Does Canada need a carbon tax?

Vancouver, Canada (GLOBE-Net) - As an instrument for reducing greenhouse gas emissions, carbon credit trading has been selected over a ‘carbon tax’ in most jurisdictions worldwide. However, some business leaders and economists believe a carbon tax is a more effective vehicle for curbing emissions. A noted corporate think-tank recently published an article proposing a hefty increase in gasoline taxes, prompting a closer look at a policy instrument that has thus far been unpopular in the mainstream business community.

Many economists conclude that the application of a tax on greenhouse gas emissions is the most efficient method for reducing energy consumption, decreasing fossil fuel use, and promoting alternative energy sources. Such a tax would send a price signal directly on fossil fuel consumption and other emissions sources, ideally calculated per tonne of greenhouse gases produced. In its most explicit form, a carbon tax could involve a levy per litre of gasoline purchased, based on the emissions that will result from its combustion.

With a direct cost placed on emissions, companies will be encouraged to invest in cleaner technologies and increase energy efficiency. Leading companies will be rewarded with tax savings while laggards will be penalized. Revenues from such penalties could be used to lower other taxes or invest in environmental technologies. Consumers also will adjust their spending patterns to avoid higher costs.

While appealing because it achieves emissions cuts in a theoretically efficient manner, carbon taxation has taken a backseat to another market-based policy: carbon trading. Carbon credits are issued or auctioned and emitters can only release as much greenhouse gas emissions for which they have credits. Excess credits can be sold to those who need them on the open market, creating a financial incentive for investments that lower emissions.

Perhaps due to an predictable aversion to taxes by the business community and a preference for market-based buy and sell mechanisms, many business groups endorse the credit trading approach.

Most governments view carbon taxes as a politically risky proposition, as the public reaction to any policy that increases the price of goods such as gasoline is usually negative.

But a growing number of analysts and economists, as well as political and business leaders, are backing the idea of a tax on emissions.
The National Roundtable on the Environment and the Economy (NRTEE) promotes Ecological Fiscal Reform, “a strategy that redirects a government’s taxation and expenditure programs to create an integrated set of incentives to support the shift to sustainable development.” In that context, the Roundtable suggests that a broad-based price signal such as a carbon tax (or carbon trading) “warrants serious discussion and attention”, given the limited effectiveness of the current subsidy and information approach.

Difficulties in implementing a carbon tax would include public mistrust of taxes and the need to ensure the proper use of the proceeds by government. But a low charge on energy or carbon could be used to support other emissions reduction instruments, says the Roundtable Report.

In her 2004 report to Parliament, Johanne Gelinas, Canada’s Commissioner of the Environment and Sustainable Development, recommended that the Department of Finance identify areas in which the federal tax system is an impediment to sustainable development, and encouraged fiscal reform to better integrate the economy and the environment.

Canada’s current tax system provides credits and other incentives for renewable energy and energy efficiency, but also contains support for emissions intensive industries, and the overall fiscal approach to the environment is rather “piecemeal”, notes a review of Ecological fiscal reform by the Library of Parliament.

A more complete analysis of a carbon tax was recently undertaken by The American Enterprise Institute, a U.S. based conservative think-tank supported by business interests, which published an article in favour of removing subsidies for all types of energy and imposing a tax on greenhouse gas emissions.

The paper attacks government policies which provide subsidies and tax breaks for oil and gas production as well as renewable energy and ethanol. A better approach, argues author Kevin Hassett, a former economic advisor to George W. Bush, would be to levy a tax on the energy sources that one wishes to discourage. If carbon emissions are the concern, then a tax on fossil fuels is an appropriate response.

The article indicates that a tax of $12 per metric ton of greenhouse gas emissions would make wind and biomass energy cost-competitive with natural gas. A tax of that scale would increase gasoline prices by only ten cents per gallon if it were fully passed on to consumers.

If the tax were set at a price of US$15 per tonne of CO2, comparable to the market price of carbon credits in the European Union Emissions Trading System (EU ETS), the price of gasoline would be raised by 13 cents a gallon, the cost of natural gas electricity by 0.6 cents per kilowatt hour (kWh), and the cost of coal-generated electricity by 1.4 cents per kWh.

The billions in revenue that would be generated from such a carbon tax could be used to reduce other taxes, making the overall effect revenue neutral. Overall taxes paid would remain the same, but those who emit large amounts of greenhouse gases would be more heavily taxed than those who employ cleaner forms of energy.

Taxes versus Trading

Duke Energy Chairman Paul Anderson has also supported a carbon tax. While it may seem unusual for the head of a firm with major interests in coal power to promote an emissions tax, Anderson believes that a tax is the easiest, quickest way to address emissions without playing favourites among industries.

He and others believe that a carbon tax avoids some of the significant shortfalls of carbon trading systems. Carbon trading requires extensive government controls and supervision, and the decision on which sectors to include can leave some business interests holding the bill while others emit freely. A carbon tax is an equal-opportunity price on emissions and can be applied to sectors which would be difficult to cover using emissions trading, such as transportation and consumer goods. As well, it cuts out the hefty transaction and regulatory costs associated with carbon credit markets.

A carbon tax would also avoid ‘hot-air’- the idea that some credits don’t represent real reductions in emissions, and are perceived by some as an expensive way of achieving nothing. In the emerging international carbon credit market, there have been some undesirable collateral developments which cast doubt on the effectiveness of emissions trading.

For example, trifluoromethane, or HFC-23, a particularly potent greenhouse gas, has been the target of many projects under the Kyoto Protocol’s Clean Development Mechanism, which allows companies in industrialized countries to earn credits by investing to reduce emissions in developing nations. The results of some projects show the system’s potential weaknesses. A United Nations study concluded that industrial nations would pay up to $800 million to buy the credits earned by incinerating the gas, even though the cost of building and operating the incinerators would be a mere $31 million annually.

A carbon tax which equalled the much lower cost could be easily applied to encourage Chinese firms to invest in the incinerator technology, it is argued.

However, opportunities for such ‘easy’ projects are not likely to be available much longer, and carbon market analysts say that future growth is more likely in the areas of energy efficiency, renewable energy, and carbon capture and sequestration. Such projects would produce more verifiable emissions reductions and can also bring revenue to firms in both developing and industrialized countries while accelerating the adoption of new technologies.

Also carbon markets remain vulnerable to price fluctuations, such as the precipitous drop in the value of EU credits earlier this year caused by over-allocation. A carbon tax would require only small adjustments to cope with inflation, advocates point out.

It is held that a properly designed carbon tax could be revenue neutral or positive for many firms. The government revenue earned could be used to reduce other taxes, or invested in other areas of the economy. Instead of taxing ‘good’ behaviour such as making income, a carbon levy taxes ‘bad’ behaviour, namely greenhouse gas emissions. This philosophy can be applied to other areas as well, in what is called a ‘green tax shift’.

Gasoline taxes are a form of carbon tax already in place, and New Zealand, Germany and the United Kingdom have been charging greenhouse gas taxes with some encouraging results. The United States applies a small tax on oil and gas revenues that supply a ‘Superfund’ which is used to clean up the most contaminated sites across the country.

In Canada, former federal Environment Minister Rona Ambrose has stated that it was not the federal government’s intention to impose a carbon tax. Speaking at the announcement of the federal Clean Air Act in Vancouver in October 2006, she said “we will not use a carbon tax because the only people that end up paying are Canadian taxpayers – and we think they have paid enough with their health… Any industry that goes over their greenhouse gas limits will be fined and will pay into a Canadian Technology Fund. The money paid into the fund will be reinvested in technology to reduce greenhouse gases.”

Québec’s twenty-four point climate change plan includes a tax on oil and gas companies for hydrocarbon products sold in bulk to retailers. The tax will produce around $200 million a year for a “Green Fund” which will provide resources for other aspects of the plan.

There are reasons why a taxation approach has generally been poorly received. First, taxation of any sort does not normally appeal to anyone. The idea of trading emissions sounds more like a free market instrument, something which businesses can easily respond to. While a carbon tax is also market based because it sets a price for emissions and allows companies to respond however they wish, the idea of credit trading seems easier to swallow for many.

In Canada’s western oil producing-region, a carbon tax or other fiscal measures may be viewed as an updated version of the much maligned National Energy Program of the 1970s, and a cash-grab against the oil and industry. Even so, an Ipsos-Reid poll in November 2006 found that 54 percent of Albertans favour a carbon tax, higher than the national average of 52 per cent.

But such poll results have garnered little political favour for carbon taxation. Former Alberta Premier Ralph Klein responded to the poll, saying “It’s nice to say that we support a carbon tax until you have to dig into your pocket and come up with the money.” He added that the poll would produce a different result depending on whether the tax was $10 per month or $100 per month. For legislators, setting the hard emissions cap needed for carbon trading allows them to establish firm emissions targets and meet them, which is politically attractive and easily applicable to agreements like the Kyoto Protocol. A carbon tax would produce slightly uncertain results, however, since setting it at an appropriate level depends on gauging how much businesses will be willing to pay before they will invest in cleaner technologies.

Another argument for emissions trading is that it allows emissions reductions to be allocated to the most efficient places. For instance, a coal plant in a developing country can be replaced by natural gas or hydroelectricity at a much lower cost than achieving equivalent emissions cuts here in Canada. A carbon tax would only encourage domestic investments, and would only encourage emissions reductions that are cheaper than the tax itself.

Putting a price on carbon

Regardless of which policy is enacted, the key ingredient must be a financial penalty for emitting greenhouse gases. Any policy without this monetary incentive is doomed to fail, as has been demonstrated with the lack of success of Canada’s past approach, economists note.

In Burning Our Money to Warm the Planet — Canada’s Ineffective Efforts to Reduce Greenhouse Gas Emissions (PDF, Professor Mark Jaccard of Simon Fraser University predicts that a continuation of the past “subsidy and information” approach in Canada would result in a cost of $80 billion over the next 35 years while allowing emissions to rise by a further 50 percent.

While a carbon tax is preferable according to Jaccard, “if the public is not yet ready for complete reliance on the taxation approach” a tightening limit on emissions or an expanded cap-and-trade scheme could be employed.

While current voluntary systems have achieved some progress, businesses and consumers respond to the bottom line, and many will continue to make energy-inefficient choices as long as the free discharge of greenhouse gases is permitted to continue.

Incentives and subsidies allow firms and individuals to ‘free ride’, or continue to emit GHGs without fear of penalty. While programs such as the Wind Power Production Incentive (WPPI), which provides a subsidy for wind energy, have led to an increase in alternative energy use in Canada, economists argue that such programs can distort consumer behaviour in choosing alternative energy sources, making them a biased and inefficient policy overall.

With a price on emissions, there are opportunities for companies to increase profits by investing in clean technologies such as wind power, and those who rely to heavily on inefficient fossil fuels will pay the price.

Businesses will almost certainly pass these extra costs on to the consumer to some degree. A carbon tax in Canada would have to be applied at the point of sale instead of the point of production to avoid excessive harm to the oil and gas industry, which is a price-taker in international markets. Emissions tied to Canada’s energy exports would then become an issue which could require further action.

Until clean sources of energy become less expensive than conventional fossil fuels, the reality is that reducing greenhouse gas emissions will cost some money in the short-term. But the cost will be minimal if the proper policies are employed. Climate science and economic studies indicate that the cost of inaction will be far greater than a few cents per litre increase at the gas pump.

In order to avoid the potential political misstep of an explicit carbon tax, the government may choose a more subtle approach to send the necessary price signal to consumers and businesses. There are a number of tax adjustments which could be made to simulate a carbon tax without specifically applying one, and there is ample room to use existing tax instruments more effectively in this manner. Tax credits can encourage environmentally positive activities such as creating carbon sinks, while subsidies can be removed and/or penalties can be imposed for environmentally negative activities which produce pollution.

The central imperative is taking effective action on climate change, be it a carbon tax, an emissions trading system, or promotion of alternative energy and environmental technologies. Climate change is real and ignoring the issue will only increase economic and environmental costs in the future. Tax or trade, the trend of skyrocketing greenhouse gas emissions in Canada must be reversed.

You can return to the main Market News page, or press the Back button on your browser.