Carbon leakage—the Whac-A-Mole effect

There are many problems with Canada’s federal carbon tax plan, which will rise to $50 per tonne of greenhouse gas (GHG) emissions in 2022, including that a national carbon tax will inevitably be inequitable at the provincial level.

Some provinces are blessed with vast quantities of low-GHG hydropower while others, such as Alberta, do not have large sources of affordable low-GHG energy.

Another problem is that a $50/tonne carbon tax is not enough to significantly change consumer behaviour such as gasoline consumption, and because Canada is a very small global contributor to GHG emissions, will provide no measurable environmental benefits.

And crucially, there’s the issue of “carbon leakage,” which happens when emission-intensive and trade-exposed industries—facing costly climate polices (GHG regulations or carbon taxes)—relocate to jurisdictions with less-stringent environmental policies. Carbon leakage has the potential to further undermine the utility of Canada’s carbon tax given that the United States, our major trading partner, doesn’t have a comparable carbon-pricing plan.

A recent study by Fraser Institute researchers Elmira Aliakbari and Ashley Stedman (with senior fellow Ross McKitrick) put some numbers to the risk of carbon leakage resulting from Ottawa’s federal carbon tax. As a result of a $50 per tonne carbon tax:

…13 industries are exposed to competitiveness pressures in the short run. Specifically, the petroleum and coal product manufacturing sector, which accounts for approximately 0.8% of the national output, will see an estimated cost increase of 25% from a $50 carbon tax and is very exposed to competitiveness pressures. Agriculture and chemical manufacturing (pesticide, fertilizer, and others) is another sector that may be affected by the imposition of a carbon tax. Similarly, many manufacturing sectors including basic chemical manufacturing, primary metal manufacturing, cement and concrete product manufacturing, miscellaneous chemical product manufacturing, and non-metallic mineral product manufacturing will be negatively affected. For instance, the tradable basic chemical manufacturing sector would see a production cost increase of 5.7% in the short term. Similarly, a highly tradable primary metal manufacturing would face a 3.6% increase in production cost. Competitiveness pressures will also be significant for oil and gas extraction and pulp, paper, and paperboard mills, among others.

These higher costs of doing business will not cause an immediate exodus of industries, but as economists point out, capital is liquid and new investment in activities burdened by the carbon tax could flow out of Canada and take their emissions elsewhere, possibly to jurisdictions with lower environmental standards, reducing any benefits of the carbon tax.

Carbon leakage is a bit like a game of Whac-A-Mole. Yes, with carbon taxes in Canada, we may reduce domestic emissions. But in reality, we’ll likely whack them down here to see them pop up elsewhere.