News Analysis Oct 20, 2020 6:19 PM EST

Canada's carbon pricing is a failure, says new report

A new study from the Fraser Institute analyzes 31 OECD countries which have implemented carbon pricing regulations

Canada's carbon pricing is a failure, says new report
Noah David Alter Toronto
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A new study from the Fraser Institute analyzes 31 OECD countries which have implemented carbon pricing regulations, arguing that most of these countries, including Canada, are failing to abide by textbook economic models in the implementation of carbon pricing systems, thereby "undermining their theoretical efficiency."

Governments have been struggling for decades to understand how greenhouse gas (GHG) emissions can be controlled and regulated. While traditional approaches have included "command-and-control regulations" and government financial incentives, economists have since developed more market-based approaches to handling GHG emissions, leaving them largely divided between cap-and-trade and carbon taxes.

The rationale for these measures originates from an economic concept known as "the tragedy of the commons." The concept refers to economic externalities which negatively impact society as a whole, but do not have any special impact on those involved in a transaction. While economic transactions between two or more parties generally account for the costs and benefits sustained by all, they fail to account for "the commons," causing the negative (or positive) impact on society to be ignored in their pricing mechanisms.

In the case of GHG emissions, an example would be an individual purchasing a product from a known polluter. The customer pays for the product at a rate set by the market, which accounts for the cost of production as well the profit margins desired by the manufacturer, and the price which customers are willing to pay for such products. They do not, however, cover the cost society has to pay for the GHG emissions involved in creating the product, since such costs are not bared by either the manufacturer or the seller, but are rather spread across all of society.

Economists, therefore, have proposed two market-based solutions to tackle this problem. Some economists have argued in favour of a cap-and-trade system, whereby the government limits the total amount of GHG emissions the country can produce, and allows companies to trade "carbon credits" amongst each other, with a single carbon credit granting the company permissions to produce a set volume of GHG emissions. As a result, companies which produce more GHG emissions can purchase credits from companies which produce less, but the total amount of GHG emissions produced within a country remains the same.

The other proposal is a carbon tax, which places a set price on GHG emissions, typically measured by tonne, and forces companies to pay a tax proportional to the GHG emissions they produce, regardless of how much they emit.

Under both systems, the companies which have the cheapest options for reducing emissions will do so when the cost of reducing emissions is less than or equal to the tax rate on those emissions, creating a market equilibrium. According to the Fraser Institute, the reason economists favour these market-based approaches "over traditional command-and-control regulations is that the former can raise revenue that could be used to offset some of the costs of the policy while the latter imposes additional costs with no offsetting revenue potential."

While many western countries have implemented one of these two carbon-pricing systems, the Fraser Institute argued that these policies will only increase efficiency if they replace, rather than coincide with, other taxes and regulations. "Research generally shows that using carbon tax revenues to cut capital taxes—corporate taxes or personal income rates on interest, dividends, or capital gains—produces the largest economic efficiency benefits, roughly offsetting the economic cost of the carbon tax," the report reads. Essentially, carbon pricing policies can still generate revenue for the government even as other taxes are being lowered while it continues to incentivize more environmentally-friendly production methods.

Another problem which the Fraser Institute study identifies is that revenue raised from carbon pricing policies rarely goes back into the economy and generally ends up becoming another method by which the government extracts revenue. Canada is an anomaly in this situation, with 90% of revenue raised from the carbon tax in the four provinces in which it applies going towards incentive programs for consumers, thereby putting the money back in the economy.

The Fraser Institute did note that Canada failed to combine carbon pricing schemes with general reductions in regulation and tax rates. This effectively amounts to a double tax, whereby economic agents must bare the cost of taxes and regulation at the same time. This distorts the price of GHG emissions by sending unclear price signals, leading to higher costs for companies, higher prices for consumers, all while failing to optimally reduce GHG emissions to the degree desired by carbon-pricing policies.

In fact, Canada has moved in the opposite direction entirely, seeking to place further GHG regulations on top of a carbon pricing system. The Fraser report cites regulations on methane emissions in the Canadian oil and gas sector as an example, drawing on a 2017 report on the matter from Canada's Ecofiscal Commission.

Economists agree that carbon pricing is an effective and efficient policy in reducing emissions. However, if Canada is more willing to embrace regulations at the behest of ideologically-driven environmentalist advocacy groups rather than focusing on a rational and responsible policy which can effectively reduce emissions while minimizing economic degradation, Canadians will continue to face higher costs of living while failing to reach GHG emission reduction targets.

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