Monday, 25 February 2019

Greenhouse gas recommendations from the Government’s Tax Working Group

by Catherine Leining, Policy Fellow at Motu Economic and Public Policy Research

On 21 February 2019, the Government’s Tax Working Group (TWG) issued a report with advice on using environmental taxes to manage greenhouse gas emissions. It recommended retaining the New Zealand Emissions Trading Scheme (NZ ETS) with reforms to provide greater guidance on price, generate revenue through auctioning, and enable periodic review. It also recommended extending emission pricing to biological emissions from the agriculture sector, whether through the NZ ETS or a complementary system. It suggested those changes can help drive behaviour change to reduce emissions, generate revenue supporting the transition to a more sustainable economy, and, in the longer term, broaden the overall tax base.

New Zealand is facing a challenging low-emission transition and effective emission pricing needs to be part of the solution, alongside other regulations, policies and measures. It is positive the TGW recognises the merits of reforming rather than replacing the NZ ETS.

As discussed further in a Motu paper, three practical design changes would enable the NZ ETS to send clear price signals for efficient low-emission investment: introducing auctioning under a cap which limits domestic emissions, adding mechanisms that guard against unacceptable price extremes in both directions, and applying both quality and quantity limits to purchasing of international emission reductions. Intended changes along these lines were announced by the government in December 2018. Extending emission pricing to biological emissions, whether through the NZ ETS or other means, would help New Zealand to distribute mitigation effort and opportunities across sectors and enable more coherent price signals to guide land-use decisions. 

The TWG does not stray into the territory of recommending how ambitious domestic emission prices should be or assessing the potential fiscal effects from government purchase of international emission reductions to increase the volume of auctioning. While the TWG notes that accelerating the phase-out of free allocation would generate more auction revenue, it does not prescribe any conditions or rate for phase-out. This is an area for careful consideration as the potential risk and cost of emissions leakage overseas can be expected to decline under the Paris Agreement. 

The TWG’s estimates for NZ ETS revenue range from $130 to $830 million per year on average over 2021-2030, based on emission prices rising from $20 per tonne in 2021 to $50 per tonne in 2030. These scenarios align with the government’s current carbon budget projections. This implies they leave a target deficit of 203 million tonnes of carbon dioxide equivalent to be achieved through domestic emission reductions, net forestry removals and purchasing of international emission reductions. The TWG notes that auction revenues would increase under higher target-consistent emission prices (e.g. up to $80 per tonne by 2030 as indicated in modelling applied by the Productivity Commission). In the long term, auction revenues will change in line with both higher emission prices and lower emissions under steeper targets.

Building from the TWG’s recommendations, more work is needed on how the substantial revenue stream to be generated by the NZ ETS can be returned effectively to the economy in order to manage distributional effects from rising emission prices and support a smooth low-emission transition. More work is also needed on potential interactions between the NZ ETS, other environmental taxes (e.g. addressing waste, transport or water quality), and regulations. Above all, maintaining cross-party support for long-term policy continuity on the operation of the NZ ETS will be essential for sustaining confidence and investment by market participants as well as buy-in from the general public.

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