Federal payout to steel plant exposes carbon tax flaw

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Appeared in the Ottawa Sun, Aug 4, 2021
Federal payout to steel plant exposes carbon tax flaw

Prime Minister Trudeau recently announced a federal grant of up $420 million to Algoma Steel to help the company shift from coal-fired processes to an “electric-arc” furnace technique. Although Trudeau praised the measure as the equivalent of removing 900,000 passenger vehicles from the road, it actually showcases the problems with the political approach to fighting climate change. The whole point of a carbon tax is to remove politics from the equation, so the “price on carbon” lets market participants decide where to cut emissions. By having to pay stiff carbon taxes and finance millions in subsidies to particular companies, the average Canadian taxpayer is getting hit with the worst of both worlds.

The standard economic case for a carbon tax treats greenhouse gas emissions as a “negative externality,” similar to conventional air pollution. According to this textbook theory, when businesses or consumers engage in activities that shower harms on third parties, they end up engaging in more of the activity than is socially optimal. The profit-and-loss system only works to coordinate behaviour when market prices communicate all relevant information, and in the case of negative externalities, people aren’t getting the full feedback on how they affect the rest of humanity.

Because of this, so the argument goes, the government can step in and levy a “price on carbon”—in the form of a carbon tax or a cap-and-trade program—to cause the relevant players to “internalize the externality” and take full account of the consequences of their actions.

The reason so many economists favour a carbon tax over direct “command and control” environmental regulation is that it relies on localized knowledge of market participants to cut emissions in the cheapest way possible. The current federal carbon tax of $40 per tonne, for example, gives businesses an incentive to change their operations to eliminate any unit of emissions that, on the margin, doesn’t boost their revenue by more than $40. Businesses will still end up emitting some carbon dioxide, of course, but only after they review their operations and cut where they can in the cheapest possible way.

In contrast, if a few experts working for the federal government try to dictate the specific operations that need to be changed, it will force the whole system to rely on the limited knowledge of a handful of people. Moreover, the incentives won’t be the same, as federal officials don’t worry about a company’s profitability as much as its shareholders do.

Yet this textbook rationale for a carbon tax is defeated if the government goes ahead and picks winners and losers anyway. By using tax dollars to induce a particular company to reduce its emissions in a particular way, the Trudeau government is raising the cost of achieving its climate goals. Moreover, it will simply invite other companies to apply for their subsidies as well.

When the Canadian government first introduced a carbon tax, some economists—including me—explicitly warned it would not live up to promises. All of the alleged “efficiency” and cost-effectiveness of a carbon tax would go out the window if it were combined with other measures for the government to spend money and pass regulations to directly influence emissions. Unfortunately, Prime Minister Trudeau’s recent decision regarding Algoma Steel has justified our warnings.