The Treasury

Global Navigation

Personal tools

1 Introduction

In October 2002, the New Zealand Government announced its intention to introduce a charge on carbon dioxide (and fossil fuel) emissions from the year 2007. The charge forms part of the Government’s policy package on climate change designed to meet New Zealand’s greenhouse gas reduction target under the Kyoto Protocol. The charge will approximate international emissions prices, but will be capped at $25 per tonne of carbon dioxide. The aim of this paper is to analyse the price, welfare and inequality changes that may arise from the imposition of such a carbon tax.[1] The exact magnitude of the tax is still unknown. For this reason, the paper analyses three carbon tax rates of $7, $15 and $25 per tonne of carbon dioxide.

The analysis proceeds as follows. First, it is necessary to provide a link between a carbon tax (expressed in terms of tonnes of carbon dioxide) and the price changes of commodities; this depends on the carbon dioxide intensities of each good. These intensities in turn depend on the fossil fuels used in the production of each good and the nature of inter-industry transactions. Second, given the price changes, it is necessary to evaluate the effect on the welfare of households; this stage requires the use of a demand model. This paper uses the linear expenditure system, where the parameters vary between household types and total expenditure levels. Third, the overall evaluation of the carbon tax requires the calculation of inequality measures, involving an allowance for household composition.

Section 2 sets out the basic framework of analysis. Subsection 2.1 derives an expression for the carbon dioxide intensities of commodities. These intensities together with a carbon tax rate are then used to calculate the effective carbon tax rates on commodities and subseqent prices changes, expressions for which are derived in subsection 2.2.

Section 3 applies the framework to New Zealand. Subsection 3.1 describes the sources from which the data were gathered and the processes used to evaluate the expressions derived in section 2. Subsection 3.2 outlines the data and methodology used to analyse the demand responses of consumers. One problem relates to the different levels of aggregation used in the input-output and household demand analyses. The theory behind the various measures used to conduct the analysis is provided in Appendix B. The implied price and indirect tax changes for alternative carbon dioxide rates are then reported in subsection 3.3. As a partial equilibrium analysis, reductions in carbon dioxide emissions are assumed to be generated purely through consumer substitution. Hence, the possible effects of the carbon tax on the use of fuels and other intermediate inputs by industries are not modelled here.

Section 4 analyses the welfare and inequality effects arising from the three carbon tax rates. Welfare changes, measured in terms of equivalent variations, are examined for a range of household types and levels of total weekly expenditure. These welfare measures give an indication of the disproportionality of the impact at different total expenditure levels, for the household types. Overall measures of inequality are also computed for each household type and for all households combined. These use the individual as the basic unit of analysis and make use of adult equivalence scales in producing each individual’s level of ‘wellbeing’.

Conclusions are provided in section 5.


Notes

  • [1]This paper does not consider the effects of such a tax on aggregate emissions. For a review of rates needed for target emissions reductions, see Pearce (1991). See also Cornwell and Creedy (1997). On changes in emissions in Australia, see Common and Salma (1992).
Page top