Meeting Canada’s climate targets in a way that is best for our economic prosperity requires broad policy that creates consistent incentives across all emissions in the economy, from individual households and small businesses to heavy industry. Output-based pricing must be a key part of that mix if Canada is to strike the right balance between pricing emissions and protecting competitiveness.

The federal government’s “backstop” carbon-pricing policy will apply in provinces and territories that haven’t implemented a sufficiently broad and stringent policy of their own. The backstop has two parts. The first is the levy on the carbon embedded in fossil fuels such as gasoline and diesel; this is pretty straightforward. The second is a separate pricing system for large industrial emitters; this is the complex part that needs some explanation. Despite the complexity, however, it is interesting to see that governments of all political stripes seem to be adopting similar ways of treating the economy’s large emitters.

Economists agree that carbon pricing is the most flexible and cheapest way to reduce greenhouse gas emissions. Other options are certainly available, but they are more complicated and more costly for the economy.

But climate policy must also be designed to protect business competitiveness. Many large emitters sell their products in international markets, competing against firms that face weaker climate policy at home. Without careful design choices, carbon pricing could drive investment and production (and the emissions associated with them) to jurisdictions with weaker policy. A good carbon price needs to address this concern.

The federal government’s output-based carbon pricing system (OBPS) meets this concern head-on. The system establishes a benchmark for each sector based on “emissions intensity” (emissions per unit of output). Firms that have emissions-intensities above the benchmark must either purchase credits from high-performing firms or pay the carbon price to government. Firms that are below the benchmark earn credits, which they can sell to other firms. The existence of such credits ensures that any additional emissions reductions have value, maintaining the financial incentive to continuously reduce emissions.

Note that an output-based pricing system is not the same thing as an exemption for industry, in which case there would be no incentive whatsoever to reduce emissions. With exemptions, the lucky emitters are off the hook entirely, and this forces other industries to do more of the heavy lifting. In contrast, output-based pricing maintains the incentives for all covered industries to reduce emissions, but reduces the total cost of doing so—thereby protecting business competitiveness. The OBPS encourages large emitters to reduce their emissions by improving their performance rather than by reducing production or employment.

Output-based pricing systems make a lot of sense for a trading nation such as Canada. Perhaps it is not surprising that many provincial policies are taking this basic approach: Alberta’s carbon competitiveness incentive regulation took effect in 2018. It was the first output-based pricing system in Canada and served as a template for the federal system; Saskatchewan has developed an output-based performance standard, a flexible regulatory approach that use the same benchmarking approach as the federal and Alberta policies; Ontario recently proposed an approach similar to Saskatchewan’s in its emissions performance standards; Quebec’s cap-and-trade system offers free output-based allocations to energy-intensive, and trade-exposed sectors; Nova Scotia’s cap-and-trade similarly offers free allocations to energy-intensive and trade-exposed sectors; and British Columbia recently announced its Industrial Incentive program, which rewards companies with low emissions-intensities by reducing the amount of carbon tax they pay.

There are admittedly some differences across these provincial policies, but there is nonetheless a striking degree of convergence with the federal approach. Each puts a price on carbon emissions for big industry and creates continuous incentives for firms to reduce emissions by improving their performance. At the same time, each system provides additional support to emissions-intensive, trade-exposed industries to reduce their policy costs without undermining the incentives to reduce emissions. This approach to policy design is a feature, not a bug, and it will ensure that carbon pricing is not a barrier to vibrant businesses and strong economic growth in Canada.

Meeting Canada’s climate targets in a way that is best for our economic prosperity requires broad policy that creates consistent incentives across all emissions in the economy, from individual households and small businesses to heavy industry. Output-based pricing must be a key part of that mix if Canada is to strike the right balance between pricing emissions and protecting competitiveness. And considering our lively national debate around climate policy, it’s no small feat that governments across the country seem to agree.

This opinion piece was originally published in the Hill Times on March 11, 2019.

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