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The case for a federal carbon price

Glen Hodgson
Senior Vice-President and Chief Economist
Forecasting and Analysis

Originally Published in The Globe and Mail on June 15, 2016

Carbon pricing is a powerful tool at the disposal of governments to help Canada transition toward a low-carbon economy. The federal and provincial governments are discussing ways to implement a more pan-Canadian approach to carbon pricing. A number of provinces have introduced, or are preparing to introduce, their own carbon-pricing systems tailored to local economic and greenhouse gas (GHG) emission circumstances. There is a strong case for the federal government to join them.

A carbon price creates incentives to innovate and reduce the consumption and production of hydrocarbons and GHG emissions with a significantly lower impact on gross domestic product than relying on regulations. Canada’s Ecofiscal Commission, of which I am a member, analyzed the issue of carbon pricing in Canada in detail in its study The Way Forward (which just won the Canadian Economics Association’s Doug Purvis award for the top research study in 2015). The Ecofiscal Commission reached a consensus recommending carbon pricing at the provincial level via a carbon tax or cap-and-trade system as an effective policy action that could be enacted fairly quickly.

Carbon pricing is clearly more effective than regulations. Canada’s provinces have different economies and different sources and levels of greenhouse gas emissions. There is provincial momentum – four provinces have already implemented or are acting to put a price on carbon, and Manitoba has recently suggested it would develop its own carbon price system. Recycling revenues from carbon pricing on energy and industrial production is a political and policy challenge, especially if recycling takes place across provincial boundaries. Provincial carbon pricing avoids that concern.

That said, Canada is a complex federation where innovations in policy have often been launched by one government, be it federal or provincial. Other governments learn from the practice and then examine if they wish to implement a similar policy. The provincial carbon-pricing systems adopted or under development are different, continuing the long Canadian tradition of policy asymmetry to achieve similar ends.

In a world where provinces are introducing carbon-pricing systems that reflect their political, economic and GHG emission differences, why might the federal government introduce its own carbon-pricing mechanism? In our view, there are four reasons for considering a federal carbon price.

1. National coverage: A federal carbon price would create a common incentive across the entire country to reduce the consumption and production of carbon.

2. Better public policy: A federal carbon price would accelerate the adjustment to a low-carbon economy through changes to relative prices, reducing the need for regulations to meet GHG emission target ambitions. Using price signals to reduce GHG emissions has a more positive economic impact than relying on regulations, providing flexibility and choice to consumers and businesses.

3. Price clarity over time: A federal carbon price could provide clear signals on what is called stringency, or planned increases in the carbon price over time. This core principle would help consumers better plan their vehicle purchases, energy use in housing and other lifestyle choices. Businesses would have greater price certainty and incentives to innovate, finding the best technologies and processes to reduce industrial emissions.

4. Superior fiscal outcomes: Introducing a federal carbon price would generate new government revenues and create fiscal room to reduce other taxes, specifically on income and investment. This approach would improve overall economic competitiveness within the existing fiscal framework. Using subsidies to change relative prices and influence behaviour is a cost to governments, while using a price on carbon to change relative prices would generate positive cash flow.

To build public support, our preference would be for the federal carbon price to be revenue neutral. Alternatively, carbon price revenue could be used to fund low-carbon infrastructure investment or transferred to other levels, specifically municipalities (thereby allowing any planned federal infrastructure transfers to be reduced).

Initial implementation of a federal carbon price need not be complicated, since the feds already have the gasoline tax – a de facto carbon tax – as a base. Individuals could choose to avoid a carbon tax on gasoline by using alternatives like public transit, hybrid/electric vehicles, cycling or walking. Other variations of a federal carbon price could of course be considered, distinguishing between end-demand for energy and GHGs resulting from industrial production.

There are good economic, policy and practical reasons why provinces should be designing and implementing comprehensive carbon-pricing systems that address their specific interests. But the federal government could also consider its own approach to carbon pricing, thereby creating fiscal space for other pro-growth priorities to help Canada transition to a low-carbon economy.

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