Summer daze: comparing carbon pricing policies
Summer in Canada: time to lounge by a lake, right? Well, not if you’re part of the federal-provincial working group on carbon pricing (or, for that matter, a dedicated Ecofiscal Commission researcher…). For carbon wonks, the arrival of summer this year means we’re well into a six-month process initiated at a first Ministers meeting in Vancouver in March seeking to coordinate federal and provincial climate policy in Canada. And just like the weather, that conversation appears to be heating up.
I’m fairly confident that federal and provincial carbon experts are grappling with plenty of complicated questions. But for me, the crux of the issue comes down to this one: How can we compare the stringency of provincial carbon policies?
Comparing provincial policies is critical
By stringency, we really mean the extent to which policies will drive reductions in GHG emissions. More stringent policy = deeper reductions.
Comparing the stringency of carbon policies matters for two main reasons.
First, it allows for benchmarking provincial efforts. Clearly, more stringent policy is required for Canada to achieve its 2030 objectives. But how much will provincial policies contribute toward national efforts to reduction emissions?
Second, it can support efforts to coordinate policies. More coordinated policies tend to be more cost-effective overall, because they don’t drive high-cost emissions reductions in one region while leaving low-cost opportunities unrealized in another. Coordination can also address concerns around inter-provincial competitiveness.
But comparing stringency isn’t necessarily easy
How do we define effort? Emissions reductions are clearly the end goal. But measuring emissions reductions isn’t straightforward: we need to know not only emissions levels, but also what that emissions would have been in the absence of policy. Sure, we can measure levels of emissions in absolute terms, but that ignores the fact that provinces have different emissions trends, independent of policy. Are emissions reductions relative to a historical year (e.g., 1990 or 2005), a function of policy, or something else?
That’s one of the reasons why economists tend to think of comparing policy stringency in terms of carbon prices. (The other, of course, is that aligning provinces around a common carbon price leads to a more cost-effective approach overall). Higher carbon prices create more incentives to reduce emissions. Carbon prices are easy to observe, whether set by the rate of a carbon tax or the market price of permits in a cap-and-trade system. And normally, we tend to think of prices and quantities as being two sides of the same coin: a given price is associated with a given level of emissions reductions, and vice versa.
That tidy equivalency between price and quantity, however, starts to break down across different policy designs. The upshot? Comparing systems is (surprise!) a little more complicated.
Narrower coverage reduces effectiveness — and increases costs
One difference between provincial policies that complicates comparison is coverage (i.e., the share of total emissions to which the policy applies). As we discussed in our first report, carbon pricing policies in Canada have different levels of coverage. Broader policy will drive more emissions reductions relative to a narrower policy, all else being equal. As a result, comparing policies with different coverage isn’t quite an apples-to-apples comparison.
International emissions reductions also create some wrinkles
Some—but not all—provincial carbon pricing policies allow for international permit trading. For example, Ontario argues that its cap-and-trade system will be more stringent than what’s reflected by the system’s price alone. The reason is the linkage with California. California has more lower cost emissions reductions available than Ontario (and Quebec). It makes sense for Ontario emitters to purchase permits from California, thus avoiding higher cost emissions reductions at home. But that essentially broadens the base of emissions in Ontario beyond its own emissions. Ontario is not wrong to suggest that linkage allows for more emissions reductions at lower cost, and thus at a lower carbon price, than if it were not linked.
The path forward for comparing stringency?
Where does that leave us? Confused, perhaps. But a few parting thoughts:
First, prices alone might not cut it in comparing very different provincial carbon pricing policies and in supporting practical approaches to coordinating these policies. Yes, a similar carbon price across Canada is the most cost-effective approach overall. But since a common, linked carbon market seems unlikely to emerge, we do need a way to compare policy stringency in a common framework.
By the same token, focusing only on quantities is impractical too. In theory, you could divvy up Canadian emissions reductions by province such that these allocations roughly match up with an approximately consistent carbon price. Doing so, though, requires putting some trust in economic modelling tools. And as economic circumstances (e.g., the price of oil, rates of economic growth) change over time, so would the efficient distribution of emissions between provinces.
This all suggests that we might need to consider multiple metrics to compare policies. Stay tuned for a new research paper (coming soon) from Ecofiscal doing exactly that. We’ll consider a range of metrics to compare existing carbon pricing policies, and even develop a couple new ones.
Just think of it as some light summer reading.