We can design fair carbon pricing (and we already are)

Climate and Energy

In discussions about carbon pricing, the question of how it will impact low-income households comes up a lot. Put in other words, is carbon pricing unfair? In this blog, I discuss how carbon pricing might affect low-income earners, how smart policy can address potential equity issues, and what Canadian governments are doing about it. The key point? In assessing fairness, we need to look at the implications of both the carbon price itself and the way governments recycle the revenue from it. By recycling revenues wisely, we absolutely can — and should — ensure carbon pricing doesn’t disadvantage lower-income families.

Fairness implications of a carbon price

Let’s start with just carbon costs, independent of revenue recycling.

Our research suggests that carbon pricing does affect lower and higher-income households differently. Under a $30/tonne carbon price, the poorest 20% of households in four Canadian provinces could, on average, see 0.5 – 2% of their total incomes going toward carbon pricing. On the other hand, the richest 20% of households would pay around half this much (as a share of their total, larger incomes).

So why might carbon pricing have a disproportionate impact on low-income earners?

For one, a relatively large share of low-income households’ budgets goes toward heating and electricity, which can be emissions-intensive, depending on the province. As a result, their carbon costs make up a bigger share of their total income.

Further, low-income households might have fewer options for reducing their carbon tax burden. As we discuss here, the whole point of a carbon price is to avoid paying it. If individuals and businesses find ways to reduce their emissions, they pay less. But some low-carbon investments have a significant up-front cost. For example, installing energy-efficient windows or buying a car with better fuel economy can lower a household’s carbon tax bill. But if these options are out of reach for low-income households, they can end up with a limited ability to respond to carbon pricing. This can make any regressive impacts even more unfair.

Finally, we should note that the carbon price — even before considering revenue recycling — isn’t always regressive. Beck et al. find that BC’s carbon tax did not disproportionately affect low-income households. In fact, they find the opposite — that it was progressive.

Still, the potential for carbon pricing to have a disproportionate impact on low-income households is an important issue that deserves our attention. Fortunately, there are some straightforward ways to address it.

Revenues to the rescue

Governments have two main ways to address potential equity impacts from carbon pricing.

First, they can use some of the revenues to directly compensate low-income households. This approach is common with regressive taxes like sales taxes. Under Canada’s GST/HST, low-income earners receive a rebate to offset the tax’s regressive impact. As income rises, the rebate falls (I got one in my student days; now I don’t).

Second, they can use carbon pricing revenues to make investments that help low-income households. For example, governments can support their adoption of energy-saving technologies or invest in transit to provide them with better transport alternatives. The targeting of these types of measures is important though. You want to make sure that those that need help most are getting it.

Current approaches

British Columbia, Alberta, Ontario and Quebec already have carbon pricing. Each takes a different approach to dealing with the equity issue. But they all address it.

British Columbia and Alberta use rebates. British Columbia offers a Low Income Climate Action Tax Credit to qualifying households. The rebate they receive is combined with their HST rebate. Alberta offers a Carbon Levy Rebate that is mailed or deposited directly, in four quarterly payments. These rebates offset the disproportionate carbon costs that low-income earners can sometimes pay, helping preventing potential regressive impacts.

Ontario and Quebec rely on subsidy programs that help households lower their carbon pricing burden. Ontario uses carbon pricing revenues to help replace older vehicles, to support the adoption of low-carbon technology in homes, and to lower the cost of electricity. Quebec uses revenues to support the adoption of energy-efficient equipment for buildings and vehicles and to fund public transit. By helping low-income families retrofit their homes, providing them with low-carbon transportation options, and reducing their cost of living, these actions help low-income families to lower their carbon costs. This helps keep carbon pricing fair.

Money left over

Importantly, addressing potential equity issues doesn’t have to come at the expense of other revenue-recycling priorities. Our analysis shows that only 10 – 12% of carbon pricing revenues are needed to address equity concerns for the bottom 40% of households.

Governments can use the majority of carbon pricing revenues for other priorities, or simply recycle them back into the economy. Indeed, the actions the four provinces are taking on equity are just one part of what they are doing with their carbon price revenues.

Keeping the price signal intact

Similarly, making carbon pricing fair doesn’t require undermining the effectiveness of carbon pricing (as, for example, exempting low-income households would).

Recycling revenues to low-income earners maintains the incentives that carbon pricing provides. Even where households get a rebate, they still have a financial incentive to reduce their emissions, since the rebate is tied to their income, not their GHG emissions. And for those with low enough emissions, carbon pricing might even provide a net benefit.

A serious issue with a straightforward solution

The equity implications of carbon prices matter. They present an issue of genuine concern deserving of our attention. But they aren’t an argument against carbon pricing.

Governments in Canada can deal with carbon pricing’s equity impacts through smart policy that recycles revenues where they are most needed. In many cases, they already are.

2 comments

  1. Doug Sanden

    I propose a control group for comparing ctax provinces to. For AB a good control is SK. If SK doesn’t want a ctax then I propose they be given an exemption on the condition they help by being a control. That will help more than AB. It will help the world by having a good pair with/without ctax. Brittish vs eu or Sweden vs eu has a lot of ‘yes but’s.

    • Jason Dion
      Jason Dion

      Hi Doug. I am all for facilitating clean econometric analysis. But I think leaving SK as a control group would raise a lot of legitimate questions about fairness.

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