By Eric Crampton 01/03/2021


New Zealand has an excellent Emissions Trading Scheme covering everything except agriculture – a non-trivial exclusion, but we can come back to that later.

The ETS has a cap. Net emissions from the covered sector cannot exceed the cap. So any other regulations that affect sectors covered by the cap only shift things around within the cap and affect the ETS price. They do not affect the quantum of net emissions.

The Climate Commission has been proposing a lot of things that look a bit nuts when we recognise that the sectors they’re hitting are encompassed by the cap. The Climate Commission has been advancing what seem untenable justifications for things like banning new houses from having gas heating systems – they claim to be protecting consumers against having stranded assets when ETS prices make gas too expensive to run. Consumers aren’t idiots though – put a sticker on the gas appliances warning about the coming expected price increases and be done with it.

The more tenable justification for non-ETS measures has always been political economy. I don’t think the argument works, but here it is anyway.

If we relied solely on the cap, then prices would have to rise a lot. If prices rose a lot, there would be political backlash against prices. Consumers would be mad about high power prices, both at the petrol station and on the power bill. Industries exposed to carbon charges here higher than carbon charges elsewhere might leave. And it would be even harder to get agriculture into the ETS. Plus, if ETS prices rose anywhere near that much, people would plant a pile of trees and there would be political backlash against trees in some rural areas. Therefore, we should do a pile of things that we know will cost more than it would cost to just use the ETS, but they’re sneaky and opaque enough that they won’t let the ETS price risk to ETS-breaking levels. Except for banning tree-planting, which will absolutely make ETS prices rise by far more than they need to, but trust us – we have the model, and you don’t.

There are lots of problems with that, apart from my gratuitous snark about their secret-data modelling.*  ETS prices should be a neutral in agricultural accession into the ETS: just grant existing operators a bundle of credits to ease the transition. They’re no worse off, and they face relative prices that would encourage them to shift to lower-emitting options where possible.

But there’s another problem. The Commission leaps to third-best ways of dealing with equity considerations when first-best mechanisms are available. All the backlash – that’s because of equity issues in the burden of carbon prices. But the government auctions NZU it creates into the market. It gets money when it auctions those revenues. It could choose to implement a carbon dividend. Take all the money it collects at ETS auction, divide it five million ways, and send everybody a cheque at the end of the year.

It is an absolutely obvious move. It’s the kind of thing that’s been advocated by economists in Club Pigou for ages. Here’s George Schultz and Gary Becker arguing for a carbon dividend way back in 2013. This isn’t some new thing. This is canon for people who like carbon pricing. If Rod Carr doesn’t know about it, it would be surprising. I’d also written about it last year.

Anyway, run the carbon dividend and higher ETS prices can become a progressive tax and transfer system. While poorer people will spend higher fractions of their budgets on home heating and petrol, they will spend far less in absolute terms on ETS charges because rich people spend more on everything, and carbon is in everything.

Like, imagine that we increased GST by a percentage point, took all the money, divvied it up 5 million ways, and sent everybody a lump-sum cheque. It would absolutely be a progressive transfer because rich people spend a lot more money, and an extra 1% share of rich person’s total domestic spend will be much bigger than 1/5,000,000th share of the pool of revenues collected, and that 1/5,000,000th share will be bigger than an extra 1% share of a poorer person’s total domestic spend, right?

Similar for a carbon dividend.

But the carbon dividend can be even bigger.

Marc England at Genesis Energy has been worrying that higher ETS prices will mean higher electricity costs across the board. The marginal units of electricity come from thermal generation that include an ETS price, and that means that other generators will ramp up their offers at ETS auction and earn inframarginal rents.

Maybe. It’s possible, but it’s also very likely that higher expected returns to investment in renewables will draw more investment in renewables, unless the threat posed by the government’s contemplation of building the Lake Onslow scheme wrecks investment incentives.

But let’s take the inframarginal returns as a potential issue.

The government owns 51% of Meridian. Who’s the one that gets the biggest inframarginal return if ETS prices push up generation prices at auction because of those thermal units at the margin? It’s the giant hydroelectric guys, right?

So. If the government gets the lion’s share of any excess returns that happen to obtain if ETS prices rise faster than new generation comes onstream, it can just plug that money straight into the pool for the carbon dividend, right? The government gets a 51% share of any of those extra dividends. Use them to make the carbon dividend bigger.

Imagine that, at the standup, the Minister gets some cloying question about the terrible impact of higher power prices on poor people. The Minister could simply say, “Our government has absolutely recognised those kinds of problems. That’s why every household got a carbon dividend cheque last year of over $500 last year. The dividend more than covers most households’ increases in costs, leaving them free to decide whether to put the extra money into keeping the thermostat up, getting a start on insulating the attic, or to help cover some extra groceries. We trust Kiwis to make the decisions that are right for them, and the carbon dividend will help enable those choices.”

You can even start imagining carbon dividends end-year big enough that people start wearing “I Love The Emissions Trading Scheme” t-shirts.

High ETS prices, if you run this all properly, could help embed the ETS rather than break it.

Right now, it’s the darned Climate Commission that risks breaking the whole thing with needless “Hey, let’s ban all gas connections and gas bottles, it’s for your own good and for the climate – and by the way, you’re banned from having a ute” kinds of policies.


* On the Climate Commission’s secret data policy, I encourage you to read Auckland’s Prof of Stats Thomas Lumley. He’s the one the government turned to when they botched the census and needed people who knew what they were doing to oversee the repair work. And he also thinks the Commission should just publish its model. 

Featured image by StellrWeb on Unsplash