How carbon dividends affect incentives (hint: they don’t)
Clean Prosperity and EnviroEconomics published a report recommending the federal government rebate carbon-pricing revenues directly to households. The key takeaway: Implementing a carbon price and issuing these ‘carbon dividends’ could make a majority of Canadian households better off. It’s a valuable finding. But you might ask: What’s the point if you’re just giving the money back? Today, I’ll use some simple economic theory to explain how this approach not only maintains incentives to reduce GHG emissions, it can help households pocket more savings (it’ll be fun, I promise).
Let’s zoom out for a moment. In January 2019, the federal carbon pricing backstop is scheduled to come into effect for provinces that don’t already have carbon pricing in place, or specifically ask the federal government to implement it for them. The federal government is legislatively required to return all revenues it collects to the province it collects them from. They seem partial to sending revenues directly to households instead of their provincial counterparts.
Keeping households whole
Clean Prosperity’s new report recommends that the federal government do just that—rebate all carbon revenues directly to households. (This wouldn’t include emissions priced under the separate federal output-based industrial pricing system; see here for an explanation of that system.) With this approach, a large majority of households would receive more money than they would pay in carbon taxes, both directly and indirectly.
This brings us back to our original question. What does that mean for incentives around carbon?
It helps to think of this as a two-step process. Step one: households pay the carbon price whenever they produce greenhouse gas emissions. Step two: households receive regular cheques in the mail, and the size of those cheques is independent of each household’s carbon costs.
As we’ll explain, these two steps complement rather than contradict one another. Let’s look at an illustrative example with two different commuters.
Our first commuter averages 20 round trips to work a month. Taking public transit is cheaper, but they prefer to drive. As a result, Commuter #1 drives 15 times, takes transit 5 times, and pockets the extra cash. Life is good.
When a carbon price comes in, it increases the price of gas. A roundtrip by car is now slightly more expensive. To avoid spending more on their commute, Commuter #1 takes action to avoid paying the carbon price. They drive 12 times and take transit 8 times.
We see this effect everywhere in the economy. When the price of something increases, we switch to other, similar things that cost less. If the price of apples, beer, and scooters goes up, some people will switch to pears, wine, and bicycles.
But we can’t consider carbon pricing without also considering revenue recycling. With a carbon dividend, Commuter #1 also gets a quarterly cheque in the mail. But getting a cheque doesn’t mean they suddenly ignore the changes in price. It still makes sense for Commuter #1 to avoid the carbon price where possible to save money and pocket the additional cash from the dividend.
Our second commuter is a little different. They don’t have access to convenient public transit, and as a result, Commuter #2 drives to work every day.
As a result, it doesn’t make sense for Commuter #2 to shift their behaviour—even with a carbon price. Essentially, the cost of shifting to public transit is more than the cost of paying the carbon price. And that’s OK. This flexibility is exactly the point of carbon pricing: it doesn’t require specific or expensive actions to reduce GHG emissions. On its own, the carbon price adds costs for Commuter 2.
But once again, revenue recycling is part of the policy package. With the carbon dividend, Commuter #2 also gets a quarterly cheque in the mail. And for most people like Commuter #2, Clean Prosperity’s numbers suggest that the carbon dividend will more than cover the increase in the price of gas and other carbon costs.
One more point about Commuter #2: while they may have fewer options to avoid the carbon price right away, they might have more over time. For example, when it comes time to buy a new car, they might consider more fuel-efficient—or even electric—alternatives.
Don’t forget the other half of the conversation
It’s important to remember that carbon pricing is a two-step policy. It includes both the carbon price and revenue recycling. And critically, these two steps work independently of each other.
While the public and political focus remains on step one, Clean Prosperity’s report sheds some welcome light on step two. As the implementation of a Canada-wide carbon price fast approaches, it’s critical to remember that the environmental benefits of the carbon price are entirely separate from the revenue recycling choice. Yet in assessing overall economic impacts, what we do with the revenues matters.
A carbon dividend maintains incentives to switch to lower-carbon goods because there’s a separation between what the carbon price costs you and the value of the dividends. How much the carbon price costs is tied to your carbon consumption, whereas the dividend’s value is fixed.
The net result? More cash. Less carbon.
Now that the secret is out, it may be hard to hold the floodgates on provincial voters who _want_ / prefer the federal backstop over any macro-economic- optimized provincial alternative. Q. how big are these tertiary impacts from sub-optimal recycling? Is it all in the 2016 ecofiscal ‘Choose Wisely’ report or do we need a new report? https://ecofiscal.ca/reports/choose-wisely-options-trade-offs-recycling-carbon-pricing-revenues/
It’s a good question. Figure 6 in Choose Wisely gives some indication of the small (but measurable) relative economic impacts of different revenue recycling approaches.
Thank you for concretizing carbon fee and dividend. Now can you please explain where the government gets the money to fund the myriad projects ( infrastructure, mitigation, etc.) that must be implemented during this transition to clean energy?
Infrastructure is generally funded through general revenues. Preparing for a low-carbon world affected by climate change will change how we spend those revenues (e.g. more resilient, cleaner energy projects), but it likely won’t change how we collect those revenues.
It’s possible to use the revenues from carbon pricing to fund additional mitigation projects (you can read our report “Choose Wisely” for more information). This is the approach taken in Quebec, for example. But generally, we don’t need revenues to fund mitigation projects. Carbon pricing and carefully chosen complementary policies can do most of the work. Thanks for reading!
Thanks for this concise explanation and useful examples. First question, is the intent of the rebate program to be neutral (I.e. all fees collected to be turned around as rebates)? If so, then one would assume that behaviors of the minority who won’t get rebates that exceed their increased costs (assumed given the stated fact that most people will get more back than they spend) would make up the difference. Under these assumptions there must be an expected GHG footprint that would be the neutral point. Can you elaborate on what this looks like? For example a third commuter may be in the sweet spot where the distance they commute and associated carbon consumption exactly matches their expected rebate. Are there other non-commuting examples you could provide?
Thanks for the questions! The carbon tax will be revenue neutral for the federal government, as it is required by law to return revenues to the province it collects them from. The government may choose to provide some support to other sectors, but returning 100% of the revenues to households is certainly a possibility. Nothing is official yet.
There is indeed a “sweet spot” where your carbon costs would exactly match the dividend. What it “looks like” depends on the size of the dividend and the price of carbon. I’m happy to discuss further, but would need to know a little more about what exactly you’re looking for.
A few more household examples: installing energy efficient bulbs, a smart thermostat, tighter weatherstripping, or a more efficient furnace (eventually).
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