Fraser Forum

Ontario government’s cap-and-trade plan places politics over policy

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Back in 2009, America was pondering a cap-and-trade scheme called “Waxman-Markey,” for the names of its Congressional sponsors. As I pointed out, emission-trading systems have a decent academic pedigree. When done right, they can emulate an eco-tax, considered to be the most efficient (and least economically distorting) approach to pricing in the cost of environmental externalities into people’s choices. And as I observed at the time:

But emission trading schemes, like any other trading scheme, can go badly awry, particularly when the system is highly complex, and the potential for profiteering is large. That’s clearly the case with regard to carbon. While one could write a book on the potential pitfalls of cap-and-trade, three stand out vividly: politicized permit allocation; economic strangulation; and energy price volatility.
Economists argue that if done correctly, cap-and-trade can work for greenhouse gas control. But that’s only if all the permits are auctioned off to emitters. Otherwise, it’s a mess.

As I observed in that same article, both President Barack Obama and U.S. Budget Director Peter Orzag both observed that giving away emission permits would enable politicians to game the system, playing favorites with freely-allocated permits, and, in the words of Peter Orzag giving away permits:

“…would represent the largest corporate welfare program that has ever been enacted in the history of the United States.”

Harvard Economist Gregory Mankiw spelled it out concisely:

“Economists recognize that a cap-and-trade system [with free permit allocation] is equivalent to a tax on carbon emissions with the tax revenue rebated to existing carbon emitters, such as energy companies. That is, Cap-and-trade = Carbon tax + Corporate welfare. If the public understood this theorem, the carbon tax alternative, with revenues rebated to households through lower payroll or income taxes, would attract a lot more interest.”

Another economist with a long career studying cap-and-trade systems, Ian Parry at the respected U.S. think-tank Resources For the Future (RFF) explained:

“Freely allocated tradable emission permits may actually hurt the poor the most, as they transfer income to shareholders via scarcity rents created at the expense of higher prices. On the other hand, emissions taxes (or auctioned emission permits) offer the opportunity to offset regressive effects, if revenues are recycled to finance progressive changes to the tax system.”

All that brings us to today, as details of Ontario’s proposed cap-and-trade system are finally coming out. Unsurprisingly, the Wynne government made the choice to politically-allocate the permits, rather than using an auction approach generally favoured by economists.

The Globe and Mail reports:

On Thursday, the government will release draft regulations under which 102 large industrial emitters will get free allowances to produce GHGs at current levels in 2017 and would then have to reduce their emissions by more than 4 per cent a year until 2020, The Globe and Mail reported Wednesday... Distributors of gasoline, home heating fuel and natural gas will have to purchase permits for every litre or cubic metre they sell, a government source told The Globe. The levy would add 4.3 cents to a litre of gasoline and about $5 to $6 a month for heating the average home, while raising more than $1.3-billion from consumers.

One has to wonder, did the Wynne government make any effort to learn from past experiences with emission trading of greenhouse gases?

The government claims that households, particularly poorer households will not feel the pain of the new cap-and-trade regime because the government is going to give them some of the money paid in by better-off households, and help them improve their energy efficiency.

But again, one has to ask, was there any due diligence in trying to avoid mistakes of the past?

A study just last year, from the University of Chicago studied the experience of 30,000 homes in Michigan, some of which were given assistance to improve household energy efficiency, and others which were not. The researchers found that the cost of improving household efficiency was more than twice the value of the energy savings.

Having committed itself to international targets for greenhouse gas emission reductions (and omitting for now the wisdom of accepting those targets), governments at all levels across Canada are looking for ways to reduce their greenhouse gas emissions. Some approaches are clearly better than others and some are not only worse, but egregiously worse. Cap-and-trade, particularly as implemented in Ontario, is in the latter category.

The Wynne government should have known this, but instead, politics has undermined policy, and Ontarian households are going to feel the pain, while politically connected industries will reap a windfall.


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