Canada’s phony debate about carbon taxes

In the Ontario PC leadership race, all four candidates hoping to replace Patrick Brown as leader oppose carbon taxes, a centrepiece of Brown’s Tory platform. The federal Conservative Party also opposes carbon taxes.

Some commentators see this as a betrayal of Conservative free-market instincts because (supposedly) our choice is between inefficient bureaucratic regulation and the enlightened Liberal approach of using price-signals to hit greenhouse gas targets. According to this reasoning, economically-literate Conservatives should prefer the latter.

But in reality, Canadians have been offered no such choice. We face the Conservative option of costly and inefficient regulations, and the Liberal package of even costlier and more inefficient regulations, with new taxes added on top. It’s dismaying how many commentators who should know better think that the shiny paint of carbon taxes somehow fixes the underlying policy defects.

Any carbon-pricing proposal intended to fit the economic definition of an efficient instrument needs the word “alone” in the title. The economics literature is filled with analyses showing the superiority of carbon taxes alone over regulations. Replacing regulations with a revenue-neutral carbon tax alone can be efficient (as long as the rate is set optimally).

But if we already have a coal ban, ethanol subsidies, feed-in-tariffs, Tesla subsidies, home renovation handouts, a cap on oilsands production, etc., and a carbon tax is simply added on top, economic theory does not say the tax will fix the regulatory inefficiencies. Instead it will likely make them worse.

I can think of only one instance when a Canadian politician proposed an actual system of carbon pricing. In December 2002, while the Chretien government was promulgating a vast regulatory hodgepodge called the Climate Change Plan For Canada (which, mercifully, was soon abandoned), then Natural Resources Minister Herb Dhaliwal wrote to the Canadian Association of Petroleum Producers to add a little footnote. He assured them that, regardless of the requirement of the climate plan, the industry would have the option of buying emission credits for no more than $15 per tonne.

This was an economically-valid approach, because the price acted as a ceiling on compliance costs—not a floor. Efficiencies arise when emitters, facing a price, identify the abatement options that cost less than the charge and reject the rest. Most provincial and federal packages don’t do this; instead they use the pricing tool as a revenue measure to fund government programs that subsidize the costly strategies the market rejected. This destroys the economic logic of the policy, and justifies Conservative charges that carbon taxes (and cap-and-trade) are just revenue grabs.

The estimated marginal costs of greenhouse gas policies implemented so far in Canada range from a few hundred to a few thousand dollars per tonne. The Obama administration asked its scientific and economic advisers to produce a reasonable estimate for the social costs of carbon emissions, and the resulting numbers were in the $20 to $40 per tonne range through mid-century. On its own this would suffice to show that Canada’s emission policies fail cost-benefit tests.

There’s another more technical point echoed repeatedly in the economics literature but ignored by media and policymakers alike, which further indicts Canada’s policies. The optimal emission price is not the social cost of carbon by itself, it’s that number deflated by an indicator of the cost of the rest of the tax system, called the marginal cost of public funds. This is the number that estimates how much economic welfare is relinquished by the private sector in order to add a dollar of revenue to the public sector. Because of Canada’s heavy tax burden, this number is much higher in Canada than the United States. Recent estimates range from a low of about $1.40 in Alberta to nearly $7 in Ontario. A social cost of carbon of $30 per tonne would imply an optimal emissions price as low as $5 in Ontario.

Canada’s problem is not that we lack politicians who support carbon pricing, it’s that the politicians who keep proposing carbon pricing are attaching the term to policy packages that have nothing to do with the actual concept. The Dhaliwal letter was a brief bright candle of economic logic. Unfortunately, its proposal was never implemented, while most of the bad ideas it was meant to prevent were.