Canada should rethink its carbon-pricing policies

It’s widely acknowledged among economists that carbon-pricing is the most efficient way to reduce greenhouse gas emissions and address climate change. While tackling climate change is a priority, existing carbon-pricing schemes across most high-income countries—including Canada—need a rethink as they all fail to resemble anything close to well-designed policy.

Again, putting a price on carbon is the most cost-effective way to reduce emissions as it provides flexibility to individuals and businesses to either pay the price of emitting or find cheaper ways to reduce their emissions. The price system involves a network of individuals and businesses and helps determine where, how and how much emissions should be reduced. Critically, however, there are several key conditions that must be met for carbon-pricing to be efficient (i.e. least costly).

First, carbon-pricing should be “revenue neutral,” meaning that revenue collected from carbon taxes must be used to reduce other more costly taxes including personal and business income taxes.

Second, and related to the first condition, governments must avoid subsidising substitutes for carbon-emitting activities. Subsidising substitutes (such as wind and solar energy) increases the cost of reducing emissions and defeats the whole purpose of carbon-pricing, which is to allow the market and prices to determine the right substitutes.

Third, the introduction of carbon-pricing should trigger the repeal of emissions-related regulations. Layering a carbon tax on top of existing regulations increases the cost of emissions reduction because it means both regulations and prices affect decisions. Again, the point of a carbon tax is to rely on prices and market decisions to drive the reduction in emissions.

In our new study, we analyzed carbon-pricing policies in 31 high-income countries (OECD) to determine whether existing carbon-pricing schemes meet the key conditions of a well-designed carbon policy. The study found that no high-income OECD country has implemented a well-designed carbon-pricing system.

Specifically, no country is using all revenues from carbon-pricing (either from carbon taxes or emissions-trading systems or a combination of both) to reduce other more costly taxes, which again helps to improve economic growth. In fact, our study found, on average, that 74 per cent of carbon tax revenues in 14 high-income OECD countries were used simply as general revenues for the government. Only 14 per cent of carbon tax revenues (on average) were returned to taxpayers. This suggests that carbon taxes are mainly used as a revenue-raising tool for governments rather than a mechanism to reduce emissions in the most affordable way possible.

The remaining 12 per cent of carbon tax revenues (on average) were allocated for environmental purposes. For example, in 2017, France allocated almost 30 per cent of its carbon tax revenues to a special fund that subsidizes the development of renewable energy sources (including wind and solar) while Japan spent all its carbon tax revenue on energy conservation programs, renewable energy infrastructure and energy efficient equipment for small and medium-sized companies.

Finally, no high-income OECD country with carbon-pricing has eliminated the corresponding emission-related regulations. Indeed, many of these countries not only failed to replace existing regulations with carbon-pricing but actually introduced new regulations after introducing carbon-pricing.

Overall, no high-income OECD country has implemented a well-designed carbon-pricing system that reduces emissions while improving the economy. Governments across Canada—including in Ottawa—should rethink these policies so we can reduce emissions in a more efficient and productive way, with an eye on the economy and the prosperity of Canadians.