Canada’s carbon tax hampers key industries, may spur ‘carbon leakage’

With Canada’s carbon tax set to reach $50 per tonne in 2022, many Canadian industries are bracing for potential cost increases. Not only will they pay the tax on their own emissions, but they’ll pay higher prices for inputs from other sectors that also face the tax. Given that the United States, our largest trading partner, doesn’t have a comparable carbon-pricing system, we must understand the potential competitiveness risks.

In addition to effects on employment and income, the loss of competitiveness may cause firms to move production and/or new investment to countries without a carbon tax or emissions trading system–a phenomenon known as “carbon leakage.”

If this happens, Canadians will pay an economic price for our reduced competitiveness—in the form of lower employment and/or investment—but emissions will remain relatively stable since the underlying activity causing the emissions has simply shifted to another jurisdictions, which dramatically undermines the intended purpose of the carbon tax.

To understand the extent of this issue for Canadian industries, the study uses the latest data from Statistics Canada to examine the short-term effects of an economywide $50 per tonne carbon tax on domestic commodity prices and the production costs of different sectors of the economy.

According to a recent Fraser Institute study, four industries—petroleum and coal products, agricultural chemicals (pesticide, fertilizer and others), electric power generation, transmission and distribution, and basic chemical manufacturing—will face unit production cost increases of more than 5 per cent in the short-run once the full tax is introduced.

Forty other industries including oil and gas extraction, cement and concrete product manufacturing and primary metal manufacturing, which combined account for nearly 20 per cent of Canada’s output, would see noticeable production cost increases.

The study then looked at which sectors face both a risk of increased costs and international competition. These so-called “trade-exposed” industries are the least able to pass on higher costs to consumers, and thus face the greatest risks from reduced competitiveness.

Accounting for both cost increases and the degree to which sectors are exposed to competition from trade, 13 industries (accounting for 7.0 per cent of Canada’s economy) will face serious competitiveness pressures from the $50 carbon tax, at least in the short-run.

Specifically, the petroleum and coal-product manufacturing sector will see an estimated cost increase of 25 per cent from a $50 carbon tax and is very exposed to competitiveness pressures. Agriculture and chemical manufacturing (pesticide, fertilizer and others) is another sector at great competitiveness risk along with other manufacturing sectors involved in chemicals, primary metals, cement, concrete and non-metallic mineral products.

In response to these concerns, the federal government has designed a system of compensation payments called the Output-Based Pricing System (OBPS) with the intent of limiting the harm to sectors exposed to trade and competitive pressures. However, the study concluded that the compensation system’s design is not tied specifically to factors that determine a firm’s risk of reduced competitiveness. As a result, some firms that lose significant international market share will end up worse off—even under the OBPS compensation plan.

Another important finding of the study is that many sectors of the Canadian economy will not experience much change in their production costs due to the carbon tax. This also means their emissions won’t decline much, if at all.

Finally, sectors facing the biggest competitiveness risk are unevenly distributed across the country, which means some regions will bear a heavier burden than others.

Policymakers must recognize that Canada’s carbon tax comes with serious competitiveness risks for many energy-intensive and trade-exposed industries. The loss of competitiveness could ultimately mean an exodus of economic activities out of Canada, meaning less prosperity here while emissions remain relatively unchanged. This is a lose-lose proposition for the country.