Economists Olewiler and Kesselman get the economics wrong on B.C.’s carbon tax

In recent Vancouver Sun column, Simon Fraser University economists Nancy Olewiler and Rhys Kesselman dispute an earlier column by three Fraser Institute economists (Kenneth Green, Elmira Aliakbari and Ashley Stedman), which criticized changes to British Columbia’s carbon tax.

Green et al. made two points: (1) abandoning revenue-neutrality makes the tax intrinsically less efficient, and (2) using the revenues to subsidize other emission-reduction options makes it even worse. Olewiler and Kesselman claim that Green et al. are “off-base on all counts.” But it’s Olewiler and Kesselman who get the economics wrong.

The two topics under dispute correspond, roughly speaking, to the macroeconomic costs and the microeconomic benefits of a carbon tax. Regarding the first, Olewiler and Kesselman make the sweeping assertion that “How a government chooses to use the revenues from a carbon tax has nothing to do with the efficiency of the tax itself.”

This is incorrect and disregards decades of research into the macroeconomic impacts of alternate revenue-recycling options.

While a carbon tax might have virtuous intentions, it is nonetheless a tax, and like all taxes it both imposes its own burdens and amplifies the economic costs of all the other taxes in the economy. These secondary effects matter. The way to minimize the overall macroeconomic burden of an emissions tax is to use the revenue to reduce other tax rates, thus offsetting the secondary feedbacks. Research has shown that failure to do so (for instance, by spending the money or refunding it in lump-sum transfers) can inflate the total macroeconomic cost of a carbon tax between two and 10-fold, depending on the emission reduction target. The revenue-recycling decision matters acutely. On this issue, to coin a phrase, “the science is settled.”

Perhaps Olewiler and Kesselman are thinking of the microeconomic benefits of a carbon tax, namely the incentives for emitters to find the least-costly way to reduce emissions. A carbon tax works by creating a price ceiling, below which it is cheaper to cut emissions than to pay the tax. With everyone facing the same ceiling, decision-makers throughout the economy have an incentive to identify the cheapest abatement strategies and reject the rest, thus achieving the overall emission reduction target in the least costly way. In this Olewiler and Kesselman are correct: the revenue-recycling rule does not affect this aspect of the tax’s efficiency.

Both sides agree with this logic, in principle. Green et al. then note the corollary, that supplementing the tax with other green regulations scrambles the incentives and dissipates the microeconomic benefits. Olewiler and Kesselman protest this, citing with approval policies like low-carbon fuel standards, zero-emission vehicle charging stations, renewable electricity mandates, et cetera. But the fact that regulations are needed to get people to adopt these strategies shows that they are the inefficient options the market rejected. By coercing people to pay for them anyway, the government defeats the whole purpose of a price mechanism.

In other words, any emission reductions achieved through such regulatory measures must cost more than equivalent reductions achieved under the carbon tax.

I’m sure Professor Olewiler grasps this point—I have her textbook open on my desk at the page where she explains it. So I am stumped at their claim that “Proper economic analysis repudiates the Fraser Institute’s… rejection of regulatory climate measures.” They acknowledge that a high carbon tax has negative effects on competitiveness, but don’t acknowledge that this will be even more true of their list of supplementary regulatory measures. Just because compliance with regulations doesn’t involve remitting taxes to the government doesn’t mean it isn’t costly for households and businesses. The costs will be better hidden, but if anything they will be even larger.

The Fraser Institute economists have correctly identified principles that could minimize the economic burden of achieving B.C.’s emission targets. The B.C. government has chosen to move in a different direction. No one should be under the impression that this decision comes without costs.