6 things you need to know about the carbon tax before it goes away

Does the world need another article or post about the carbon tax? Probably not. I have tossed around writing a post about it for over a year, and you can argue there is less point now than ever before.

However, the carbon tax is still an election issue. The leader of the Conservative Party of Canada, Pierre Poilievre, still wants to fight a Carbon Tax Election. It was a winning issue before his opponent cancelled the carbon tax, and his political life depends on reigniting the same passion about the industrial carbon price. He is still accusing the interim Prime Minister of implementing a secret carbon tax, or of bringing it back after the election. That being the case, I feel it still might be useful to add some perspective about what it is and how it works.

Six things:

1. Is it carbon PRICING or a carbon TAX?
2. Why do economists love carbon pricing?
3. Does carbon pricing work?
4. Was the Canadian consumer carbon tax revenue neutral?
5. Was the carbon tax making life unaffordable?
6. Is the carbon tax really gone?

Is it carbon PRICING or a carbon TAX?

Pollution is what economists call a market failure. It’s a failure in the usual order of things in a market-based system. Example: When you pay for a haircut you pay for all the inputs and associated costs – the shampoo, the physical space, the labour of the hairdresser etc. However, when you fill up your gas tank or forge a brick in your factory, the cost of those products is missing one important thing: the environmental cost of the pollution that is created.

That cost is large. A report by the Boston Consulting Group and University of Cambridge estimates that global economic output could be reduced by up to 34% by the end of the century if the climate warms to 3°C over pre-industrial levels. As we’re already at 1.5° and accelerating upwards, 3° is well within the realm of possibility. These global economic costs might not hit home like, say, paying rent on a hair salon booth, because these costs are nebulous and experienced somewhere down the road. But the cost is very real and is not naturally reflected in the price you pay for products that generate emissions.

This is where the term Carbon Pricing comes from – because carbon pricing schemes incorporate some portion of the cost of CO₂ into the price of the product, thereby addressing (in part) the market failure. I think it’s important to understand where this comes from.

A Carbon Tax is just a type of carbon pricing – one that obviously take the form of a tax. Others more often used for industrial emitters include transferrable emissions permits, cap and trade and so on. The thing these all have in common is that they are market-based mechanisms where reductions in emissions are driven ultimately by the price we put on them.

Why do economists love carbon pricing?

Economists do love carbon pricing. Here is an open letter from 343 economists across Canada supporting carbon pricing. This statement has received over 1,700 endorsements from economists around the world. Here is another one featuring 28 Nobel Prize winners. What’s the deal?

You have probably read 100 times that carbon pricing is the most efficient way to reduce emissions, but why? I’ll give a couple examples:

Let’s say there are two factories, an old one and a new one, that emit CO₂, and let’s say the government wants to reduce emissions by 200,000 tonnes. It will cost the old factory $10M to reduce 100 KT and the new factory $5M. Total cost if the government regulates emissions reductions equally between the two to hit its target: $15M. But if you establish a carbon market (carbon pricing) then New Factory can do the heavy lifting – it will eliminate all 200 KT of emissions for $10M and sell credit/permits/whatever mechanism to Old Factory for some amount between $5M and $10M. Old Factory saves money by spending less than $10M. New factory saves money by spending (net) less than $5M. Total cost savings = $5M. That’s $5M less cost passed on to consumers vs. a plain regulatory environment.

A retail carbon tax works in much the same way. Decisions are made “on the margin”. In other words, you do the math and decide what purchases to make and when based on your unique values and circumstances.

Another example: the government wants to reduce auto emissions by encouraging electric cars. Option 1: Regulation – subsidize electric cars by say $10,000 each. Some people who claim the subsidy would have bought an electric car any way, thus it’s all wasted money. Some people would have bought an EV with only a $5,000 subsidy. For almost nobody would the marginal benefit of buying the EV be exactly $10,000. But with Option 2: Carbon Tax, decisions are always made based on your calculation of expected benefit based on how much driving you do, and your expectations of the carbon tax increasing over time. You made the decision precisely at the point at which you feel it makes sense for you.

This is why economists say it’s efficient: there is in theory no wasted money in a well-designed carbon market. PLUS: it is often lower cost to administer. Letting a competitive market do all the hard work is a “small government” solution. This is why Conservative governments used to support carbon pricing, including … by the way … the government of Alberta, which was the first to implement industrial carbon pricing in North America.

Does carbon pricing work?

That’s the million dollar question, isn’t it? We know how it’s supposed to work, but does it really?

Good question.

In Canada, our total CO₂ emissions have decreased since our Paris Agreement ‘baseline’ year of 2005 and our carbon intensity has been trending down for even longer for a variety of reasons of which carbon pricing (consumer and industrial) are just one more recent part. I don’t know that you can conclusively say that the national consumer carbon tax has significantly reduced emissions in Canada at this point.

As usual, nothing is simple. There are lots of different schemes in lots of different countries with lots of different people analyzing them in different ways. It’s hard to know where to start. That’s why I like ‘meta-studies’ that compile and normalize results of published individual studies. A) because I’m lazy, and B) because they evaluate studies from all over the place using a consistent and normalized basis of comparison.

This Germany-based multinational team took a look at 80 studies of 21 carbon pricing schemes (including the recently cancelled BC Carbon Tax, but not the newer Canadian backstop carbon tax). Conclusion: 17 of the 21 show statistically significant emissions reductions, with most reducing emissions by 5-10%.

I once read a take from an economist who opposed a retail carbon tax – not because it wouldn’t work, but because it wouldn’t work at politically feasible levels. In other words, the size of a tax that would influence behaviour would also cause people to revolt. I would say that’s not always true – some countries have carbon taxes twice as high as Canada’s and people are fine with it. Although people in those countries probably don’t drive pickup trucks as large as ours.

Trudeau attempted to accommodate that in two ways. First, with the carbon tax rebate that returned the collected funds to the taxpayers, and second, by starting it small and increasing it over time.

Starting small and increasing over time is the right way to do it. Why? Because people are unlikely to make big changes in the short term, but demand for fuel is more elastic over the long term. Starting with a small (and mostly ineffective) tax will minimize the pain in those early years. But … if you know the price of fuel will be increasing in a predictable way over time then you can plan for it, with vehicle purchases, house renos or whatever as budget and circumstances allow, so when the price does get high you’re using less of the stuff. Industry and car manufacturers can plan for it as well, by developing and providing products that meet those expectations.

“Predictability” is the key word there, because that is sometimes hard to come by in a system like ours. Trudeau himself undermined it with his carve-out of home heating fuel a year ago for the Atlantic provinces. That was the beginning of the end of the carbon tax.

As for the carbon tax rebate: that’s a source of contention too. You might not know it even existed if your source of information was the opposition leader’s Twitter feed. Ostensibly the rebate entirely offsets the tax. More on that below. But some people ask: what’s the point of the tax if it’s just returned to the taxpayer? The point is that the rebate is independent of the tax. It doesn’t matter if the rebate is $0 or $10,000, if you burn less gas you’ll have more money if your pocket than if you burn more gas. The incentive is always there. The rebate just raises the overall income level based on a formula that has nothing to do with your personal CO₂ emissions.

Was the carbon tax revenue neutral?

Yes. Mostly. But there’s a catch.

The guy who’s responsible for figuring this out is the Parliamentary Budget Officer (PBO), a guy named Yves Giroux. Unfortunately the messaging around this has been extraordinarily bungled by Mr. Giroux. You know that you’ve garbled your message when opposing parties use quotes from the exact same interview about the exact same report to argue completely opposing narratives about the carbon tax.

Fortunately the PBO’s reports are public and you can read them for yourself (except don’t read the first one because he screwed it up.)

So anyhow, the UPDATED REPORT shows that all direct fuel surcharge revenue is returned to tax payers. Accusations of it being nothing but a tax grab are false.

What’s the catch? The catch is that the tax is taxed. According to the PBO:

“the Government will also collect revenue from the GST on its fuel charge. We estimate that $0.4 billion in GST from the fuel charge will be collected in 2024-25”

So while it’s not “nothing but a tax grab” it is a little bit of a tax grab to the tune of $400 million in 2024-2025.

The PBO, in his way of overcomplicating things, goes further and calculates that, due to the indirect impact of the tax on the economy, the government would lose $1.9 billion in personal income tax revenues and actually end up $1.5 billion in the hole.

This assumed impact in the economy is also broken down in the report to the household level, which is how the Canadian Taxpayers Federation and others can claim that households are worse off because of the tax: “The carbon tax will cost the average household up to $399 this year more than the rebates” they say. However, if you look at the fiscal impact only (tax paid vs rebate received) that $399 cost turns into an average benefit of $173 for that same cohort (see table C5 in the appendix, if you’re interested). This distinction is not made clear by the Federation.

It’s important to note that the impact to the economy is in relation to a “do nothing” scenario, not some alternative plan with it’s associated costs.

Was the carbon tax making life unaffordable?

Attacks on the consumer carbon tax have gone far beyond the notion that they’re costing households in Ontario $399/year. Pierre Poilievre has done a very effective job at blaming affordability in general on it. High post-pandemic inflation is all due to Justin Trudeau’s carbon tax.

Let me ask you a question: are you expecting grocery prices to decrease now that the carbon tax is gone?

No, I didn’t think so. That’s because you know that every other country, carbon tax or not, had high inflation as well so intuitively it doesn’t make sense even if you want it to be true. The Bank of Canada has backed this up, stating that the impact of the carbon tax on inflation has been 0.1-0.15%. Not nothing but not much either.

Getting rid of the carbon tax at once will have a one time impact of lowering inflation (not lowering prices — just the rate at which they increase) according to the Bank of Canada, trusting that the gas companies don’t eat it all up. As I write this, the price of gas at Co-op has gone down accordingly by about 17 cents. So far so good. You will, however, lose the associated rebate forever.

Is the carbon tax really gone?

I don’t know man … you SAY the carbon tax is going away but Carbon Tax Carney is going to bring it back as a “shadow carbon tax” so nothing’s going to change.

What IS this “shadow carbon tax” or “hidden carbon tax”?

The Consumer Carbon Tax is gone and it’s not coming back. The PR battle over that has been lost. The backstop legislation that ensures that all provinces contribute to the emissions reduction effort is still in place. That legislation contained two components: the consumer carbon tax and the industrial carbon price (not a “tax” – see the top of this blog post). The latter is still around.

Probably what is being referred to as a “shadow carbon tax” is the industrial carbon price. The industrial carbon price that nobody including Pierre Poilievre was talking about until the consumer carbon tax was killed. It’s called the Output-Based Pricing System (OBPS), and under it, a value that increases annually until 2030 is applied to carbon emissions above or below a defined cap. More efficient businesses that reduce emissions below their threshold can sell the credits they earn to less efficient businesses. Interestingly, in addition to being able to trade credits on a carbon market, companies can bank them to use in the future when the $/tonne is greater.

Carney, if he were to get a mandate from the voters, would make some changes to compensate for the loss of the carbon tax. You can read a summary of his plans on his website. Basically, he is going to build a carbon market around carbon abatement – like carbon sequestration / carbon capture and storage – but which has no real incentive or structure now. Some companies are pursuing on their own accord, but economics of it are uncertain.

And then he has this: “developing and integrating a new consumer carbon credit market with the industrial pricing system.” No idea how that is going to work. Interesting idea, but sounds like something that might get difficult to manage. I guess when the simplest solution is off the table you have to get creative.

So what now?

The cancellation of the carbon tax was a triumph of bad politics over good policy. Fighting climate change isn’t going to be free or easy, yet people were convinced to turn against a solution that required no additional effort and made most people financially better off. If we can’t support that, what can we support?

We still have the industrial carbon price (for now) and there is probably more to gain from that anyhow, in terms of emissions reductions.

Look: we need to reduce carbon emissions. I’m not going to argue that point here, but you can read this short Twitter thread if you wish.

If we are going to reduce emissions, we should do it in the most efficient way possible. That’s carbon pricing. That is why the majority of the developed world has carbon pricing. Even China has carbon pricing. And yes, the United States has carbon pricing too — not at the national level but at the state level including 2 of the 3 largest states by GDP. So far it hasn’t killed any economies.

I received a survey from the Canadian Taxpayers Federation last week. The lead question was about “industrial carbon taxes” (again … not a “tax”). Specifically, it was about how much you believe it is costing individuals. Not whether other methods of reducing emissions (like Poiliervre’s vague industrial credit policy that is nowhere on his website) would take more or less money out of your pocket. No … the implied alternative is always “do nothing”.

Canada has no business freeloading off of the rest of the world’s efforts to reduce emissions. It is a collective effort. Doing nothing is not an option.