objectives

A tax that started at a low level and gradually increased over time would minimise any adverse impact on the Government’s objectives for economic growth and social cohesion, especially if the changes in the rate of the tax had been signalled well in advance.

Need to change, and ease of changing, policy settings

A low-level, broad-based tax would minimise the need for significant policy change, as there would be few circumstances in which new information (eg, about post-2012 international regimes or the cost of mitigating emissions in New Zealand or elsewhere) would make it desirable to replace the tax with some other policy instrument.

One circumstance in which a change from the tax might be considered is if New Zealand was in the position of having binding emission targets for some period beyond CP1 and there was a well-functioning international carbon market. This would raise the question of whether the tax should be replaced by an emissions trading regime. Such a change would involve significant legislative change and is discussed further below.

As long as there are major foreign competitors who do not face an equivalent cost of greenhouse gas emissions, there is the possibility the Government would not persist with a gradual increase in the tax because to do so would create unacceptable international competitiveness issues for some New Zealand firms and/or have unacceptable adverse affects on economic growth.

Transition to emissions trading

If the point of obligation remains early in the supply chain, there would be some costs in moving this point of obligation downstream to fit with any emissions trading regime. To the extent this broad-based greenhouse tax is close to the world price of carbon, the adjustment costs are likely to be small. To the extent this broad-based greenhouse gas tax is substantially below the world price of carbon – which is likely at least in its initial years of operation – the adjustment costs involved in the transition to emissions trading will be higher.

Feasibility

Applying the tax to emissions from energy and the industrial sector would not present any problems that have not been addressed in the course of the work on implementing the announced carbon tax.

Further work would need to be done on how best to apply the tax in the near future to agricultural emissions of nitrous oxide. Application of the tax to agricultural emissions of methane in a way that incentivised efficiency improvements (as well as stocking and land-use changes) would not be practical in the near future.

Conclusion

A main strength of this option is that, by starting at a low rate, it may be less politically contentious and hence more credible as a long-term policy setting. This option has a broad coverage with few exclusions, which is likely to be more efficient (and effective) than the alternatives.

Assuming this option is widely accepted, there is a good chance that change to another primary price-based measure would not be required for at least 10 years, irrespective of what post-2012 regimes emerge and what New Zealand decides to do about domestic emissions. It is possible that the tax could be increased gradually over time towards the rate that would give the appropriate level of reductions in domestic emissions while minimising the unacceptable impacts on domestic economic and social objectives (and international competitiveness concerns). However, increasing the tax may still be difficult even if the tax itself has broad acceptance, and there is likely to be pressure to hold the tax at a low level.

If New Zealand has binding emission targets for some period beyond CP1 and there is a well-functioning international carbon market, a transition to emissions trading may be desirable and would be feasible provided the international price was not so high that it was incompatible with achieving New Zealand’s economic and social objectives. Such a transition would require legislative changes. The adjustment cost of the change would be reduced if the tax had been designed with a transition to emissions trading in mind, though this is likely to increase the compliance and administrative costs of this option.

If it is credible, a low-level, broad-based tax would provide greater regulatory certainty than any of the other options considered. If sufficient cross-party political support were secured for this option, it would enable the Government to provide even greater stability and certainty for investors by signalling a credible forward price path for carbon in the New Zealand economy. However, if this broad support were not available, then many of this option’s advantages disappear, and this option would face many of the same costs as the other options.

In addition, this option has two particular risks associated with it.

One is the risk that because the tax would have only a minimal effect on behaviour and investment decisions in the short term, it would be seen as pointless and silly. This risk can be managed by clearly communicating the fact that the important things about the tax are that, firstly, it signals to all parts of the economy that emissions of greenhouse gases are no longer free and it contributes to the process of creating changed expectations about this; and secondly, it best positions New Zealand to respond to whatever emerges over the next decade.

The second risk is that any assertion by the Government that the tax will be gradually increased over time is not seen as credible. This would reduce its value as a signal to decision-makers about the costs of greenhouse gas emissions in the long term and undermine any attempt to provide greater certainty for investment by establishing widely-held, consistent expectations about the forward price path for greenhouse gas emissions in the New Zealand economy.

Option 1b: Broad-based tax (world price), targeted recycling

Specification

The elements of this option are:

  • New Zealand should move quickly to applying a "world price" carbon tax across as much of the economy as possible (excluding agriculture and forestry). In effect, this would mean a carbon tax of between $10 per tonne and $25 per tonne but no NGAs
  • the revenue from the carbon tax would be recycled into "helping" firms and individuals adjust to the tax.  This might be a combination of targeted government assistance for energy-efficient technology and structural-adjustment assistance.

The option is effectively an adaptation of the announced carbon tax. The features that differ are the removal of NGAs and their replacement with specific proposals around revenue recycling to provide targeted assistance. The success of this adaptation depends critically on whether the targeted assistance can achieve a superior emissions outcome to the NGAs.

To the extent that the targeted assistance simply offsets the price signals from the carbon tax – to mitigate the effects on international competitiveness – then it will have a similar effect to the announced NGAs.

Effect on domestic emissions

The effect of this option on domestic emissions is expected to depend on the effect of the targeted assistance. Taxing carbon at the world price should, of itself, have a larger impact on emissions than the other options (or the announced carbon tax). If the targeted assistance supports structural change and the transition to lower-emissions technologies, this could amplify the overall impact on emissions while still limiting the reductions that might otherwise occur in production in New Zealand. This structural adjustment would see firms moving ahead of current world’s best practice to adopt and develop energy-efficient technologies in their activities where they can, and encourage them to shift resources out of emissions-intensive activities where improvements in efficiency are impractical. Potentially, this could improve on the outcome from the announced carbon tax/NGAs. On the other hand, if the targeted assistance simply offsets the effects of the carbon tax to minimise international competitiveness issues, then the effect of this tax option on emissions would be reduced (and expected to be similar to that of the announced carbon tax).

Assumptions about the nature, level and allocation of the targeted assistance would have to be made to pursue this further.

Economic impact
Coverage

Not having NGAs would widen the coverage and the economic efficiency relative to the announced carbon tax.

Longer-term economic impact

Depending on its design, targeted assistance can provide either an incentive or a disincentive for economically efficient investment decisions over time.

There is a risk that some firms or industries will develop a dependence on the assistance.

It is likely that having a “world price” in the New Zealand economy would have a greater adverse effect on economic growth if there were no NGAs. Specific assumptions about the nature, level and allocation of the targeted assistance, and firms’ responses to that, would have to be made to investigate this issue further.

Learning by experience

This option would not provide opportunities for New Zealand businesses to gain experience of carbon markets. However, by improving the economics of some projects and having them implemented earlier than would otherwise be the case, this option would enhance learning by experience.

Regulatory certainty

With respect to the level of the tax, this option would provide a similar level of certainty as the announced carbon tax or the low-level, broad-based tax. The certainty, at least in the short term, would be greater than with the “holding pattern” options.

With respect to the targeted assistance programmes, a key consideration would be the Government’s decision about how long the programmes would run for before they were reviewed or discontinued.

International competitiveness

One of the challenges with this option would be to design targeted assistance programmes that satisfactorily addressed risks to the international competitiveness of New Zealand businesses.

Lobbying, compliance and administrative costs

It is likely that there would be considerable lobbying by industries and businesses around the design of the targeted assistance programmes, their duration, their performance and changes to them.

Compliance and administration costs would depend largely on the nature and design of the targeted assistance. Targeted assistance can have significant transaction costs.

Fiscal impact

The revenue from this option with the tax at $15 per tonne of CO 2e is expected to be about $600 million (inc GST) a year.

The option assumes that the revenue from the tax is the optimal amount to spend on targeted assistance. The validity of this assumption would need to be carefully examined. Ideally, the expenditure would be assessed on its own merits relative to competing priorities for the use of that revenue.

This tax is compatible with good tax-policy design, as it is applied widely at a common rate, with few exclusions.

Sustainability and flexibility
Impact on achieving economic and social objectives

It would be a big challenge to design and implement targeted assistance that supported emissions reduction, satisfactorily addressed international competitiveness issues, and did not create significant inequities and inefficiencies. This would be an area of major risk.

Need to change, and ease of changing, policy settings

One of the factors that would determine whether there was a need to change the policy settings in the short or medium term would be the performance of the targeted assistance programmes. If it became apparent that there was conflict with achieving economic and social objectives, it is likely that the Government would wish to change the policy settings. This is likely to be a major undertaking.

There is also the issue of how long the targeted assistance programmes should run for, and how we would know when they had achieved their objective.

Transition to emissions trading

To make a transition to emissions trading from this option easier, the points of obligation for this tax could be established with such a transition in mind. If the tax had been adjusted over time to track the “world price”, price discontinuities at the time of transition would not be a problem.

Feasibility

The design and administration of targeted assistance could be complex, and it may be difficult to avoid creating some perverse incentives. Design of cost-effective targeted assistance requires that there is clarity about objectives, eg, in relation to domestic emissions and structural change in the economy.

It is likely that the process of designing the targeted assistance would reveal issues that the Government would see as large risks.

Conclusion

The impact on economic growth and efficiency would depend crucially on the objectives and the design of the targeted assistance. Design of the targeted assistance would be complex, especially to minimise adverse effects on economic efficiency, and administration of the assistance could require significant resources.

Regulatory uncertainty would be on a par with the announced carbon tax and higher than with the low-level, broad-based tax.

Option 2a: Defer a decision on price-based measures

Specification

Do not proceed with the announced carbon tax/NGA policy; give a commitment that there will be no decision on a primary price-based measure for at least five years (ie, until 2011); defer implementation of any primary price-based measure until at least 2013.

Effect on domestic emissions

In the short term, the effect on domestic emissions is expected to be less than under the announced carbon tax or any of the modified carbon taxes considered in the review. In the longer term, the effect would depend on the policy settings eventually adopted by the Government.

Economic impact
Coverage

This option would apply to all emissions and so would not create distortions in production and consumption decisions (other than the distortion of greenhouse gases continuing to be costless).

On the one hand, the absence of a price on emissions that are acknowledged to have economic costs would be economically inefficient in both the short and the long term. On the other hand, because it would provide the same (zero) price signal to all firms, it would not distort within or between sectors of the economy.

Initial direct price impact

There would be no price increases due to a carbon tax through to 2012. Direct price impacts beyond 2012 would depend on the policy settings eventually adopted by the Government.

Longer-term economic impact

Under this policy, there would be a tendency to defer investment decisions until the policy for the future was clearer. If this occurred on a large enough scale, or in critical areas such as electricity generation, it could materially reduce economic growth in the short or medium term. Long-term impacts would depend largely on the climate change mitigation policies eventually adopted by the Government.

In comparison with the announced carbon tax or any of the modified carbon taxes, this option would provide less information about future prices of greenhouse gases in New Zealand.

Learning by experience

This option would not provide opportunities or incentives for New Zealand firms to learn by experience in international carbon markets or from the earlier implementation of emissions-reducing projects involving technology that is not well-established in New Zealand.

International competitiveness

No international competitiveness issues in the short term. The extent of international competitiveness issues beyond 2012 would depend on the policy settings eventually adopted by the Government.

Regulatory certainty

Regulatory uncertainty during the short term would be greater than under the announced carbon tax or any of the modified carbon taxes. This would be expected to deter some investment and defer other investment. Regulatory uncertainty in the longer term would depend on the policy settings eventually adopted by the Government.

Compliance, administration and lobbying costs

There would be none of these costs in the short term. The costs beyond 2012 would depend on the policy settings eventually adopted by the Government.

Fiscal impact

This option would not raise net tax revenue before 2012.

As the effect on domestic emissions during CP1 would be less than the effect of the announced carbon tax, deferring a decision on a primary price-based measure would increase the fiscal cost of meeting our CP1 obligations under the Kyoto Protocol by a modest amount.

The impact beyond 2012 would depend on the policy settings eventually adopted by the Government.

As there is no carbon tax, this option has no effect on tax design.

Sustainability and flexibility
Impact on achieving economic and social objectives

In the short term, it is likely that some investment will be deterred or delayed; in the longer term, it depends on the policies adopted by the Government.

Need to change, and ease of changing, policy settings

This option would postpone the major effort required to implement a primary price-based measure.

Transition to emissions trading

If a primary price-based measure were to be implemented by the Government post-2012, it is possible that it might be an emissions trading scheme.

Feasibility

The option is feasible.

Conclusion

One main effect of this option would be to increase uncertainty for business and research investment about the pricing of greenhouse gases in New Zealand for at least the next five years. It is likely that wherever possible, eg, in research funding or possibly electricity generation, decisions will be deferred. If it is considered imprudent to signal now whether it is likely that greenhouse gas emissions in New Zealand will be priced in the future, this is an advantage. Otherwise, it is a disadvantage.

If the Government does not wish to provide any signal now about the likelihood of greenhouse gases being priced in the future in New Zealand, it is an option that is uncomplicated and needs few resources to implement.

A strategy for our international engagement would need to be developed should the government proceed with this option.

Option 2b: A tax on large industrial emitters of CO2 where their emissions intensity is above world’s best practice

Specification

The tax would apply only to large industrial final emitters of CO2, possibly excluding power stations, gas suppliers and the oil refinery.

“Large” would be defined as firms emitting more than 1% (or perhaps 0.5%) of New Zealand’s emissions of CO2. Large industrial final emitters that did not meet world’s-best-practice emission-intensity levels would pay the tax on emissions above a straight line from where they were in 2004 to world’s best practice in 2012 for a period starting in mid-2007. Emitters who met world’s-best-practice emission-intensity levels would not pay any tax.

It would be implemented at a level that created substantial incentives for large final industrial emitters to meet world’s-best-practice emission-intensity levels, say $15 per tonne of CO2e or the world price of carbon.

To the extent that fossil fuel power stations, gas suppliers and the oil refinery were close to world’s best practice, they would pay little if any tax and the price increases passed through to electricity, gas and petrol/diesel users would be small – too small to significantly increase the risk to firms’ international competitiveness. If, however, they were not close to world’s best practice, the issue of international competitiveness might be relevant. This would potentially be a reason for excluding them from the coverage of the tax.

One percent of New Zealand’s emissions of CO2 is about 0.35Mt per year; this is the quantity of CO2 that is produced by burning 180,000 tonnes of coal or 6.8 million GJ of gas. As a point of reference, Genesis Energy has produced between 3.5 and 5 million tonnes of CO2 a year for the last four June years (principally from the Huntly power station).

If the threshold were set at 1% of New Zealand’s total CO2emissions, then 12 firms would be covered. Extending the threshold to 0.5% of total emissions would extend the coverage of the tax to an additional two or three firms. There are four companies that emit large amounts of CO2 when they generate electricity, supply natural gas or refine crude oil that could potentially be excluded.

From our experience with NGAs, it is expected that most large industrial final emitters will be close to world’s best practice in emissions intensity (within 7%). This suggests that if the threshold for liability were set at 1% and the four gas, electricity and refining firms were excluded, the quantity of emissions paying the tax would be less than 0.43Mt a year.

The tax would be reviewed (with the expectation that it would be replaced by more appropriate policy settings) once there was sufficient clarity about post-2012 international regimes, their implications for New Zealand and the cost of emission reduction in New Zealand.

Effect on domestic emissions

In the short term, this option is expected to result in much the same level of emissions as the announced carbon tax and the low-level, broad-based tax. This level of emissions would probably be below the level associated with the “defer a decision on a price-based measure” option.

In the longer term, this option and the “defer a decision on a price-based measure” option are likely to give less reductions in domestic emissions than the other options, because of the five-year or longer delay in giving clear signals to all business and investment research managers.

Economic impact
Coverage

Coverage would be limited and hence emissions reductions would not be economically efficient. Excluding electricity generation, gas supply and oil refining from the scope of the tax simplifies it considerably, but means an even more limited coverage.

Initial direct price impact

While this option remained in effect, there would be cost increases for very few firms and, where there were cost increases, they would be relatively small. Initial direct price increases when this option is replaced are unknown.

Longer-term economic impact

Under this policy, there would be a tendency to defer investment decisions until the policy for the future was clearer. If this occurred on a large enough scale outside of these large industrial final emitters, or in critical areas such as electricity generation if these were excluded from the scope of the tax, it could materially reduce economic growth in the short or medium term. Long-term impacts would depend largely on the climate change mitigation policies eventually adopted by the Government.

In comparison with the current carbon tax, the low-level, broad-based tax and the broad-based (world price), targeted recycling tax, less information about future prices of greenhouse gases in New Zealand would be provided.

Learning by experience

In the short term, this option would not provide significant opportunities or incentives for firms to learn by participating in international carbon markets or from the earlier implementation of projects involving technologies that are not established in New Zealand.

International competitiveness

There would be few international competitiveness issues in the short term. The extent of international competitiveness issues in the longer term would depend on the climate change mitigation policies eventually adopted by the Government.

Regulatory certainty

Regulatory uncertainty during the short term would be greater than with the broad-based tax options; this would be expected to deter some investment and defer other investment.

Regulatory uncertainty in the longer term would depend largely on the climate change mitigation policies eventually adopted by the Government.

Compliance administration and lobbying costs

In the short term, there would be compliance and administrative costs at a similar level per firm as for NGAs, but for fewer firms. The costs in the longer term would depend largely on the climate change mitigation policies eventually adopted by the Government.

There would be little opportunity for gaming by firms. Transaction costs are expected to be significant at the level of the firm, but would apply to only a few firms.

Fiscal impact

It is expected that the revenue from the option would be small, because most of the firms that would potentially be liable to pay it will be at, or close to, world’s best practice in emissions intensity and because there would be no tax on CO2emissions from transport (or, potentially, electricity generation, gas and refining).

If the threshold for liability is set at 1% and if companies that emit large amounts of CO2 when they generate electricity, supply natural gas or refine crude oil are excluded from coverage of the tax, it is estimated that the tax revenue will be less than $7 million a year.

A narrow, specific tax regime for a selected group of firms or industries is inconsistent with the general approach to tax policy, but may be justifiable in these circumstances.

Sustainability and flexibility
Impact on achieving economic and social objectives

A tax imposed on a small number of high-emissions firms should minimise any adverse impact on the Government’s objectives for economic growth and social cohesion. If electricity generation, gas and refining are included, this tax may have a wider impact on businesses and consumers (depending on its level and whether/how it is passed on).

If this tax is regarded as a temporary measure, it is likely that some investment outside the firms subject to the tax will be deterred or delayed.

Need to change, and ease of changing, policy settings

There would not be a lot of work involved in changing the announced tax/NGA policy to this option.

Given that this option is proposed as a “holding pattern” option, it leaves open at least two possibilities for future longer-term policy settings:

  • a change to an economically efficient, primary price-based measure (either a tax or emissions trading) that dispenses with NGAs
  • no economically efficient, primary price-based measure (either continuation of the tax on large emitters above world’s best practice or no primary price-based measure).

The first of these would imply that the Government would undertake two major initiatives (both involving substantial legislation) on climate change price-based measures policy settings, possibly within as short a time as five years.

Transition to emissions trading

This option would not provide a good platform for a transition to emissions trading.

Feasibility

Such a tax is feasible. It would be a simplified version (eg, no NGA rebates) of the announced carbon tax/NGAs, for which most of the implementation issues have now been resolved. It would apply to less firms than those likely to be eligible for an NGA under the current carbon tax/NGA policy.

Conclusion

With a minimum of changes from the current carbon tax/NGA option, this option removes the tax from areas that are seen by some people as contentious – transport (where it will have very little effect) and energy (except for the direct use of fossil fuels by large industrial emitters) – and focuses it on emissions from large industrials that exceed world’s-best-practice emission intensity. Excluding electricity generation (and gas and refining) from the scope of the tax simplifies it considerably, but would be an important source of economic inefficiency.

This option reduces the proportion of New Zealand’s total emissions that are influenced. This is desirable if the Government’s objective for the short term is to limit the areas where it seeks to influence decisions to large industrial emitters of CO2.

One important effect of this option would be to increase uncertainty for business and research investment about the pricing of greenhouse gases in New Zealand, for at least the next five years. It is likely that decisions will be deferred where possible; eg, in research funding or, possibly, electricity generation. If it is considered imprudent to signal now whether it is likely that greenhouse gas emissions in New Zealand will be priced in the future, this is an advantage. Otherwise, it is a disadvantage.

If the Government does not wish to provide any signal now about the likelihood of greenhouse gases being priced in the future in New Zealand, it is an option that is much more complicated than the “defer a decision on a price-based measure” option.