Late last year, the Trudeau government unveiled its new climate plan, which calls for the federal carbon tax to increase to $170 per tonne by 2030, with revenues rebated to households or spent by Ottawa. This plan, among other things, will increase government budget deficits, which have already hit historic highs during the COVID-recession, resulting in rapidly rising government debt across Canada.

In fact, according to a new study, once the carbon tax is fully implemented, combined federal and provincial deficits will increase by about $22 billion annually.

To understand why, it’s first important to understand the state of government finances across Canada today. The federal government expects to borrow more than $380 billion in 2020-21 and more than $650 billion between now and 2025-26 (not including the $70 billion to $100 billion it plans to spend to stimulate the economy). These massive numbers also exclude any new spending—which will be financed by borrowing—the government may announce in this spring’s federal budget.

Among the provinces, as of the end of February, most provinces were reporting budget deficits for the current year and into the future. In total, the provinces expect to borrow $91.6 billion in 2020-21, with Ontario ($38.5 billion), Alberta ($20.2 billion), British Columbia ($13.6 billion) and Quebec ($12.3 billion) leading the way.

Crucially, these numbers do not account for increasing pressure on government finances due to Canada’s aging population. A 2020 study (completed pre-COVID) found that, due largely to our population aging, Ottawa will not balance the federal budget before 2050 and federal debt levels will rise to levels not seen since the early 1990s when Canada experienced a near-debt and currency crisis.

It’s in this context that Ottawa has raised the federal carbon tax, from a previous maximum of $50 per tonne to $170 per tonne by 2030. Again, while it may sound counterintuitive, this higher carbon tax will cause larger government deficits, for two main reasons.

First, according to the Trudeau government plan, most of the revenue (90 per cent) collected from the federal carbon tax will be returned to households via lump sum rebates. (The government has not indicated this policy will change as the cost of the carbon tax increases.) The total estimated cost of the rebate in 2030, when the carbon tax reaches $170 per tonne, is $27.4 billion.

Second, the Trudeau government has repeatedly claimed the higher carbon tax will have “almost zero impact” on the economy, but tellingly, has not released any quantitative or modelling analysis. However, the aforementioned new study, which employed an expansive quantitative model of Canada’s economy (referred to as a partial general equilibrium model), found the higher tax will cause the Canadian economy to shrink by 1.8 per cent, which in 2019 would equal roughly $38 billion. The study also finds that a $170 carbon tax will reduce employment by about 184,000 jobs and cost the average Canadian worker $1,540 in foregone income—even after accounting for the carbon tax rebate.

The contraction of the Canadian economy means other tax rates (on personal income, for example), both federally and provincially, will raise less revenue than before because the underlying tax base is smaller. Again, this combination of a smaller tax base and the rebating and/or spending of all carbon tax revenue, means that combined federal and provincial deficits will increase by a total of about $22 billion annually once the carbon tax is fully implemented.

Clearly, with the current weak state of federal and provincial government finances, increasing pressures from an aging population and perhaps more new government spending on the horizon, governments across Canada will continue to face rising deficits and more debt. The higher carbon tax rate will only further strain government finances.