Carbon Pricing

Revenue-neutral carbon pricing like the system we have in Canada is widely recognized as the lowest-cost, most pro-growth way to reduce emissions, due to its simplicity, transparency, and flexibility. Carbon pricing has been endorsed by hundreds of economists in Canada, the US, and around the globe.

Carbon pricing is like a tailwind that moves all boats in the right direction—it incentivizes every part of our economy to reduce emissions, and rewards those who make low-carbon choices. It signals to businesses that there will be money to be made in new technology and innovation that reduces carbon footprints.

Carbon taxes work. The Canadian government has estimated that current carbon pricing policies will reduce emissions by 50-60 Mt by 2030, the largest reduction of any policy in the Pan-Canadian Framework on Clean Growth and Climate Change.

Clean Prosperity has seven recommendations for Canada’s carbon pricing system.

Recommendation: Continue to increase the carbon price by at least $10/tonne per year, adjusted for inflation, through 2040.

Gradually raising the carbon price is key to meeting Canada’s Paris Agreement targets. If the federal government doesn’t increase the carbon price, it will be forced to reduce emissions using regulation and spending, which will be more expensive and less sustainable than relying on market forces. Government regulation and investment play important complementary roles, but a rising carbon price should be at the heart of a cost-effective climate plan.

Raising the carbon price will also stimulate the development of technologies that Canada will need to decarbonize its economy, like clean hydrogen and carbon capture. If the carbon price continues to increase by $10/tonne every year, we project that by 2035 it will exceed the cost of direct air capture, which will accelerate the growth of this industry.

UPDATE: In December 2020, the federal government announced a plan to increase the carbon price to $170/tonne by 2030.

Recommendation: Appoint an independent panel to review the carbon price annually, to determine if it is achieving expected emissions reductions.

The independent panel would ensure that carbon pricing is having its intended effect. Based on its analysis of emissions data, the panel would have the authority to raise the carbon price up to an additional $10/year if emissions were not declining quickly enough to meet Canada’s climate targets. The panel could also recommend complementary climate policies.

Recommendation: Adopt a border carbon adjustment (BCA) to replace output-based pricing, in coordination with other countries.

If the full carbon price was applied to industry, we could achieve an additional 43 Mt of emissions reductions, and put Canada in a position to meet its pledge to exceed the Paris target. 

Applying the full carbon price to industry should be done in conjunction with a border carbon adjustment (BCA). A BCA puts a carbon fee on imports so that they face the same costs as domestic producers that pay carbon taxes. It then rebates the carbon tax on exports to keep them on a level playing field with global competitors. A BCA would protect Canadian businesses against unfair competition from companies in jurisdictions with lax environmental policies.

A BCA is also the best way for Canada to influence global emissions. Charging a carbon fee at the border will incentivize exporting countries to impose their own carbon pricing programs, in order to retain the revenue. The IMF estimates that a global carbon price of $100/tonne would be enough to keep the world below 2°C of warming.

Other countries are already preparing to implement BCAs—the EU has committed to introduce one by 2023, and US presidential candidate Joe Biden has proposed such a policy in his climate plan. Canada needs to coordinate its BCA with these and other trading partners.

Recommendation: Make the carbon tax rebate a quarterly direct payment to Canadians.

All the proceeds from carbon pricing are returned to Canadians, leaving most households better off. But only about a third of eligible Canadians even know they’re receiving the rebate, because it’s buried in their income tax return. 

The government should switch the rebate to a quarterly direct payment. Direct payments will increase support for this critical policy, and they will help reduce emissions—research on similar programs like the Canada child benefit show that recipients use their payments in ways that match the objectives of the program. 

Quarterly direct payments will also save the government over $35 million annually by 2022, by avoiding the financing costs currently incurred by sending rebates to Canadians in advance of collecting the carbon fees.

UPDATE: In April 2021, the federal government announced its intention to distribute carbon tax rebates via quarterly direct payments, beginning in 2022.

Recommendation: Increase the rebate top-ups to non-urban residents to account for the higher costs they face.

Rural residents currently receive a 10% top-up on their carbon tax rebates to account for the fact that they face higher fuel and heating costs, with fewer alternatives to reduce these costs. 

Our research shows that rural households spend 18% more on carbon costs. We also find that suburban households face higher costs than urban residents, suggesting that they merit top-ups as well. 

We recommend that the government increase top-ups paid to rural and suburban residents, and fund the top-ups from the GST collected on the carbon tax—estimated at $235 million annually by 2022. Refunding the GST collected on the carbon tax addresses public concerns about a “tax on a tax”.

Recommendation: Use carbon tax proceeds allocated to small and medium-sized enterprises to fund a small business tax credit of 0.75%, increasing to 1% in 2022.

Small and medium-sized enterprises (SMEs) currently receive 7% of the total proceeds from carbon pricing through two energy efficiency grant programs. But these programs are cumbersome and only benefit a select set of SMEs. 

We recommend that the government instead adopt a small business tax credit that would effectively reduce the small business tax rate by 0.75% immediately, rising to 1% by 2022.

Recommendation: Address the extra costs faced by farmers through a temporary exemption on fuel used to dry grain.

As the carbon price rises, farmers who dry their grain will face disproportionate cost increases. In many cases they’ll be forced to absorb these extra costs. Where they can pass on the costs, the impact will be higher food prices for consumers. 

Unfortunately, there aren’t yet viable low-carbon alternatives to natural gas for drying grain. For this reason, the government should consider a carbon tax exemption for fuel used in grain drying. The exemption would sunset in five to 10 years, which would give time for low-carbon alternatives to come to market.