Carbon Tax

Apr 162014

Market Based InstrumentsIn a previous post I explained that the Carbon Price is not a Carbon Tax. That it was an Effluent Charge with a Tax Differential component. Regardless of this, they are all examples of Market Based Instruments. What they are is actually known as Price Based Market Based Instruments or just Price Based Instruments. There are generally three kinds of Market Based Instruments: Price Based Instruments, Quantity Based Instruments (or Rights Based Instruments) and Information Based Instruments.

You may have heard the Minister for the Environment explain that they will replace the “Carbon Tax” with a market based mechanism, insinuating that the Carbon Price is not a market based instrument. He is quite wrong; my master’s thesis was entitled ‘Market Based Instruments for Reducing Pollution Loads Entering Darwin Harbour’ and I will explain in basic terms what these actually are.

Price Based Instruments

Market based instruments that set a price, a charge or a fixed unit cost are known as Price Based Instruments. As previously discussed, Price Based Instruments might include policy mechanisms and instruments such as effluent charges and taxes. But they may also include:

Full Cost Pricing (and include different pricing structures)

Tax Rebates and Tax Differentiation

Insurance Premium Charges

Reverse Deposit Schemes (Container Deposit Schemes)

Subsidies, Rebates and Grants

User Charges

Performance Bonds


These are what is known as Pigouvian Taxes. And I think the term Pigouvian Tax is where a lot of the confusion has entered the debate. However, all this term means is that the polluter absorbs the full cost of the production (or consumption) process. How this is done most efficiently and effectively is to be determined by the policy maker, and will be the subject of a later post. How price based instruments act as a market based instrument will also be discussed at a later stage, because it isn’t necessarily intuitively apparent – which is partly the problem that gives rise to comments and purchase in the population that pricing is not a market mechanism.

Quantity and Rights-Based Instruments

Quantity and rights-based Market Based Instruments are what most people think about when they think of ‘Market Based Instruments’. There really only a few types of instruments in this category and it is probably the narrowest policy set for Market Based Instruments. There really are only two types of Market Based Instruments in this category:

Cap and Trade Schemes, Permits and Tradeable Permits

Total Maximum Daily Load Schemes (including accounting and budgeting schemes)

These Market Based Instruments contain a strong regulatory basis as well as frequent market transactions. Offsets can be created and in this sense they operate both as a futures exchange and also a quasi options exchange, with regulatory bodies acting as market-makers. The exchange’s effectiveness is successful or not successful depending on the interaction of these elements.

Theoretically, such Market Based Instruments are most suited to environmental policies where there are a large number of diffuse polluters, and the impacts of pollution are not isolated. That is, a reduction in pollution in one area will benefit the whole, not just the local environment. I will discuss this dynamic at a later date. But in short, it is why Australia’s carbon pollution reduction policies have favoured a cap and trade scheme.

Information-Based Market Based Instruments

Information based Market Based Instruments are also known in the literature as Friction Reduction Schemes, or Friction Reduction Market Based Instruments.

You may ask why these are included as Market Based Instruments. The simple answer is that markets function on the basis of information. There are two things that move a market – noise, and information. Companies listed on stock exchanges are regularly releasing information. It is a legal requirement. There is legal recourse for some buyers when they have been sold something under false pretences in many different kinds of transactions.

These Market Based Instruments are said to reduce friction because they are designed to provide the user or the transacting parties with the available information. Available information is an important component of rational choice making in decision theory in classical economics, and I have some level of qualms with this philosophical position. But for the purposes of policy making, it is at least a worthy aspiring goal for policy.

Information based Market Based Instruments include:

Right to Know legislation


Public Information Campaigns



I hope that I have had some success in helping shed light on what actually Market Based Instruments actually are in environmental policy. There is a broad range of policy options at the hands of decision makers. The pros and cons of each and in what circumstances each market based instrument is likely to be effective will be discussed over time in this blog. But don’t be fooled by politicians and their use of jargon when discussing Market Based Instruments and the underlying philosophy for addressing environmental problems.

If you have any questions or queries, leave a comment, or suggestion. Or if you want me to go over anything in detail, let me know!

Mar 112014

Carbon Tax/ Price ModelUnless you’ve been living under a rock it has been impossible not to hear of the “Carbon Tax” debate in Australian politics. Given my knowledge of market-based instruments for environmental purposes, I feel compelled to explain many of the issues that confound the Australian public. If you require further detail, you can consult my thesis on the topic.

This post is the first in a series of posts explaining why the “carbon tax” is actually good policy and a different mechanism to what most pundits and voters think it is.


What is a Tax?

A tax is an enforced and unavoidable contribution to an authority.

Income tax for example (unless illegally manipulated) is a fixed contribution, or equivalent to, as a rate of money earned. $100,000 will be taxed the same (accounting for adjustments) as any other $100,000 earned from any other work. The tax is collected regardless of the outcomes of your work or the manner in which your work is done.

Tax revenue is consolidated into a revenue pool and is not set aside for specific purposes or programmes, such as 3rd party insurance.

For environmental purposes, a tax is usually applied to inputs. For example, fertiliser taxes apply a charge as a rate of a specific active ingredient. The resultant outputs and impacts of the fertiliser use are irrelevant to the way the tax is charged and collected.

Environmental taxes apply to what would be considered as the front end rather than to the emissions – or the back end. For this reason, an environmental tax is a blunt instrument and isn’t regarded as an effective policy choice for improved environmental outcomes due to the lack of consideration of outputs, limited influence on changing behaviour and or negative environmental impacts – known as externalities.

However, the “Carbon Tax” does not work in this manner and it has been shown to influence behaviour.


The “Carbon Tax”

Under the Clean Energy Plan the “Carbon Price” or the “Carbon Tax” was set.

This is where the confusion is allowed to reign supreme. The carbon price is a direct pricing instrument (more about this later, or see my thesis). Under which, by definition it is what is known as an Emissions Charge, or an effluent charge.

An emissions charge is a direct pricing mechanism for the outputs – the emissions. Not on the inputs. Not on the coal going to power stations, but on the estimated or measured emissions.

If we refer to the previous example regarding income and income tax, we can use the example of electricity generation to show the difference in how the Carbon Price works. The energy output is equivalent to income earned. And the CO2 emissions are equivalent to the work performed. The price is levied against the work performed – not on energy output.

The charge will vary depending upon the work performed, regardless of energy output. In this way it is avoidable.

And that’s how polluter behaviour is changed. Input choices are left to the polluter; however, it is the outputs and the emissions that are the important component and that which is assessed. So polluters can either reduce their emissions by changing the inputs, or end of pipe emissions reductions. That decision can be based on what achieves the most cost effective outcome, and at the same time, achieving an improved environmental outcome.

The revenue generated from the carbon price, or emissions charge, is recycled to compound emissions reductions. In Australia this is going to various grant schemes, offsets and renewable energy initiatives. It is designed to be an encapsulated system that will continually reduce carbon emissions.

Income tax reduction (tax differentiation) with the estimated revenue generated is directed to those who have a relatively inelastic demand for electricity consumption. I will write about this at another point. But there are multiple elements to the carbon price as a policy and as a mechanism.


What does it mean?

When broken down, and the topic is discussed with correct terminology, the rationale behind the carbon price becomes a lot clearer and the mechanism behind changing behaviour makes much more sense. What people think of as a Carbon Tax is actually at this time a hybrid Emissions Charge and Tax Differentiation Scheme.

I’m not sure why the debate was allowed to be manipulated without an actual understanding of the underlying mechanisms at work. Granted, they appear to be quite complicated policy instruments. But they are not at a fundamental level.

It is similar to the way car registration operates, but not how income tax is collected. It is another failure of our political leaders to get to grips with policy explanation and education of the public in the process, because these mechanisms are not foreign to us.


But now that you are with me, and over the first hurdle, we can progress further into other areas of the policy.