Four myths about Ontario’s cap-and-trade system
Ontario’s cap-and-trade system is now in force and is the focus of much debate. Amidst all of the discussion, there is plenty of rhetoric, hyperbole, and questionable statements. Some of these have grown into large and scary myths which need to be debunked.
The first myth is that the cap-and-trade system will significantly raise the already-high electricity costs for families and businesses. It is true that Ontario’s electricity prices are higher than elsewhere in Canada, and it is also true that much of this has been driven by costly policy decisions from the past — including policies that provide massive subsidies to intermittent renewable power sources.
But Ontario’s electricity system is now mostly carbon free — the province relies on natural gas for only about 10 per cent of its total electricity production. As a result, the cap-and-trade system, which puts a price on carbon emissions, should add very little to electricity costs.
The second myth is that carbon pricing will seriously damage the competitiveness of Ontario’s businesses. The policy would indeed be a major mistake if the province’s firms responded by simply moving their operations to other jurisdictions with lower (or no) carbon prices. However, research by Canada’s Ecofiscal Commission (which I chair) shows that only a very small fraction of the economy — less than 2 per cent of provincial GDP — is seriously exposed to this risk.
But what about the firms that are in this category, Ontario’s “large GHG emitters”? Won’t the carbon price spell the end of these businesses? The answer is no. An important part of Ontario’s cap-and-trade system is that “emissions intensive” firms will receive some of their required emissions permits for free, in an amount that depends on their output. These free permits have real cash value, which goes straight to the recipients’ bottom lines, offsetting much of the impact on their competitiveness.
This brings us to the third myth, that giving these permits to businesses undermines the carbon-pricing policy. This popular argument misses the crucial point of any carbon price. The objective of the policy isn’t to reduce total business profits — it is to raise specific prices so that firms change their business practices in a way that reduces their carbon emissions. The combination of the carbon price and the free permits gives businesses a clear incentive to reduce their GHG emissions by changing their operations but not by shrinking their economic activity.
The fourth myth is probably the biggest one of all — that a carbon price will not succeed in reducing GHG emissions. As consumers we know that we respond to higher prices by adjusting our purchases. Each household will react differently. Some will choose a more fuel-efficient vehicle, while others change the way they heat their homes or decide to insulate their basements or choose to have more staycations.
For businesses, higher carbon-related costs will lead them to switch to cheaper inputs, some of which will only be developed in response to the demand induced by the carbon price. They will also have the incentive to develop lower-emitting ways of making their products or delivering their services. But each business has the flexibility to figure out how best it can adjust to the carbon price.
Such a large collection of small responses to price movements is what makes our market economy tick; it is the essence of Adam Smith’s age-old arguments about how market prices provide order for a complex social system. It is also why a carbon price — as opposed to intrusive and prescriptive government regulations — is such an efficient approach to reducing GHG emissions.
There is plenty of research from Canada and around the world showing that carbon prices actually do reduce GHG emissions. But nobody should expect dramatic results right away. It takes a while for households and businesses to adjust to new prices in the marketplace. Their responses will gradually occur, and emissions will gradually fall, especially as the carbon price rises over time.
Ontario’s new cap-and-trade system is designed to reduce GHG emissions while protecting the competitiveness of the business sector. There will no doubt be some growing pains in the first few years, and policy adjustments in response. This is to be expected. But we shouldn’t let the scary myths get in the way of the facts.