Carbon Dating Politics

When new laws seemingly have the potential to impact economies in the longer term, it is often tempting to make portfolio changes in the here and now. But that’s often a shortsighted approach. Legislation can and frequently does change, which can mitigate the market impact—an important, often overlooked consideration for investors.

For example, consider Australia’s carbon tax. In November 2011, then-Prime Minister Julia Gillard’s government passed a law requiring the biggest carbon emitters pay A$23 for every ton of carbon emitted from July 2012 through 2015. At that point, a cap and trade system—similar to Europe's—would supersede the tax scheme. The tax was rather unpopular—consumers knew the costs would be passed to them, and government promises to offset the extra burden with tax cuts were cold comfort—and it threatened to impede Aussie businesses. When the Mineral Resources Rent Tax (MRRT) took effect shortly thereafter, to many, Australia seemed an increasingly unattractive place to do business.

It likely also seemed a not-so-great place to invest—higher industry taxes can ding earnings. But Australian stocks have had a pretty good run since the tax was passed. Simply basing investment decisions solely on possible unintended consequences isn’t the right move. Markets move on probabilities, and in the case of legislation, the probability of laws getting implemented as planned over time is key. Laws are ever-changing—politicians can amend or repeal them as easily as they can pass them. What’s key is the likelihood of this happening before a law’s unintended consequences are felt.

And this is what seems to be happening now in Australia. Gillard’s now out—largely because the carbon and mining taxes killed her popularity. New PM Kevin Rudd, who ousted Gillard last month, announced his government will abandon the carbon tax and adopt cap and trade a year earlier than planned. So starting in July 2014, carbon payments will drop from about A$24 to about A$6 per ton. This still leaves some headwinds for Australian businesses and consumers, but at a much less burdensome rate. And it could get even easier, considering opposition leader Tony Abbott, whose Liberal Party is polling well ahead of Rudd’s Labor party, has pledged to repeal the scheme entirely (along with the mining tax) if he wins August’s general election.

This is only one example of seemingly economically onerous legislation getting watered down over time. Happens all the time! Legislators are politicians, after all, and the desire to win voters usually wins out in the end—and voters prefer laws that don’t take a bite out of their wallets. So politicians often moderate. They delay implementation dates, giving them plenty of time to revise the law to mitigate the side effects, or they repeal it. In little more than one year, one Aussie PM implemented a carbon tax, another PM watered it down, and still another could kill the tax entirely. Sometimes a law’s biggest proponents drive the U-turn—Rudd famously called climate change “the greatest moral, environmental and economic challenge of our age” in 2007. It’s not unlike President Obama’s recent backtracking on the healthcare law that colloquially bears his name. The more the Affordable Care Act’s potential unintended consequences become widely known, the more incentive he and Congress have to delay key provisions, scale it back and, potentially, repeal it entirely. This is a big reason why markets took its 2010 passage in stride—stocks are forward-looking, and they understand the likelihood politicians moderate.

Politics are big market drivers—and key to that is what happens to laws after they’re passed. So don’t just react to legislation. Remember, politicians often concede some middle ground to obtain their goals and consider the likelihood of laws losing teeth.