A delicate (im)balance: policy interactions and the federal Clean Fuel Standard

policy interactions
Climate and Energy

Since releasing our report on complementary climate policies, we’ve written a lot about the importance of policy interactions and their implications for effectiveness and cost-effectiveness (see here and here). But one issue we haven’t yet discussed is how policy interactions can affect Canadian federalism.

Interactions between provincial carbon pricing policies and federal non-pricing policies can have uneven impacts across provinces. This opens the door to tricky questions about how best to balance inter-provincial fairness. To illustrate, I want to focus on a timely, concrete example: the federal government’s Clean Fuel Standard (CFS).

All fueled up

The CFS is still in the hopper, but it’s expected to roll out in 2019. The proposed policy will have broad coverage and require an overall reduction in the lifecycle carbon intensity of fuels used by the transportation sector, industry, buildings, and homes. It aims to reduce annual emissions by 30 megatonnes per year by 2030, making it a big plank of the federal government’s efforts to curb GHG emissions. Importantly, emissions reductions must be incremental. That is, emissions reductions must be in addition to reductions from other policies.

The emissions covered under the CFS overlap with the emissions covered under provincial climate policies. Perhaps most importantly, they will overlap with the emissions covered by carbon pricing. This overlap is the root cause of the interaction issue, so let’s go a bit deeper.

Uneven impacts

In provinces with carbon taxes, the CFS will lead to additional emissions reductions. Carbon taxes do not require a specific quantity of emissions reductions, so any reductions that come from the CFS will be in addition to those from carbon taxes. The CFS drives additional emissions reductions, with additional costs. So far, so good.

But the opposite is true in provinces with cap-and-trade systems. Here the CFS will not lead to additional emissions reductions. Emissions caps are fixed: any emissions reductions that occur because the CFS mean fewer emissions reductions need to be realized elsewhere in the economy. It effectively displaces other emissions reductions that would have happened under the cap-and-trade system, alone.

This issue is effectively about burden sharing. The CFS will result in additional emissions reductions; however, they will all come from carbon tax provinces, not cap-and-trade provinces. Other non-pricing climate policies that overlap with carbon pricing may have similar consequences.

A uniquely Canadian problem

This is a uniquely Canadian problem and requires careful consideration. Maintaining inter-provincial fairness is critical for robust and durable climate policy. Yet these issues have, so far, remained off the radar. The preliminary consultation document for the CFS, for example, is mum on the issue of interaction effects and inter-provincial fairness.

We also don’t know if the federal government has integrated these policy interactions into their goal of achieving 30 Mt per year by 2030. If the policy doesn’t lead to additional emissions reductions in provinces with cap-and-trade systems, the goal will either be that much harder to reach, or could increase the burden on jurisdictions with carbon taxes. Neither outcome is great.

Delicate challenges require delicate solutions

What can Canadian governments do about this thorny issue? One solution is to consider cap adjustments. This would require provinces with cap-and-trade policies to tighten their caps to reflect the emissions reductions achieved by the CFS (or any other federal non-pricing policy). Although technically and politically challenging, this might be the best way to address the inter-provincial issue.

Alternatively, the government could rely less on the CFS, and more on increasing the stringency of carbon pricing policies, although this approach may also come with political obstacles.

But before governments can contemplate potential solutions, the first step is to acknowledge that there’s a problem. Fortunately, there’s still time to make changes to how the CFS—and other federal climate policies—are designed and implemented.

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