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Carbon pricing: Prospects and protests

February 11, 2019

6-minute read

The federal government’s plan to put a price on carbon is set to be a top issue heading into October’s federal election. The carbon pricing backstop—which lets provinces and territories implement their own plans but imposes a minimum carbon tax on those who do not—has drawn the ire of provincial governments in Ontario, Manitoba, Saskatchewan and New Brunswick.

Carbon pricing has become something of an obsession—to a degree unseen in any other area of public policy. Advocates—including most of Canada’s environmental groups and many policy analysts and academics—have made it the litmus test of the credibility of a government’s climate plan. A price on carbon, no matter how small, is widely applauded for its efficient, market-friendly approach to reducing emissions.

Here’s the problem: existing and near-term carbon taxes are too small to have much impact, while higher carbon prices that would actually make a dent in behaviour seem to be political non-starters. Even if there was no provincial opposition to the federal carbon pricing plan, Canada would still miss its greenhouse gas (GHG) reduction targets by a wide margin.

To solve this conundrum, we need to do two things: first, bring notions of equity and fairness back into the conversation; and second, back off a narrow carbon pricing approach and reconsider more politically acceptable regulations, marketplace standards and public investments.

How did we get here?

The intuition for carbon pricing is that the pollution associated with producing goods and services causes damages that are not reflected in the sale price. In the jargon of economics, pollution is an external cost of production, or “externality.” Carbon pricing aims to “internalize the externality” by adding a tax or fee to reflect those costs. In doing so, the theory goes, prices more fully reflect the real costs of production, products will be more expensive, and markets will allocate resources more efficiently.

Getting from the textbook ideal to the real world, however, is more challenging. Putting a dollar value on such damages is tricky. What’s the value of a lost species? How do you translate adverse health impacts into dollars? How much damage is caused by one metre of sea level rise? Some observers scoff at the entire notion of putting dollar values on impacts that cannot inherently be measured. Those who attempt to make estimates are often restricted to measuring impacts in terms of use-value to humans.

Thus, we have no idea how high a carbon tax should be to “internalize the externality.” Since we don’t want to shock households and businesses with a sudden spike in prices, the policy answer has been to start with a small tax and then increase it annually.

Where fairness comes into play is that carbon taxes are regressive, meaning low-income households pay a greater share of their income to the tax than higher-income households. To address this regressive impact, a central design issue is to ensure a share of carbon tax revenues flows back to low- to moderate-income households in the form of credit.

In addition, most households have relatively little ability, due to structural issues, to change their behaviour in the short-run. We live in a society structured around the use of fossil fuels—there are limits to how much we can realistically change, on our own, in our everyday lives. We might be able to control how much we drive (depending on the availability of public transit and how far we live from our place of work) or whether to turn down the thermostat (depending on where we live and how well-insulated our home is). Over a longer period of time, consumers make decisions about what type of car they will buy or what furnace they will install—but at the time a carbon tax is imposed they will feel burdened, particularly if there are no readily available alternatives.

Carbon tax proponents also tend to ignore another “price on carbon” in the form of fuel taxes. From a consumer perspective, fuel taxes amount to the same thing and they are larger than the fully phased-in $50 per tonne carbon price backstop. They range from 13 cents per litre of gas in Alberta to 19.2 cents per litre in Quebec (in carbon terms, $55 to $82 per tonne of CO2) at the provincial level, and another 10 cents per litre at the federal level ($43 per tonne of CO2). Some urban areas like Metro Vancouver have an additional regional fuel tax (17 cents per litre or $72 per tonne of CO2).

Lessons from carbon pricing in BC

These issues around fairness and effectiveness have played out for more than a decade in British Columbia, North America’s poster child for carbon pricing. BC’s first phase of carbon pricing occurred between 2008 and 2012 under the BC Liberals, led by Gordon Campbell, and is now in a second phase under an BC NDP minority government (backed by the BC Greens) in conjunction with the federal carbon pricing plan.

BC’s carbon tax started out at $10 per tonne of CO2 emitted in July 2008 (2.3 cents per litre at the pump), and then rose to $30 per tonne as of July 2012 (7 cents per litre). The carbon tax featured prominently in the 2009 election, won by the BC Liberals in spite of a very negative “axe the tax” campaign from the opposition BC NDP. The BC Liberals later abandoned carbon pricing increases when the tax hit $30 per tonne in 2012, and sidelined climate action altogether in favour of doubling down of fossil fuels by developing a liquefied natural gas (LNG) industry.

BC’s current government increased the carbon tax modestly in 2018 to $35 per tonne, with three more annual ($5) increases scheduled. These increases put BC only slightly ahead of the federal carbon price backstop, which will be $50 per tonne (11.6 cents per litre) in 2022.

On the other hand, low levels of a carbon tax still generate a lot of revenue. At $35 per tonne, BC’s carbon tax will pull in just shy of $1.5 billion in 2018/19. The potential of that revenue stream to fund climate action investments is significant, and may be more important than the “price signal” of the tax itself. Such revenues can also be used to compensate low- to moderate-income households to make the system more fair.

Instead, the previous government’s policy was “revenue neutrality,” with carbon tax revenue largely used to pay for corporate income tax cuts, plus smaller amounts to personal income tax cuts and a low-income climate action credit. Endorsed by economists, revenue neutrality was supposed to make the carbon tax more palatable to the public but for most households it is counter-intuitive. People may not like paying taxes, but when they do, they want to see results for their money.

Importantly, the current BC government broke with the policy of revenue neutrality and has also increased the amount of the low-income credit. These are positive developments to improve the fairness of BC’s carbon tax regime.

Households vs industry

Another challenge with carbon pricing in practice is that it tends to predominantly fall on households, not industry. Industrial emissions comprise the lion’s share of emissions in Canada, but carbon pricing for industry has been watered down due to concerns about “competitiveness.”

For large industrial emitters the federal government will only be charging a carbon price on the portion of their emissions above an “output-based emissions limit” (details here). And companies will also be able to buy credits from companies that beat their own thresholds or, much worse, use carbon offsets (which have a poor track record due to accounting tricks).

In its new CleanBC climate plan, the BC government has a slightly different take. It will rebate the incremental carbon tax paid (that above $30 per tonne) to industrial performers who meet a GHG intensity benchmark. Some of the remaining carbon tax paid by industry will be used to support clean energy investments.

The upshot: the notion of a carbon price signal rippling through the economy and making markets work better has been abandoned. Simon Fraser University energy economist Mark Jaccard—once a proponent of carbon pricing—now argues instead for flexible regulations and marketplace standards.

If you look closely, BC’s new climate plan avoids being more aggressive on carbon pricing in favour of regulations and standards, such as mandating a certain percentage of passenger vehicles be zero-emission by a certain date and introducing tighter energy efficiency regulations for new buildings (see this post).

In terms of public opinion, people seem much more willing to embrace regulations on companies rather than a visible carbon tax. While regulations may also lead to higher prices, their advantage is being hidden from view. And in hindsight such regulations usually end up being much less costly than anticipated.

What’s next?

The main takeaway from the federal-provincial skirmishes is that politics matter. The federal government’s carbon price backstop includes another form of revenue neutrality by rebating any carbon tax it collects back the originating province. Recently it has been proposed that these revenues would flow directly to households in the provinces that do not develop their own carbon pricing plans and instead pay the federal backstop price, but it’s not clear whether this will improve the plan’s popularity.

The politics of carbon pricing from a decade ago linger today. In the 2008 federal election campaign then-Liberal leader Stephan Dion proposed a tax shift modelled on BC’s carbon tax. It failed dismally. Then-Prime Minister Stephen Harper, for his part, derided the carbon tax as a “tax on everything.” Perhaps he saw correctly where public opinion lay by calling instead for regulations on a sector-by sector basis (although his government never got around to implementing them).

Carbon pricing can be one part of the solution on climate change, but it may well be more effective to lean on regulation and standards. It would also make a big difference if revenues collected are tied to actions Canadians can see, like building new infrastructure, building transit lines or retrofitting homes. Combined with a broad-based credit to address the regressive element of the tax, this could be a winning formula for Canada.

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