What’s up? Not much, just Canada’s carbon tax.

With the rate at which our news cycle is shortening, it is really no surprise that climate change faded into the background in discussions about current events. After all, so many things have happened in 2020 that would make any sane person question, has it really only been 12 months? However, our world is running out of time to play peek-a-boo with climate change, just because you can’t immediately see its damages does not mean that they don’t exist. For instance, we can draw parallels from climate change and the recent coronavirus pandemic in their abilities to disproportionately impact the underprivileged communities and individuals within the society. The Canadian government recently unveiled its new climate plan, including annual increases in carbon pricing.

As an economics student who just made it through her final finals-season across several time zones, I will in this post go through the federal government’s carbon pricing annex of its new climate plan, and with my leftover brain cells try to rationalize its implication through an environmental economics lens.

Carbon pricing, and some Canadian context

Carbon pricing is an elegant system that works by putting a price on damages caused by pollution. It represents a way to address emissions mitigation in the most efficient way possible, in addition to incentivizing innovation on technology. It puts pressure on polluters to internalize some of the damage caused by emissions.

Canadian jurisdictions have had pollution pricing in place since 2009. These systems are flexible enough to allow technological advancements, as well as geographical and economic differences between regions across the country. Currently, provinces and territories have the option to choose between a federal pricing system, or designing a pricing mechanism specific to its own jurisdiction, subject to mandates set by the federal government to meet national standards.

According to the federal government, putting a price on carbon pollution is working in Canada, through channels such as encouraging efficient and cleaner use of technologies, incentivizing innovation of new approaches to reducing pollution and saving money at the same time.

Contrary to what some fossil fuel lobbyists might have us believe, carbon pricing is not a cost to society as a whole. In fact, there will be continued support from the federal government in the form of transfers to make sure that the majority of households will continue to be better off. The new system will remain revenue neutral, in that the revenue collected from firms will be transferred back into society in the forms of payments and climate action programs.

Therefore, the government “profit” generated for carbon pricing represents a transfer of benefits back to individuals and communities under a mechanism that promises to make the majority of Canadians better off. In addition, the amounts received by households do not depend on energy consumption, giving families incentive for using less energy.

So what’s the big deal ?

The new update in the government’s climate plan announced an annual increase of carbon price through to 2030. The central policy outlined in the document would update the annual increase in carbon price from $10 per year to $15 per year beginning in 2023, paving way for a steady yearly rise in the tax to $170 per tonne by 2030.

As profit maximizers, the most efficient level of emissions for businesses would be at the point at which they would be indifferent to paying the carbon tax, or producing one more tonne of carbon emission. Therefore, by increasing carbon price overtime, polluters would become more likely to choose reducing emissions over paying the tax.

This new carbon pricing mechanism is designed to increase slowly and predictably over time. This would give some flexibility to businesses to think about discount rates and how they will approach trade-offs across time in pollution reduction. Individuals and businesses will likely be more motivated to make changes and begin investing in more efficient technology today, if they know that it will be more expensive to pollute ten years from now.

This is an effective approach in incentivizing technological innovations to reduce carbon emissions, because firms that employ new technology or businesses strategies that produce less pollution will be able to pay less for their damages. As profit maximizers, businesses will try to find better ways to reduce costs in mitigation of carbon emissions. In the long term, this will hopefully lead to a low-carbon transformation that will keep the Liberal government’s promise on track for Canada to go net-zero by the year 2050.

The government will also ensure that the price remains affordable, while maintaining a level that encourages communities to increase energy efficiency to further reduce emissions. The new plan also outlined a more ambitious transfer to accompany the increases in carbon pricing, and the government is committed to return more in payments than they face in costs. This means that annual payments to individuals could eventually increase to quarterly payments!

Social cost of carbon

When considering pricing of pollution and carbon, it is also important for the government to consider externalities, especially costs in the forms of health damage to individuals and environmental damage to ecosystems. Greenhouse gases and carbon emissions are cumulative pollutants that build up overtime, so it is very difficult to measure and predict damages to society. The social cost of carbon accounts for damages caused by global pollution that is expected from a ton of extra emission of carbon dioxide.The Canadian government currently uses $50 per tonne of CO2 as its measure of social cost carbon.

At first glance, the government’s plan to increase the price to $170 per tonne of emissions may seem like a really significant step in emissions reduction, it may even seem like overkill to price emissions at more than 3 times its estimated social cost. However, the current social cost and other similar estimates from older formulas likely underestimate damages of climate change and the social benefits of reducing carbon pollution, and it is especially difficult to predict long term external costs. Consequently, the government has stated in the annex document of its intentions to revise and the social cost of carbon.

Federal Enforcement

It is evident that there exists friction between the provincial and federal governments, as the carbon tax has found staunch opposition from some of the conservative governments across the country. The new plan for carbon pricing puts emphasis on strengthening federal presence within carbon pricing systems. The federal government would need to maintain its jurisdiction over provincial and territorial pricing systems, while upholding effective price signals nationally.

More rigorous assessment also needs to take place on the federal end, as the federal government would need to review its criteria for evaluating effectiveness of provincial systems, in order to strengthen national standards to help meet Canada’s climate goals. This is especially important as inaccurate information will hinder the effectiveness of the system and cause it to underdeliver in terms of emissions reduction.

The key elements to help the government to strengthen assessment and regulation are outlined below:

  • “Common scope and coverage: ensuring all systems apply a price to a more consistent set of greenhouse gas emission sources
  • Clear price signal: making sure all systems create a strong incentive to cut emissions by sending a clear price signal, including credit markets. Government rebates to consumers and businesses should not weaken price goal
  • Increasing stability: consumers and businesses need long-term certainty about which carbon pricing system applies. This may involve moving to multi-year assessment periods.”

Meeting these monitoring objectives would require collective effort between federal, provincial and territorial governments, and local communities. The government also needs to make sure that equity considerations are taken into account. This includes recognizing differences in culture (i.e. for Indigenous populations), geography and other circumstances such as food security and costs of living for communities across the country.

Back to the future…

Moving forward, the government also outlined a federal offset system that promotes cost-effective, voluntary reductions and emission removal by businesses that are not currently covered by carbon pricing. This system may also encourage project developers such as farmers, foresters, and Indigenous communities to implement projects and engage in innovation to reduce carbon pollution. Businesses can use offset credits to meet their internal corporate climate goals as well.

Prime Minister Trudeau has also touched upon the impacts of globalization and the demand for cleaner technology from industry investors. This trend also adds additional incentive for jurisdictions and businesses to move towards greener practises, as it would attract global investment.

Despite foreseeable benefits, the federal government still faces challenges to carbon pricing in its current form. One of the main barriers comes from constitutional opposition from conservative-run provinces like Alberta and Ontario. The current government still has a difficult balance to strike between the conservative opposition, and that of the NDP and Green parties who do not believe that the plan is ambitious enough, especially given Canada’s consistent underperformance in its actions to meet 2030 targets.

Personally, I am quite optimistic that Canada may be able to pull off and surpass the 2030 targets, especially given our government’s response to the Covid-19 pandemic. As this decade unfolds we should be able to get more clarity on the impacts of this new climate plan, both environmentally and economically. For now, cheers to 2021!

References

Connolly, A. (2020, December). The carbon tax is going up. Here’s how much more you could pay at the pumps. Global News. Retrieved from https://globalnews.ca/news/7515981/canada-climate-change-plan-justin-trudeau/

Environment and Climate Change Canada. (2020). A Healthy Environment and a Healthy Economy. Environment and Climate Change Canada.

Field, B., & Field, M. K. (2020). Environmental Economics (8th ed.). McGraw-Hill Education.