The Least Costly Path to Climate Action

Carbon pricing has been a wedge issue for the last decade – dividing provinces, political parties, and of course, dinner tables across Canada. For those who oppose a carbon tax, it is a ‘job killing tax on everything’, usually accompanied by unchecked increases in government spending, and is more about raising money for governments than reducing emissions across the economy. Meanwhile, many economists and policy wonks have argued that carbon pricing is the best way to achieve both a strong economy and a clean environment, allowing us to reduce greenhouse gas emissions at the lowest possible cost to Canadians.

So, how do we know which view is right? The public is rightfully concerned with the potential economic implications of current and proposed carbon policies, and to date, governments have been challenged in clearly explaining them. Many political and business leaders have called for thorough economic impact analyses to get a clearer understanding of both the economic implications of carbon pricing alternatives and their associated emission reductions.

Despite this, to date there has been very little analysis released that weighs both the economic and environmental impacts of various carbon policies, while taking into account the very different economic and policy contexts in each province. This research gap has led to misinformation on the likely impacts of carbon policy, leading to highly polarized positions on taking climate action.

To fill this gap, Canadians for Clean Prosperity, commissioned our co-authors Chris Bataille and Dave Sawyer to undertake a new analysis and modeling. The modeling reveals that with the right mix of carbon pricing policies, Canada, and the provinces can make significant progress towards meeting the country’s emission reduction targets – a 30% reduction in emissions from 2005 levels by 2030 – with only modest economic costs. We looked at which mix of policies could achieve the greatest carbon reductions at the lowest economic cost – a goal that we believe is a critical one for governments and policy makers. It is our hope that a better understanding of the economic implications of carbon policies will add some light to a debate usually characterized by heat, and help counter the polarization of this important policy debate.

What we modelled

To test the performance and scalability of carbon pricing alternatives, we examined two leading carbon-pricing schemes, at both national and provincial levels, to assess how economic activity and emissions change:

The Pure Carbon Tax Scenario

A pure carbon tax, modelled after the system implemented in British Columbia in 2008, covers buildings, transport, light manufacturing and large industrial emitters. As in BC, this scenario assumes a price on emissions across these sectors, but is revenue neutral, with revenues being used to reduce corporate and personal taxes as well as lump-sum payments to households. A key difference between the carbon tax we assess and that currently in place in BC is that ours covers not only the GHGs from burning fossil fuels, but fugitive and process GHG emissions (e.g. GHGs from the chemical process of making cement, and natural gas that leaks from the oil and gas wells and pipelines) as it is anticipated that future carbon policies will include these types of emissions.

The Hybrid Carbon Price Scenario

Our second alternative was a hybrid carbon pricing system, following the 2015 proposal of Alberta’s Climate Leadership Plan, which is the basis for the system Alberta plans to implement in 2018. As with the BC system, the Alberta plan includes a broad-based carbon tax on buildings, transport, and light manufacturing. Under the Alberta system, however, emissions-intensive, trade-exposed (EITE) industrial emitters are able to use other compliance options, such as trading carbon allowances, and are given output-based allocations linked to their output and GHG intensity.

For both models, we assumed that the carbon price would rise from $30 per tonne in 2018 to roughly $110 per tonne by 2030. Except where noted, we’ve presented our findings based on systems wherein revenue is recycled through tax cuts.

We found that when these policies are applied Canada-wide, both the pure carbon tax and the hybrid method of pricing carbon can cost-effectively close Canada’s gap to its 2030 emission reduction target. Across the board these two policies deliver substantially more reductions compared to the current trajectory of federal and provincial policies.

Reductions in emissions under the BC-style carbon tax and Alberta-style hybrid carbon price scenarios are particularly striking in Saskatchewan, where emissions in the analysis rise 10% by 2030 under current provincial policies. Under a BC-style carbon tax emissions are expected to drop by 18%. Better still, under Alberta’s hybrid model Saskatchewan can expect to see a 33% drop in emissions. By 2030 Canada can reduce its emissions by about 13 to 14% below 2005 levels under either a pure carbon tax or hybrid carbon price model, compared to the 5% reductions expected under current policies (including federal transportation and coal regulations, Quebec and Ontario’s cap and trade system, BC’s carbon tax, and Alberta’s proposed carbon pricing system).

It’s clear that deeper reductions are seen in all provinces across Canada under both variations of carbon pricing. However, our modeling also shows that these deeper emission reductions don’t need to come at an increased cost. We can decarbonize while better protecting economic performance using a hybrid carbon price policy at the national level. When applied to key jurisdictions and Canada-wide, the hybrid carbon price policy actually boosts economic performance when compared to current and developing federal and provincial policies. For energy producing provinces, an Alberta-style hybrid carbon price model (which provides some emissions allowances to industry based on their production) improves economic performance by 1.43% in Alberta and 4.23% in Saskatchewan, compared to the fragmented mix of current and developing federal and provincial policies [see Still Minding the Gap, produced by EnviroEconomics and available on their website]. The hybrid model, applied at the national level with regional trading, is seen to help alleviate competitiveness concerns in the two western provinces, which have largely been assumed to be the most impacted by carbon pricing, as well as helping with Canada-wide competitiveness concerns.

Of course, significant revenue is expected to be collected by government as we continue to price carbon, so we also assessed two ways governments can use the revenue collected to maximize emissions reductions and minimize negative economic impacts:

Returning money to taxpayers in the form of tax cuts: Revenue neutral recycling designed to reduce the economic impact of the policy, with 90% of money collected returned by government to reduce industry and personal income taxes, with the remaining 10% given directly to households to address adverse income impacts.

Spending on programs and projects that reduce emissions: Programmatic spending intended to reinforce the emission objective of the policy, with government expenditures focused on increasing low emitting technology by driving down the long-term costs of technology.

The two recycling alternatives trigger different outcomes: Tax cuts somewhat offsetting the economic impact of the carbon tax, while spending on programs and projects costs more but generates marginally greater emission reductions. It is important to note, however, that how governments choose to spend the money collected has less of an impact on either emissions or economic performance than the actual carbon policy selected – i.e. carbon tax vs. hybrid approach.

Let us pose the question again that prompted our modeling in the first place: which policy will achieve the greatest carbon reductions at the lowest possible economic costs?

Making sense of it all

To take stock in what we now know:

Carbon emissions: If governments simply want to reduce the most emissions while minimizing economic costs, a British Columbia-style carbon tax, expanded to cover not just combustion but also process and fugitive emissions, remains the most effective policy tool.

Economic impacts: If governments want to focus on maximizing growth, the national and provincial economies perform significantly better under an Alberta-style hybrid carbon price model (with a carbon tax and complementary output based allocations and trading for EITE firms) than under a pure carbon tax model, where costs to the economy as revealed by GDP are much larger. This is particularly true for Alberta and Saskatchewan, where allocations based on GHG intensity and production in a form similar to Alberta’s proposed hybrid model help significantly lower overall costs to local economies. The national trading provisions also help to finance more reductions in some regions, effectively smoothing investment costs nationally.

Spending the revenue: When governments choose to cut taxes with the revenue generated through carbon policies, as is done under British Columbia’s carbon tax, negative economic impacts are somewhat offset. When governments opt to spend the revenues on emissions reducing programs and/or projects, costs increase but greater emission reductions are seen.

Conclusion: Political implications & trade-offs

As the provinces and federal government continue to negotiate a way forward to reduce Canada’s carbon emissions, Canadians should be asking how can we meet out targets at the lowest costs to the economy. The modeling above lays out two clear options for reaching our targets – each with different costs and benefits. Furthermore, the modeling shows that a hybrid model will get Canada closer to meeting reduction targets, with the least harm to the economy. It also shows that broad-based carbon pricing can be scaled to cost-effectively align Canada’s emissions trajectory with deeper GHG reduction aspirations.

Having these issues with stakeholders across the political spectrum with divergent opinions on carbon pricing, we know that politicians and advocacy groups across the board are united in a desire for a strong economy and clean environment. It is our hope that this modeling helps inform a more reasoned and nuanced debate by showing that a strong economy and deep cuts to carbon emissions are both possible, in tandem.

The economic modeling and analysis makes it clear that a national carbon tax (covering combustion, process and fugitive emissions) performs slightly better than the hybrid model (covering the same emissions base) at reducing GHGs and doing so at a lower cost per tonne reduced. That said, a hybrid carbon pricing policy (i.e. broad-based carbon tax paired with output based allocations and trading opportunities for large industrial emitters), results in dramatically less regional economic strain on Alberta and Saskatchewan, with only small effects in most other provinces.

A hybrid carbon pricing policy can be developed through cooperative action, applied either through a federal policy or by aligning provincial policies. In either case a hybrid policy would build off current subnational EITE intensity based emission trading systems in Alberta, Ontario and Quebec, with enabling legislation in BC and developing policy in Newfoundland and Labrador indicating an opportunity to align there as well. By extension, it would also be easier in the longer term to link with other carbon pricing systems in North America or around the world.

For Canada to meet its 2030 emissions targets, a significant share of reductions must come from the western energy producing provinces. Doing this in a way that is both economically and politically acceptable is one of the primary reasons why Alberta’s Climate Leadership Plan advocated the hybrid model. Given this new analysis, we can now confidently say that this model also works admirably when scaled up on a Canada-wide basis. These policies recognize the precarious economic circumstances in the west at the moment, and ease the transitional economic impact on GHG intensive industry while preserving the incentive to invest in low carbon production technologies.

Building broad based political support for any carbon pricing policy will require both strong environmental and economic performance as well as a perception of regional fairness. We believe that adopting an Alberta-style hybrid carbon pricing policy, and recycling the revenues by reducing personal and corporate income taxes, represents the best way forward for Canadian governments to achieve this goal.

Suggested Reading

The Scheer Plan Report: Your Questions, Our Answers

View Report Summary THE SCHEER PLAN REPORT: Q&A On July 10, Clean Prosperity and EnviroEconomics released a report that assessed Andrew Scheer’s Climate Plan and the impact it would have on households and the environment. Here are a few questions we thought you might have about that report, along with our answers to them. Why did you do this