Will the direct action plan work?

The current Australian government has repealed the previous government’s carbon pricing policy and proposed a direct action plan to reduce carbon emissions. According to this plan, the government will use a A$2.55 billion emissions reduction fund to pay industries for emissions reduction so as to achieve the target of a 5% emissions reduction on 2000 levels by 2020. The funding for emissions reduction is allocated through reverse auction. Using a CGE approach, this paper models this reverse auction and assesses the effectiveness of the government-funded emission reduction activity. The modelling results show that the direct action plan can reduce emissions but its effectiveness and efficiency are in doubt. Assuming that industry capacity to reduce emissions is a portion of its activity emissions base and that the emission abatement cost is the forgone profit per megatonne of emissions abated, a fund of A$2.55 billion can generate 56.597 megatonnes of carbon abatement credits, or 81% of Australia’s emission reduction obligation, but real GDP will decrease by 0.137% when labour supply is unconstrained, or by 0.276% if total employment is fixed. To achieve Australia’s obligation, the emissions reduction fund needs to be increased to A$6.117 billion. The blow-out in cost is due to the limited emissions abatement capacity of industries of low abatement cost. The involvement of industries of high abatement cost in emission reduction activities contributes considerably to the inefficiency of the direct action policy. The other sources of ineffectiveness and inefficiency may include the shortterm nature and budgetary cost of this policy, the credibility of carbon abatement credits, and the auditing and other administration costs associated with the direct action policy.