Tuesday, July 26, 2011

Will the carbon tax change business behaviour?

Thank you to those who emailed me about how the Australian Federal Government's proposed carbon tax would be viewed by behavioural economics. Political views aside, here's the run down;

Is a tax on emitters better than an incentive to drive behavioural change?
Absolutely.  We are more driven to avoid pain than seek gain, so in this case an incentive such as a rebate for organisations who reduce emissions (gain) would be less likely to change behaviour than the introduction of a penalty (pain).  The behavioural principle at play is loss aversion, where we are motivated to avoid a situation where we lose something.  The government is hoping to stimulate the large emitters to change their behaviour because otherwise those businesses will face significant cost.   As a more personal example, think of the following. Would you be more likely to join up to health insurance if you were paid an incentive of $400 to do so, or were taxed $400 if you did not? The proof is in the fact that in Australia we have compulsory health insurance because too few of us were taking proactive action to insure our health.

If the tax is simply passed on to consumers, is it really changing emitter behaviour?
Yes.  Whilst many businesses may adjust their pricing to pass on the cost of the carbon tax, we are all motivated by margin.  Just as with any tax, businesses will be motivated to reduce the amount payable because that helps the bottom line.   Again, it is loss aversion that motivates businesses to take steps to eliminate costs, and now emissions are part of that equation.

Can the carbon tax be used to charge higher prices?
Invariably the tax will be used to adjust pricing, and consumers will expect that. But here is the opportunity for you; by resetting expectations and having a publicly justifiable reason to change, new price levels will be anchored in the market.  Think back to when petrol was under $1 per litre.  Whilst  that now seems like a dream, as consumers we have had our expectations reframed and have been able to adapt to the new pricing levels. What about bananas? With supply of bananas contracting after Cyclone Yasi and the Queensland Floods, prices have skyrocketed ($13/kg in Melbourne). Whilst not everyone can afford to buy bananas now, once supply returns you can be sure that the normal average cost per kilo will be higher than it was before expectations were anchored at the higher price.

A side note on price anchoring. The federal Opposition and the Greens both played a role in helping the Government gain psychological acceptance of the carbon price of $23 per tonne. How? The Greens had asked for a $40/tonne price and the Opposition had jumped on Treasury modelling at $30/tonne.  This meant that by the time $23/tonne was determined, it hardly raised a whimper.

So in sum, the carbon tax will change the behaviour of businesses, but so too would any new impost.  No surprise that it will force businesses to look for new ways to reduce cost and improve margin, but it just so happens that this may help the planet in the process.

As always, let me know if you have an issue on which you would like a behavioural economics perspective. Email peoplepatterns@gmail.com or tweet @peoplepatterns. Until next time, happy taxing.

This post also appeared in http://www.smartcompany.com.au/blogs/20110726-will-the-carbon-tax-change-business-behaviour.html

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