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Rethinking Carbon Pricing

Economists generally view a price on carbon as the most efficient way to reduce greenhouse gas (GHG) emissions.  The theory goes that emitters will react to an increase in cost by reducing usage.  This reduced usage can come from conservation, renewables or conversion to lower carbon intensive fuels.

The key to any carbon price is that it is revenue neutral, in that it isn’t simply another tax.  The revenue to any carbon price must either offset another tax, such as income tax or be directly paid back to individuals and businesses.

Studies have shown, that when done correctly, a carbon price has a negligible effect on the economy (as measured by GDP) and that any negative economic effect is far outweighed by the negative economic effects of global warming.  (Think of all the infrastructure damage, losses in production and unnecessary activity required due to increased flooding, increased storms, increased wild-fires, etc.)

The two main approaches for carbon pricing have been a straight levy or tax (Alberta, BC, Finland, Switzerland), or “Cap-and-Trade” (Ontario…until recently, Quebec, California, European Union, China).  To be honest, I have wavered as to which would be best at accomplishing the goal of hitting GHG emission reduction targets with minimal cost to society.  A carbon tax is much simpler, but Cap-and-Trade allows for easier implementation of “offsets”, where there are benefits for technologies that reduce GHG emissions.  (For example, there is no mechanism that I know of under a carbon tax for reducing methane emissions from livestock, whereas, under Cap-and-Trade, the methane reduction could be treated as an “offset” that can then be sold to an emitter.)

The Economist magazine recently published an article that compares the two forms of tax.  The conclusions of the article are:

  • Carbon taxes are 50% better at reducing GHG emissions.
  • Carbon taxes are better received by the public when labelled a “fee” or “levy” instead of a “tax”.
  • Carbon taxes where the money is returned directly to citizens are much more acceptable, as opposed to offsetting income taxes.

Ontario opting out of Cap-and-Trade may not be such a bad thing after all.  The federal government will likely impose a carbon tax onto Ontario and will return a large portion directly to Ontarians.  The remainder will go towards conservation initiatives within the province.  There will, of course, be an administrative cost to this, which we as taxpayers must keep in check.  This cost should be much lower than any administrative cost associated with Cap-and-Trade.