by Jean-François Wen

Our next report will explore the challenges and opportunities with different approaches to recycling revenues from carbon pricing. To better understand the trade-offs associated with each revenue recycling option, we commissioned a set of six papers authored by some of Canada’s leading policy thinkers. What are the advantages of each option? Under which conditions do they work best? Our new Revenue Recycling blog series provides a glimpse into some of these difficult questions, voiced first-hand by the authors of each paper.

Most provincial governments have faced persistent deficits and mounting debt since the recession in 2008-09. For example, the net debt-GDP ratio of Canada’s two largest and most indebted provinces, Ontario and Quebec, both increased by about 15 percentage points since 2007-08. Furthermore, the unfunded liability associated with future health care costs compounds the fiscal imbalance. Revenues from carbon pricing can help restore fiscal sustainability in Canada and reduce public debts to prudent levels.

Debt reduction as a target for carbon revenue recycling has three distinctive merits relative to other potential uses of the revenues.

First, the size of the public debt affects intergenerational equity

Public debt is an obligation that is passed from current generations to future generations. Since much of the recent run-up in debt is attributable to current spending, rather than to building up infrastructure that would generate future benefits, we owe it to future generations to now draw down the debt.

Second, the size of the public debt impacts economic performance

Servicing high debt levels may necessitate future increases in marginal tax rates, which would discourage investment and labour effort. Government borrowing also reduces national saving, resulting in less capital accumulation or greater foreign indebtedness. Each of these channels diminishes the incomes of Canadians. For example, the availability of less capital harms the productivity of Canadian workers and thereby restrains wage growth.

Third, high debt levels increase the danger of fiscal unsustainability and insolvency

These fiscal risks can disrupt the economy by precipitating a financial crisis. Debt spirals occur when rising interest rates, required by lenders as compensation for higher probabilities of default, cause a government to have to borrow even more. While the debt levels of Canadian governments are currently well below those of Greece and several other European examples that feature in the news headlines, the economic and social strains those countries are facing serve as a reminder of how intractable debt spirals can become.

Carbon pricing revenue could have a significant impact on provincial debt levels

Take the cases of Quebec and Ontario and suppose that $1 billion of additional revenues are generated by carbon pricing in each province. Quebec’s 2015 annual budget forecasts its debt-to-GDP ratio to equal 42.6 in the year 2019/20. With $1 billion in revenue recycling applied to debt reduction in each year starting in 2016/17, the debt-GDP ratio is expected to be 1 percentage point lower than it otherwise would be by 2019/20. Ontario’s annual budget reports only as far as 2017/18, when the provincial debt-GDP ratio is expected to be 39.2 percent. Again, if the additional revenues are applied to debt reduction in each year, as of 2016/17, and all non-carbon revenues and spending were to grow at the same rate as GDP in 2018/19 and 2019/20, then my calculations suggest that Ontario’s debt-GDP ratio would decline by half a percentage point by 2019/20, compared to what it would otherwise be. These would be steps in the right direction for turning the tide on the massive recent provincial debt accumulations.

About the Author

Jean-François Wen is a Professor of Economics and a Research Fellow at the School of Public Policy at the University of Calgary. He has published articles on the effects of taxation and social insurance programs on economic performance and income inequality, as well as several on provincial government debt. He is a co-author of the textbook Public Finance in Canada and has served as a consultant for the World Bank and the International Monetary Fund concerning policy reforms in various countries. Most recently, he co-authored a report on tax reform in Senegal. Professor Wen was previously a faculty member of the School of Business and Economics at Wilfrid Laurier University and an economist at the Bank of Canada. He has a Ph.D. from Queen’s University and holds the Chartered Financial Analyst (CFA) designation.

Revenue Recycling Blog Series:
1. Reducing existing taxes
2. Transferring revenue to households
3. Investing in clean technology
4. Investing in public infrastructure
5. Reducing government debt
6. Providing transitional support to industry