Emissions pricing and congestion pricing have a lot in common. The economics of both are straightforward. And the politics of both are a mess.
Like carbon charging, congestion charging simply makes sense. About 90 per cent of economists surveyed endorsed carbon and congestion charging – a decade ago. And the case for both has not got weaker with time.
Political problems in both cases risk undermining the systems.
So far, New Zealand does not have a congestion charging scheme to reduce traffic, but the Transport Select Committee has been considering a proposed Auckland congestion charge.
Auckland’s proposed congestion charging scheme includes discounted travel for commuters with Community Services Cards, among other measures intended to mitigate equity effects. High prices are seen as a problem.
New Zealand’s Emissions Trading Scheme (ETS) imposes a cost on non-agricultural greenhouse gas emissions. Fear of allowing carbon prices to rise has brought a host of proposed regulatory interventions that increase the cost of reaching net zero without reducing net emissions.
Bans on fossil-fuel industrial heating, bans on petrol vehicle imports, and bans on new home gas connections cannot reduce net emissions. They only result in carbon credits being available for someone else to purchase instead. The price of emission credits in the ETS is then lower, but the cost of reaching net zero is higher.
In both cases, distorting prices and increasing overall costs are proposed to help avoid visible rising costs for poorer households.
But careful use of the revenues collected by both systems could solve the political problems each faces, while ensuring that both systems work well.
Government should not interfere with prices to remedy equity concerns. The principle is so basic that it forms the core of university-level welfare economics.
The first fundamental theorem of welfare economics shows that, when markets work well, prices lead to efficient outcomes. Efficiency here simply means that nobody can be made better off without hurting someone else by even more.
But there are many potential outcomes that are efficient.
The second fundamental theorem says that if your view of equity prefers one efficient outcome to another, government simply needs to provide the right sort of redistribution – finding the least bad ways of getting money from those with more of it to those with less.
Doing that well solves the equity issue, without breaking the price system. That matters because while many potential outcomes are efficient, vastly more outcomes are not. Putting a thumb on prices, because of equity considerations, risks leaving everyone worse off. And there are far better alternatives.
Congestion charging and carbon charging both collect pots of money. Auckland’s proposed congestion charge would tax peak-time commuters. The Government would collect the resulting revenue. The Government sells emission credits into the ETS, also generating revenue.
If the Government could simply set the congestion charges that let traffic flow, and let rising carbon prices with a declining ETS cap do the heavy lifting towards net zero, the revenues from both schemes could help improve the tax system.
Most taxes cause distortions. Congestion and carbon charges instead eliminate distortions. They would be base-broadening measures that could allow some worse taxes to be cut while providing room for some additional spending.
In the real world, fear of high carbon or congestion charges hitting poorer households means politics gets in the way. The equity concerns are real, although in the case of congestion charges, they are rather more debatable.
But there is a better solution than interfering with the ETS, or skewing congestion prices.
In both cases, collected revenues could fund a dividend that would be returned to households.
Budget 2021 announced the ring-fencing of government ETS revenues from next year, rather than continuing to put them into general revenues. While the Government has not announced what it will do with those revenues, it could provide every household with a carbon dividend.
Dividend payments would wind up being progressive, as richer people spend more on everything and carbon is in everything. Rising ETS prices would then mean a higher carbon dividend.
Similarly, congestion charge revenues, net of the amount required to run the system, could be rebated back to households. There are lots of different ways of designing that kind of scheme. Dividend payments could be higher for families with Community Services Cards. So long as the scheme does not pay people more if they drive more at rush hour, it will mitigate equity issues without breaking the system.
Carbon and congestion dividends would reverse the politics of higher carbon and congestion charges. Rather than causing political pressure that risks breaking the systems, rising prices would help embed both.
The politics of congestion and carbon charging do not have to break either system. But solving the political problem requires using the revenues carefully.