Let the emissions trading scheme do the work

Dr Eric Crampton
The Dominion Post
7 March, 2022

The latest survey of New Zealand economists provides a clear steer for climate policy.

Rather than use policies like fuel economy standards for imported vehicles, which target emissions already covered by the Emissions Trading Scheme’s cap on net emissions, the government should simply tighten the cap more quickly.

If other market failures make it harder for firms and households to adjust to rising carbon prices, additional policies should address those problems directly.

And if rising carbon prices hurt poorer households, the government should compensate households through a carbon dividend rather than try to target emission reductions sector-by-sector.

Last year, the New Zealand Association of Economists (NZAE) and the New Zealand Initiative set an Economic Experts Panel to answer questions about economic policy. Distinguished Fellows of the NZAE, along with Association Life Members and Past Presidents, and NZIER Economist of the Year award winners, were invited to join the panel.

We released the first round of survey results last month. Our surveyed economists agreed that rent control does not improve the availability and affordability of rental housing in places that have implemented it; that more high-skilled migration would make the average Kiwi better off; and, that governments cannot finance as much real government spending as they want by just printing more money.

None of those statements are at all controversial among economists but are too often at odds with Wellington policy officials.

This month, we asked about climate policy.

New Zealand’s Emissions Trading Scheme (ETS) has improved considerably over the past few years. Through the 2010s, the ETS was a lot more like a low carbon tax set at $20 per tonne. Now that there is a real and declining cap on net emissions, the price of carbon has risen to $80 per tonne. The carbon charge in a litre of petrol rose accordingly, from about $0.05 to about $0.20.

A lot of Wellington officials support adding policies on top of the ETS. They argue that doing so can force emissions to reduce more quickly.

But when policies target sectors covered by the ETS and those sectors purchase fewer carbon permits, more permits are left for others to buy instead.

And while it is true that the government could take that opportunity to cut the ETS cap more quickly, it could cut the ETS cap more quickly and at less cost to the country as a whole without regulating fuel economy.

We asked whether our expert panel agreed or disagreed with the following proposition: “Tightening the Emissions Trading Scheme’s cap on net emissions would be a less expensive way to reduce carbon-dioxide emissions than a collection of policies, such as fuel economy standards for imported vehicles, that target emissions already covered by the ETS.”

Thirty-one percent strongly agreed with the proposition, fifty-four percent agreed, and the rest were either uncertain or had no opinion. No surveyed economist disagreed.

But that hardly means that economists see no role for complementary policies. Complementary policies can have an important role to play if there are complementary problems to solve.

The ETS puts a price on carbon that deals with the market failure we would otherwise have in carbon emissions. If other market failures unduly hinder adjusting to rising carbon prices, policies directly targeting those market failures may reduce the cost of mitigating emissions. Seventy-seven percent of our surveyed experts agreed, and none disagreed.

So it is not that economists are opposed to regulatory activity per se. It is rather that those policies need to be appropriately targeted at real additional market failures. And, as Graham Scott warned in a comment on the survey, government would need to ensure that the additional policies “do not do more harm than good – as some may already be doing.”

To take an example, if you thought that an $80 carbon price hurt biodiversity because of pine tree planting, the solution would not be to tweak the ETS settings to ignore carbon sequestered in pine forests. The solution instead would be a subsidy for planting native forests, or a charge reflecting the biodiversity cost of additional pine tree planting in places where more pine trees caused demonstrable harm.

Finally, we asked our experts to choose between two options for dealing with the harms that rising carbon prices can impose on poorer households.

The government has been trying to target emission reductions in sectors that might be less likely to affect poorer households while also providing subsidies for electric vehicles.

But the government has another option. It plans on selling 19.3 million ETS credits this year. At $80 per tonne, that would raise enough money to give every family of four a carbon dividend of more than $1200.

Our experts agreed that a carbon dividend is the preferred option: 15% strongly agreed, 54% agreed, 23% were uncertain, and 8% had no opinion. No one disagreed.

New Zealand’s ETS has improved greatly over the past several years. We should let it do its job.


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