Price signals: A carbon copy of the GST

 

One of the important if not critical reasons for the implementation of the goods and services tax in 2000 was to change the behavior of consumers and the household sector.

Unashamedly, the broadening of the tax base with the GST had an express purpose:  to discourage consumption and to raise household savings.  The overall price structure of the economy was raised by around 2.75% as the tax came in and given the usual lags and nuances around various business cycles over the past decade or so, the GST has demonstrably achieved at least that part of its objective.  Household consumption as a share of GDP is lower now than in the pre-GST days and household savings are higher.

Like the GST, the price on carbon is designed to change behavior although in a more complex way.  Demand and therefore consumption of goods and services with high carbon inputs are expected to fall.  The producers of those high intensity carbon goods and services have a massive incentive to change the was they do business – using less carbon in the production chain will save them money and boost profits.

In recent days, there has been a flood of ideas in the papers, on line, TV and radio about how we consumers can change our behavior to save money.  People want to save money on their soon-to-be-higher electricity bills by turning off lights, use more energy efficient appliances, tweaking the heater down a degree or whatever will consumer less electricity.

Hooray!  The price signals are working.

What will take longer, no doubt, is for the big polluters to change the way they do business so that they can get a competitive advance and hence higher profits before their competitors do.  They are changing already so that in years to come, they can avoid or at least minimise the cost of whatever amount of carbon they add to the atmosphere.

It will be an interesting few years to see how this supply side of the carbon price unfolds.

The bottom line of all this is that price signals work.  If price goes up, demand goes down and people also substitute.  If the cost of doing business goes up, firms change their behaviour to maintain profits and get a competitive edge.  The carbon tax or price is a text book implementation of this very basic principle.