A PENALTY- INCENTIVE ECOLOGICAL TAX

This is an extract from the detailed report

"Towards a Sustainable Energy Future (Pre Kyoto)"

by Dr Tom Romberg FIEAust CPEng.

CONTENTS

INTRODUCTION

ECOLOGICAL TAX REFORM RATIONALE

CARBON TAX REVENUE (CTR) MODELS

Rationale of the Carbon Tax Models

Uniform ETR Model

IET Penalty Model

IET Incentive Model

SOME TYPICAL ENERGY STRATEGIES

CARBON TAX REVENUE PROJECTIONS

IMPEDIMENTS TO IMPLEMENTATION

MAJOR ADVANTAGES

CONCLUSION

ACKNOWLEDGEMENT

INTRODUCTION

With the move towards a national grid and privatisation, there is little doubt the electricity sector is about to undergo a major restructuring. The prospect of greater competition will force producers to minimise their costs to maintain their competitive edge as electricity vendors shop around to try to negotiate a ‘best deal’ for their customers. These ‘market forces’ have the potential to inflict even higher greenhouse gas emission loadings on the environment. Electricity producers will be faced with the following commercial options:

1. defer investment in new plant/technologies and rely on their current plant/assets to generate the revenue needed to establish their niche in the competitive market;
2. invest in some new plant/technologies and rely on their current plant/assets to generate the revenue needed to establish their niche in the competitive market;
3. invest in new plant/technologies and refurbish current plant/assets to generate the revenue needed to maintain their niche in the competitive market.

With the increased pressure of ‘market forces’, investment in new plant for environ-mental reasons is unlikely to be a high priority, and it is widely recognised that a greater emphasis on ‘economic instruments’ is necessary to achieve environmental goals. Those being proposed to limit greenhouse gas emissions by monetary means include [13]:

emission charges; performance bonds; differential taxes; · tradeable rights/quotas;

· user charges; · non-compliance fees; · product charges; · etc.

ECOLOGICAL TAX REFORM RATIONALE

The imposition of an emission charge on fuel in proportion to the greenhouse gases they emit when used, is an economic instrument that is being widely proposed. The Australia Institute, for example, has proposed a range of ecological tax reform (ETR) measures, including a carbon tax of $23/tonne CO₂ emissions to raise $6.4 billion in revenue annually [14]. The purpose of this carbon tax is to produce both environmental and economic benefits through:

• the abolition of payroll taxes by ‘recycling’ of the taxes to state governments; and, thereby,
• stimulation of the economy through increased production and employment.

The proponents of a carbon tax recognise that, as a means of generating revenue to fund public spending, the revenue from a carbon tax is eroded over time by the implementation of programs to reduce the consumption of fossil fuels.

Furthermore, such a tax will be ineffective from an environmental viewpoint if it is simply passed on to consumers by electricity producers in collusion. Legislation may be necessary to avoid this problem in the event that self-regulation measures fail.

The degree to which the perceived benefits of a carbon tax can be used to stimulate the implementation of emission reduction measures are evaluated using the power law relationships derived in Appendix B.

CARBON TAX REVENUE (CTR) MODELS

The carbon tax revenue ($CTR) is given by the general power law relationship, equation (B2), as

... (3)

where R is the reduction in CO₂ emissions, NGI is the National Greenhouse Inventory, ε is the fractional contribution by the electricity sector, $ETR is the ETR tax rate and n is the ‘best fit’ power law exponent.

Rationale of the Carbon Tax Models

For a carbon tax rate of $23/tonne CO₂ emissions (= $ETR), we obtain the revenue for the electricity sector shown in Figure 11 for three values of the power law exponent (n).

Figure 11 - Carbon tax revenue for the electricity sector

The maximum ETR revenue raised is $4.107 billion per annum on a ‘business as usual’ basis
(R = 0), and if the electricity sector achieved a target reduction in CO₂ emissions of 43% by 2010, then the ETR revenue would fall by an equivalent amount to $2.341 billion per annum for the uniform ETR rate proposed by the Australia Institute (termed Uniform ETR Model), by higher amounts if the power law exponent is greater than unity (n > 1, termed IET Incentive Model), and by lesser amounts if the power law exponent is less than unity (n < 1, termed IET Penalty Model).

Uniform ETR Model

If the electricity sector is required (by co-operative agreement or legislation) to reduce its CO₂ emissions by 40% in 2010, that is, by a target average of 3.5% per annum, the uniform ETR rate proposed by the Australia Institute represents the average reduction in carbon tax to electricity producers whose audited reduction in CO₂ emissions achieves the prescribed target average reduction per annum. If all electricity producers achieve the target average reduction in CO₂ emissions per annum, then they are compliant with a Uniform ETR Model (n = 1).

IET Penalty Model

Electricity producers whose audited annual reduction in CO₂ emissions is less than the target average will incur an increased carbon tax rate (penalty) under an IET Penalty Model (n < 1) in order to give them greater incentive to comply with the target annual reduction in CO₂ emissions.

IET Incentive Model

Conversely, electricity producers whose audited annual reduction in CO₂ emissions is greater than the target average will attract a reduced carbon tax rate (bonus) under a IET Incentive Model (n > 1) in order to give them further incentive to reduce their CO₂ emissions.

The magnitude of the penalty/bonus tax rates will depend on the deviations from the average, and are given by the equivalent carbon tax rate ($ECTR) as a function of the reduction in CO₂ emissions (R) as:

... (4)

Some typical energy strategies are discussed in the following section to demonstrate how these models can be applied in practice.

SOME TYPICAL ENERGY STRATEGIES

Figure 12 shows the range of typical strategies that can be adopted to optimise the impost of a carbon tax, and the strategy selected by an electricity producer will depend on their particular circumstances. Figure 13 shows the equivalent carbon tax rates.

Figure 12 - Carbon taxation strategies for typical energy scenarios

Figure 13 - Equivalent carbon tax rates/tonne CO₂ emissions

Average emission strategy: The company decides to implement an energy strategy with emission reduction measures which achieve the target average reduction in CO₂ emissions between now and 2010, and so moves steadily from point A→C.

‘Minimalist’ emission strategy: The company decides to adopt a ‘business as usual’ energy strategy with minimum implementation of greenhouse abatement measures, and in so doing, moves from A→G, thereby incurring a penalty tax on its CO₂ emissions. As shown in Figure 13, the company will end up paying the equivalent of $32.89/ tonne CO₂ emissions at point G.

‘Maximalist’ emission strategy: The company decides to adopt an energy strategy which maximises their reductions in greenhouse gas emissions, and in so doing, attempts to minimise its tax burden by moving from A→E. From Figure 13, we see that the company will end up paying the equivalent of $8.28/tonne CO₂ emissions at point E.

‘Mixed mode’ emission strategy: A company may adopt a combination of the above energy strategies to ‘optimise’ its carbon tax burden depending on its financial and capital resources. For example, the company may not have the resources initially to reduce its emissions, and elects over time to move from A→F→D→E, where new plant becomes operational at point F and drops their emissions to point D.

Other mixed mode energy scenarios are possible: A→B→D→E, A→B→C→E, A→F→D→E, A→D→F→G, etc., and highlight its greater flexibility.

CARBON TAX REVENUE PROJECTIONS

The carbon tax revenues with and without renewable energy are derived in Appendix B, and are given by equations (B5) and (B6) as:

... (5)

... (6)

By way of example only, we will apply these equations to the ‘optimum’ energy scenario discussed above and presented in Figure 9. The revenue projections for the uniform tax rate proposed by the Australia Institute ($23/tonne CO₂ emissions) and an industry penalty scenario, are shown in Figures 14 and 15.

Figure 14 - ETR and penalty revenue projections (‘optimum’ energy scenario)

Figure 15 - ETR and incentive revenue projections (‘optimum’ energy scenario)

The ETR plots represent average industry compliance (scenario A→C, Figure 12), and ETR revenue falls by some 68% to $1.3 billion in 2020.

The (IET) penalty revenue, on the other hand, represents a slow/retarded industry compliance overall (scenario A→G, Figure 12) while still achieving the target CO₂ emission reductions in Figure 9. Using equation (4), this corresponds a uniform penalty tax rate of $26.81/tonne CO₂ emissions ( ). The penalty model revenue falls by 56% to $1.8 billion in 2020. Higher penalty tax revenues are obtained if electricity industry compliance falls even further, but a point will be reached ultimately where the assumption that the target reductions in CO₂ emissions as per Figure 9 are still attain-able, is no longer valid due to the high level of industry non-compliance.

Alternatively, if there is very high industry compliance such that most electricity producers are able to minimise their tax burden as discussed above (scenario A→E, Figure 12), then we obtain the incentive revenue projections given in Figure 15, where the incentive tax projections are for n = 3 as previously. We see that, at an equivalent tax rate of $8.28/tonne CO₂ emissions, the incentive tax revenues fall rapidly by 97% to $125 million by 2020, and in effect becomes a bona fide environmental tax once again rather than a substitute payroll tax.

IMPEDIMENTS TO IMPLEMENTATION

Impediments to the implementation of a penalty-incentive carbon tax are likely to be:

• industry opposition to the increased tax burden in an uncertain competitive environment, even if the impact of a carbon tax is ‘softened’ through payroll tax benefits in the immediate term as proposed by the Australia Institute;
• mechanisms for establishing the CO₂ emission targets for individual companies, industry sectors and the states for (differentiated) taxation purposes;
• measurement and auditing of the CO₂ emissions produced by individual companies, industry sectors and the states for (differentiated) taxation purposes;
• establishment of tradeable emission credits, co-operative contracts and/or other economic instruments for the phasing in of the taxation impost based on the circumstances of individual companies, industry sectors and the states.

MAJOR ADVANTAGES

The advantages of a penalty- incentive ecological tax over a uniform ETR tax are perceived to be:

• greater flexibility for electricity companies to plan, manage and implement green-house gas abatement measures most suited to their particular requirements;
• greater compliance with national and state greenhouse strategies as a result of the increased tax penalties incurred through non-compliance;
• greater incentive for companies to exploit the bonus tax rates by adopting more advanced (renewable and/or nuclear) technologies which can yield the greatest reduction in greenhouse gas emissions;
• greater facility for deferring penalties in lieu of downstream bonuses under a Co-operative Contract in order to accommodate the long lead times associated with implementing new technologies;
• broad-range application of the same penalty-incentive carbon taxation principles to all greenhouse sources and sinks as proposed by the Australia Institute.

CONCLUSION

The above analysis demonstrates that a penalty–incentive carbon tax in tandem with other economic instruments such as tradeable emission credits, provides scope for alleviating the tax burden on all emitters of greenhouse gases while at the same time rewarding those ‘high achievers’ who implement greenhouse gas abatement measures at a faster rate than the target average.

A uniform carbon tax, on the other hand, does not provide the same economic incentive for emitters to reduce their greenhouse gases. However, it does have the benefit of generating higher tax revenues in the medium term future for off-setting other tax imposts such as the payroll tax.

Industry analysts argue that the imposition a carbon tax, emission levies or any other impost would be counter-productive, and is likely to force some industries (e.g. the aluminium industry) off-shore.

Environmentalists on the other hand, argue that voluntary ‘no regrets’ measures are unlikely to achieve substantive reductions in greenhouse gas emissions without some deterrent which affects an emitter’s bottom line.

Whatever the perception of the various stakeholders, it is likely that implementation of economic measures to reduce greenhouse gas emissions will be profoundly influenced by the outcomes of negotiations in Kyoto, Japan, in December 1997 and beyond.

ACKNOWLEDGEMENT

The author gratefully acknowledges many helpful discussions with, and comments by, Mr Fred Rollo, Principal of Fred Rollo CPA and formerly Director of Finance, Redevelop Australia Consortium, on the proposed penalty-incentive carbon taxation measures presented herein.

END.