The Weekly JMP Report

The benefits of a carbon tax

Vinod Thomas, Ed Araral

Pricing the carbon content of domestic production and imports will help cut effluents

With China, the largest carbon dioxide emitter, announcing that it would balance out its carbon emissions with measures to offset them before 2060, the spotlight is now on the U.S. and India, countries that rank second and third in emissions. One way to cut effluents while earning revenues is to price the carbon content of domestic production and imports, be it energy or transport. With the International Monetary Fund endorsing the European Union’s plan to impose carbon levies on imports, India can be among the first movers in the developing world in taxing and switching from carbon-intensive fuels (like coal), the main sources of climate change.

Record heat waves in Delhi, floods in southwest China, and catastrophic forest fires in California this year are indicative of the existential danger from global warming. India ranks fifth in the Global Climate Risk Index 2020. Between 1998 and 2017, disaster-hit countries reported $2.9 trillion in direct economic losses, with 77% resulting from climate change, according to a United Nations report. The U.S. faced the highest losses, followed by China, Japan, and India.

A case for a differential global carbon tax

Air pollution has fallen worldwide after the COVID-19 outbreak, including in India. But with resumption of polluting activities, emissions in India are set to rise sharply unless strong action is taken. Carbon dioxide, the chief culprit in global warming, was 414 parts per million in August 2020 because of past accumulation. As one half comes from the three top carbon emitters, they need to drive de-carbonisation.

Stronger action

India has committed to 40% of electricity capacity being from non-fossil fuels by 2030, and lowering the ratio of emissions to GDP by one-third from 2005 levels. It is in the country’s interest to take stronger action before 2030, leading to no net carbon increase by 2050. A smart approach is pricing carbon, building on the small steps taken thus far, such as plans by some 40 large companies to price carbon, government incentives for electric vehicles, and an environmental tax in the 2020-21 budget.

One way to price carbon is through emission trading, i.e., setting a maximum amount of allowable effluents from industries, and permitting those with low emissions to sell their extra space. Pilot projects on carbon trading in China have shown success. There is valuable experience in the EU, and some American states — for example, the regional greenhouse gas initiative in the U.S. northeast. Another way is to put a carbon tax on economic activities — for example, on the use of fossil fuels like coal, as done in Canada and Sweden. Canada imposed a carbon tax at $20 per tonne of CO2 emissions in 2019, eventually rising to $50 per tonne. This is estimated to reduce greenhouse gas pollution by between 80 and 90 million tonnes by 2022. The fiscal gains from pricing carbon can be sizeable. A carbon tax at $35 per tonne of CO2 emissions in India is estimated to be capable of generating some 2% of GDP through 2030. An internally recommended carbon price of $40 per metric tonne in China could generate 14% additional revenues.

Putting a global price on carbon

Imposing a carbon tariff

Big economies like India should also use their global monopsony, or the power of a large buyer in international trade, to impose a carbon tariff as envisaged by the EU. Focusing on trade is vital because reducing the domestic carbon content of production alone would not avert the harm if imports remain carbon-intensive. Therefore, leading emitters should use their monopsony, diplomacy and financial capabilities to forge a climate coalition with partners.

India is among the nations that are hardest hit by climate impacts. There is growing public support for climate action, but we need solutions that are seen to be in India’s interest. A market-oriented approach to tax and trade carbon domestically and to induce similar action by others through international trade and diplomacy offers a way forward.

Ed Araral is Associate Professor and Director, and Vinod Thomas is Visiting Professor, at the Lee Kuan Yew School of Public Policy, National University of Singapore

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An article you may find interesting from the latest ASX Update;

What SMSFs (small to medium superannuation funds) are buying

Gemma Dale

Higher portfolio allocation to the materials sector a feature in 2021

Self-managed superannuation funds (SMSFs) have been growing less quickly in recent years, but still represent more than 1.1 million Australians and a quarter of all superannuation assets.

As individuals managing their own retirement savings, SMSFs give an excellent insight into how Australians, particularly retirees and pre-retirees, choose to invest. At nabtrade, we get to see people’s retirement investment choices in real-time.

According to the Australian Tax Office’s SMSF statistical report, allocations to cash and term deposits in SMSF have remained stable over the last five years, now representing around 20% of total assets. This has been as high as 30% in the past, reflecting trustees turning away from secure assets to seek yield as interest rates hover near zero.

Total listed share investments have increased by 21% and listed trusts have increased by 90%, however direct shares still account for over 26% of total assets, while listed trusts are just 6%. The combination of listed assets has been as high as 40% in the last decade, but market falls due to COVID-19 have reduced this to just 32%.

At nabtrade, SMSFs represent less than 10% of our total accounts, but more than 30% of trading volumes, assets held, and cash. SMSF customers are generally older and much wealthier than the average nabtrade customer; many have personal accounts as well as their SMSF.

They’re also generally well informed about shares and place larger, higher-conviction trades when they invest.

How SMSF share portfolios have changed in 12 months

Firstly, cash balances have continued to grow over 2020, despite record low interest rates. But the growth of these balances has slowed. SMSF cash balances grew well above 10% per annum leading up to 2020; they only grew by 9% last year.

This growth in cash usually reflects a conservative mood among trustees; they will save rather than reinvest dividends and start taking profits if they believe the share market is due for a pullback, and switch from buying equities to holding or selling, keeping the proceeds in cash as they wait for a buying opportunity.

2020 provided the buying opportunity nabtrade SMSF trustees were waiting for – they switched aggressively from selling to buying shares, and poured hundreds of millions of dollars into the share market.

Despite this, they still managed to grow their cash balances, bringing in cash from other sources. Many SMSF are clearly keeping their powder dry, expecting a pullback after the market’s astonishing strength post-COVID-19.

The real shift is at the sector level. Financials have always comprised the bulk of the average SMSF portfolio, as retirees enjoyed the strong yields provided by the big four banks.

Despite the enthusiastic buying of the banks during the depths of the COVID-19 crisis, SMSF allocations to financials have dropped 4% over a single year (to the end of February 2021).

Almost all of this decline has been picked up in materials, which have climbed from less than 13% of the average portfolio to 17%. 

Nabtrade investors, particularly SMSFs, are known to take profits from strong performers, but there has been no sign of this in the materials sector.

BHP Group (ASX: BHP) is a great example, with almost no selling during 2020; it has now risen from the 6^th most popular stock among SMSFs, to the 3rd. Fortescue Metals Group (ASX: FMG) has risen from 16^th to 10^th.

One unique characteristic of SMSFs is their preference for traditional managed investments, albeit listed or quoted ones.

An ASX200 Exchange Traded Fund (ETF) – the Vanguard Australian Shares Index ETF (ASX: VAS) – Australian Foundation Investment Company (ASX: AFI) and Argo Investments (ASX: ARG) are all in the top 20 investments and have remained relatively constant.

Performance drags

What has hurt performance? The recent weakness in CSL (ASX: CSL) has seen it drop from 4^th to 6^th, despite huge buying from all nabtrade investors as the price has fallen back to its COVID-19 lows.

Also, the entire energy sector, of which AGL Energy (ASX: AGL), Woodside Petroleum (ASX: WPL) and Santos (ASX: STO) are in the top 20, has been a significant drag (although the sector allocation is still roughly the same, suggesting investors bought more during COVID-19).

SMSF positioning for 2021

Portfolios appear more balanced than previous years, with a higher allocation to materials (in which they were very underweight) and a lower allocation to financials, while healthcare has a greater allocation with buying in CSL and Cochlear (ASX: COH) joining the top 20 stocks.

The top 20 stocks comprise approximately half of all holdings, suggesting a fairly diverse average portfolio.

Eagle-eyed readers will note that some of the most popular stocks from 2020’s investor buying spree, including Afterpay (ASX: APT), Zip Co (ASX: Z1P), Qantas Airways (ASX: QAN) and Flight Centre Travel Group (ASX: FLT), don’t make the top 20. Zip Co is number 24, while the travel stocks are outside the top 49.

Clearly, the “reopening trade” (stocks that benefit from border reopening, such as travel companies) has not been as popular with this more mature SMSF audience.

The full top 20 stocks, and the proportion of nabtrade SMSF investors who hold them, is below.