Why carbon pricing remains the smartest policy tool
In the organization’s final report, Canada’s Ecofiscal Commission underlines carbon pricing is the lowest-cost option for meeting emissions targets.
In the wake of the federal election, it is clear that Canadians want more action on reducing greenhouse gas emissions. Stronger policies will be essential to achieve our 2030 Paris Accord target for GHG reductions. With a new government in place, it’s time for a serious conversation about how best to bridge the gap between Canada’s current emissions and our target.
And just as the 43rd Parliament gets underway, Canada’s Ecofiscal Commission is winding down. We came together as a group of economists in 2014 with a five-year goal of exploring policies that can drive both a prosperous economy and a cleaner environment. Our final report considers Canada’s main options for bridging our emissions gap.
At the outset, let’s be clear that any policy to achieve deep reductions will impose economic costs on Canadians. This is hardly surprising given our economy’s reliance on energy and the carbon intensity of our energy system. To assume that deep reductions can occur with little effort or cost is simply naïve.
Yet some advocate exempting large parts of the economy from climate policy in an attempt to shield Canadians from any costs. For example, a policy that focuses only on reducing the emissions from heavy industry — while exempting personal transportation and home heating and electricity — might be quite popular. The problem is that this approach would actually cost Canadians the most. Industrial emitters would pass on their higher costs to consumers in the form of higher prices. And requiring industry to do all of the work forces it to have deep (and costly) cuts to compensate for growing emissions elsewhere in the economy. A broader-based policy is less expensive overall.
A second approach uses subsidies to drive “greener” behaviour. It is natural to favour receiving subsidies, but this approach also loses its appeal once the full picture is considered. Taxpayers pay for subsidies in the form of higher taxes, which typically lead to slower investment and wage growth. In addition, because subsidies require governments to identify specific technologies and activities for support, they cost more than policies that harness market forces across all parts of the economy.
The third approach – carbon pricing – imposes visible costs on emitters but is actually the lowest-cost option overall. A carbon price creates powerful economic incentives for households and businesses to reduce their emissions by changing how they live and conduct their business. Bit by bit, these changes lead to large emissions reductions over time. Many jurisdictions have tried carbon pricing — from British Columbia and Sweden to the United Kingdom and the New England states. They have made serious progress in slowing or reducing their GHG emissions while maintaining strong economic growth.
How high a carbon price is needed to achieve our targets? Like any other policy, a little stringency only gets us a little performance. For climate policy, serious emissions reductions require a serious carbon price.
Carbon prices are already set to rise to $50/tonne by 2022. For Canada to achieve its 2030 targets, the price would need to rise by about $20 per tonne each year after this. This translates into an annual increase in the price of gasoline of about 4.4 cents per litre — so a litre of gasoline would be about 40 cents more expensive in 2030 than it is today.
At the same time, however, the revenue generated by the carbon price would increase. If this revenue were given back to Canadians as rebates or tax cuts — as occurs with the current federal policy — these annual per-person rebates would rise by 2030 to be about $750 in Ontario, $2,200 in Alberta, and $4,100 in Saskatchewan. Such rebates would shelter families’ budgets in terms of purchasing power but the carbon price would still provide an incentive to switch away from carbon-intensive fuels. It is a very powerful combination.
For those who cannot abide the idea of carbon pricing but who also dislike the high costs of subsidies and industry-targeted policies, there is one remaining policy option. Some regulations can be designed to be “flexible” in that they do not specify which technologies must be used or which emitter uses them. A Clean Fuel Standard, for example, requires fuel distributors to use cleaner fuels but allows those businesses to trade credits among themselves to collectively reduce the emissions intensity of fuels sold. This market-based flexibility reduces the overall cost of the policy.
But we need to be realistic. Flexible regulations might be less visible than carbon pricing, and for that reason might be more attractive. But they are difficult to design well, and even at their best they involve higher overall costs than carbon pricing. And unlike carbon pricing, they do not generate the revenues that can be returned to households or used to reduce growth-retarding taxes.
What is the bottom line? To achieve our climate targets, we have several options from which to choose. Canadian governments should be smart about making this choice. There is good reason to care about reducing the overall costs of our policy actions, especially when we consider the level of ambition required over the next decade.
Though the Ecofiscal Commission itself will soon end, we hope our work will live on. So, here is our final advice to Canadians and their governments: Canada should increase its carbon price well beyond its current level, and make it the central plank of the overall policy package to reduce GHG emissions. And we shouldn’t be scared by the price tag. As the carbon price rises, we should ensure that the revenue gets returned to households and businesses. Canadians know that it’s time to get real about climate change. Now they need to know that the other policy options will cost far more — even though their price tags are harder to see.
This article was originally published in Policy Options on November 27, 2019.Download the Report (PDF)
There is still one aspect of the carbon tax which I fail to understand. I’m all for the application of this tax to reduce consumption of fossil fuels. What I don’t understand is the rebates notion. Why not use the profits of the carbon tax for subsidies to the renewables sector, for the transition of gas stations to e-recharge stations throughout the Canadian road network, and for incentives to the consumer, such as encouraging the purchase of electric cars?
Why waste those profits on rebates? Just to make it more politically palatable? I hope most Canadians think of themselves as mature, responsible adults rather than 5 year olds that need to be coaxed into doing the right thing with candies! P.S. If possible, I would welcome feedback, thank you.
Hi Adrian. Thanks for your question. I agree that there’s a strong case for using carbon pricing revenues to drive further GHG reductions. There are other uses that have a strong case for them too, as we show in our report Choose Wisely. Ecofiscal’s view is that we can and should have a vigorous public debate over what the “right” use of revenues is, and that the answer will be different in different places and times.
While rebates may not have much going for them in terms of their support for economic growth or their effect on GHG reductions, they offer a way to clearly and credibly signal to people that carbon pricing is not about growing the size of government and that there will be help on the affordability front. That’s not nothing.