Charade or effective federal carbon pricing?
The new year kicked off with pitched policy battles in Alberta and Ontario as both provinces introduced new programs to tax greenhouse gas emissions (often referred to as “carbon emissions”) in efforts to reduce those emissions.
These debates are occurring under the shadow of the federal government indicating it will intervene in 2018 and force carbon pricing on the provinces if they haven’t introduced their own programs. There is, however, a real question regarding whether or not the federal government is more interested in the appearance of doing something versus actually having a program that reduces emissions in a way that’s efficient, and minimizes economic harm.
Economists tend to agree that the most efficient way to manage unwanted emissions is by placing a price on them. That price should reflect the social costs of those emissions. By placing a price on carbon, emitting firms are incentivized to introduce emission-reducing technologies or change their production to the point where the marginal benefit of such activities equals the cost of the tax. In other words, the introduction of a price on carbon creates a market-based incentive for firms to respond to the social costs of carbon.
Critically, however, there are several key assumptions necessary for this approach to be efficient. First, the introduction of a carbon price must replace, not be in addition to, existing regulations (which are, themselves, indirect taxes). Second, revenues from carbon pricing (i.e. tax) must be used in totality to reduce other distortionary taxes such as marginal personal or business income taxes. Third, and related to assumption two, the revenues from the carbon tax should not be used to subsidize substitutes for carbon-emitting activities since the whole point of introducing the price is to allow the market to determine the optimal substitutes.
No jurisdiction in Canada, including the much-heralded British Columbia approach, meets these assumptions. No province has introduced an “ideal” carbon-pricing system and thus the benefits from the programs will necessarily be far less than the theories and academics suggest. Indeed, the approaches of Alberta and Ontario are almost textbook examples of what not to do. This is an important insight because most economists advocating for carbon pricing seem to assume away the role of politics in determining the actual design of carbon pricing. Once we introduce political reality into the equation, it’s almost impossible to arrive at a conclusion where anything approximating an efficient, economically benign carbon tax can be introduced.
Which brings us to the federal government and its pending imposition of a national carbon price. In a telling interview at the end of 2016, Prime Minister Trudeau indicated that provinces could fully rebate the proceeds from their carbon tax to industries that they may be concerned about. He specifically mentioned Saskatchewan farmers in the interview, which relates to the fact that Premier Wall has been the most vocal and articulate opponent of national carbon pricing:
…if Brad Wall is worried about the cost on “his farmers” or the cost on a particular industry, he can return to them all the money from the carbon tax.
The statement by the prime minister seems to indicate that the federal government is much more interested in the appearance of doing something to reduce carbon emissions than it is in actually having an effective program. Recall that both the federal government as well as a number of high profile task forces have called for a carbon tax to create incentives to reduce carbon emissions.
If, as the prime minister indicated, provinces can simply rebate the total value of the carbon tax to the industries that pay them, then the net effect of the carbon tax is essentially zero. Any province could establish a carbon tax while also creating a parallel rebate program that refunded the entirety of the tax. There would be no incentive effect or reduction in emissions. There would, however, be some net loss to the costs of administering such a system.
For example, Firm A’s tax liability for emissions might be $1 million. Such a cost would affect their investment and operational decisions. However, if the province simultaneously granted them a $1 million credit, meaning there was no cost to the firm, than the carbon pricing would have no effect even though there would technically be a carbon tax in place.
Accepting the prime minister’s words at face value, there should be no controversy. Premiers concerned about the clear costs to any industry with emissions—oil and gas, mining, construction, manufacturing, and farming to name just a few—could simply introduce a carbon-pricing system along with a full rebate program. Case closed.