Climate change: trading in deforestation

National and the Kyoto Forestry Association are trying to beat up the proposal in December's Sustainable Land Management and Climate Change discussion document for a flat deforestation levy into a "retrospective tax" in an effort to discredit the government's policy and obtain windfall gains for the forestry industry. In response, the government has finally made explicit its preference for a tradable permits regime for deforestation. A full discussion document will apparently be released next week - well before the 30 March deadline for submissions on the main document.

But cynicism about government "consultation" aside, how would such a scheme work? The idea is the same as emissions trading: the government would issue a certain number of permits, and forest owners would be required to surrender permits when they cut down their trees. While the permits could be initially auctioned or grandparented, the ability of forest owners to trade permits among themselves means that the ultimate price of deforestation would be set by the market. Forest owners cutting down trees without surrendering permits would be subjected to large fines.

The general effect of such a scheme is summarised succinctly in the press release: it would "provide a small financial gain for those wanting to stay in forestry, while those planning to change their land use would begin to start paying some of the real costs". How much gain and how much cost would depend on the supply and demand of permits, and therefore ultimately on the cap. However, from previous government documents, we know what that cap will be set at: 21.5 million tons of CO₂, or around 27,000 hectares of net deforestation.

Interesting features of such a scheme:

• The effect of such a system is theoretically exactly the same as that of a tax designed to produce the same outcome. Trading systems simply transfer the work of getting the price right from the government to the market.
• The government is likely to apply it only to pre-1990 forests. But as far as emissions are concerned, a tree is a tree is a tree. The system should be universal.
• The cap is effectively a subsidy to the New Zealand forestry industry of (currently) NZ$300 million over five years. That's how much it will cost to buy credits to cover those deforestation emissions on the international market.
• This bogs us down again in the same old arguments about allocation mechanisms, and a flat liability would be simpler. However, there are definite political advantages to such a scheme - firstly, that it takes the government out of the firing line (they're creating a market, not imposing a tax); and secondly, that it creates vested interests who will then turn around and fight to protect their newly-created property rights, thus making the policy more likely to survive.
• If the permits are denominated in carbon dioxide, there's an obvious possibility for it to turn into a de-facto offset market, which the government would be foolish to ignore. A hectare of trees is about 800 tons of CO₂. An electricity generator buying permits but not cutting down any trees could justly claim that they were reducing New Zealand's emissions by that amount. This possibility makes the question of allocation particularly fraught, as the permits may represent a cash windfall for forest owners, while an auction could see too many permits acquired by the electricity industry.
• The system could allow the importation of Kyoto credits to allow additional deforestation.

As policies go, I think it is workable, and can easily be linked up with the other markets the government is creating to form a full emissions trading system post-2012. My main concern is time. We needed this system yesterday, but it will likely take another year before it is in place (time for another round of public consultation, and some time to get the required law through Parliament). A flat deforestation charge could be implemented much faster. However, it will be much easier to implement than a flat charge, so it is probably the best course of action.