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The Australian government will bring in one of the world’s biggest carbon emissions trading schemes after MPs passed two bills by senators that are expected to vote into law in November.
A carbon tax is an environmental tax levied on the carbon content of fuels. A negative externality of production occurs when the production of a good or service creates external costs that are damaging to third parties. This is mainly related to the environmental problems.
Figure 1. Negative Externality of Production for Carbon Emission
Figure 1 shows if the government is not intervening and the market is determined by only supply and demand, known as free market, the marginal private costs of the firm are below the marginal social cost because there is an extra cost to society caused by pollution. Pollution includes increase in fossil fuel burning, which would release CO2 into the atmosphere and the loss of carbon sinks.
Also, it is said that CO2 emissions harm ocean’s ability to absorb carbon. The firm will only be concerned with its private costs and will produce at Q1. It is not producing at the socially efficient output, where the marginal social cost is equal to the marginal social benefit. This means that at a price of p* from figure 1 would create Q*. The community surplus is not maximized due to the effects of pollution, since it is causing a negative consequence.
One way government policies may counter the problem is to tax the firm in order to increase the firm’s private costs. The carbon tax aims to cut Australia’s emissions by 5% from year 2000 levels by the year 2020, and bring emissions down 80% by 2050. The tax requires the country’s 500 biggest polluters to pay A$23 per tonne for their carbon emissions.
Figure 2: Taxing a Negative Externality of Production for Carbon Emission
Figure 2 shows when the government decided to tax that will help the economy, there is still a welfare lose, but it is less than under the free market with no government intervention. The pink color shading shows the welfare loss before the tax and the red color shading shows the welfare loss after taxing, which clearly shows it would reduce the deadweight burden, but not eliminate it completely.
It is suggested that government should counter the externality to increase welfare. In this case, stakeholders include firms, labors, and households. Firms are the increase cost, labors refer to the consideration of losing job and households refer to the price level that is rising. If government chose not to tax, the economy would most likely to run in a short term, since there is too much welfare loss. However, government chose to tax the negative externality of production, which the economy could run in long-term. The higher the government tax, the less welfare loss will result. Also, households will be compensated for rising prices due to the carbon tax.
The government concluded with the plan to turn the economy into a tradable emission permits schemes. However, this is certainly not the best choice since it doesn’t lead to the reduction of pollution once allowable limit has been set and government might not have the data of the total level of pollution and it is very difficult to measure a firm’s pollution output.
To conclude my evaluation, apply taxation added to the economy is the most suitable choice government should make. It is suggested in the article, however, not their final decision. Firms are the increase cost, labors refer to the consideration of losing job and households might consider rearranging the price level and firms should consider about increasing cost, which not a lot of people could afford. The other choices take time to plan and have to consider a lot of consequences. However, taxing is not easy as well. It could be difficult to measure accurately the pollution created, but it does help reduce the welfare loss, which already is improving.
Peter Hoeller and Markku Walli, Autumn 1991, Energy Prices, Taxes and Carbon Dioxide Emissions [online] OECD Economic Studies No. 17. Available at: <http://www.oecd.org/dataoecd/33/26/34258255.pdf>
Tom Marshall, February 3 2009, CO2 Emissions harm Ocean’s ability to absorb carbon [online] Natural Environment Research Council. Available at: <http://planetearth.nerc.ac.uk/news/story.aspx?id=311>