EnviroEconomics.ca

While academic economists have long argued for a carbon tax, the political realities have driven policy to cap and trade. In response, those smart folks thinking of good policy design came up with the “safety valve” to allow for cost containment. The safety value concept has political appeal since it essentially caps the upside costs of a cap and trade system and so takes away the uncertainty of what cap and trade may end up costing emitters. It also has had appeal in the past since the climate fight was thought to be a marathon and not a sprint where cost containment seemed more important than short term action. But this has changed as new climate science points to the need for deeper action sooner. And so the rise of the safety valve is worth considering and needs a closer look.

The safely value is a significant component of Canada’s current climate policy in the form of the technology fund (payments to the feds for technology development and deployment) and the recently refined pre-certified projects mechanisms (i.e. payments for CCS). Both of these allow for some share of emissions to be paid into the two compliance mechanisms on a declining balance to 2018. They are in effect a tax that is accessed 100% up to 2018 if compliance costs or permit prices rise above the access price of these compliance mechanisms, capped at about $23 in 2017 (see thumb below). How the 65$ per tonne cost announced recently by the feds interacts with the pre-certified projects list is not yet clear to me, but still it is well below the costs of CCS for the reductions required under the government’s 2020 target of -20% below current emissions.

Given its prominence in Canadian climate policy and indeed worldwide, it is useful to better understand the safety value. An excellent article emerged recently on the history and development of the safety value (see here),

What started as an obscure, almost monastic dispute among economists three decades ago has now emerged as a potential make-or-break point for the proposed legislation. Tracking its tangled history may now be essential to outsiders who want to understand this issue — and the huge economic stakes involved — as champions on both sides of the political arena saddle up to do battle over it.

As well as a good post at Common Tragedies (see here),

The key issue with the safety value will be the tension between those that want it to be very high, and so ensure emission reductions and those who define cost containment as no cost at all and so want a low value. In the Canadian case, the safety value has been set very low, and so emission reductions during to 2012 to 2018 period will be correspondingly low. This is not pure conjecture but rather based on modelling, where Canadian compliance costs indicate that the technology fund will be fully subscribed at the current price caps.

And so, we are left with a tax layered on a cap and trade system. While the policy skeptics decry that a tax will not work, by extension neither will cap and trade, at least not how it is being implemented in Canada. And with the science arguing for more reductions, the current design of the safety value will leave Canada with a growing stock of high emitting technology that will be costly to alter in future years. That is, if politicians eventually decide to take action, future compliance costs will be higher due to short-term inaction. Canada’s use of the safety valve, it seems, is about shifting the cost and therefore political burden in time.

Jack Mintz provides an nice overview of the key issues facing Canada with respect to carbon taxation (see here). I like the article because it is somewhat boring…it reveals some key issues, nestles carbon taxation within existing tax structures in Canada and generally points to why a carbon tax is likely the way to go – it works within existing structures.

Assignment of taxing powers in a federation is an old question that Canadians have endlessly debated. …As a rule, the taxes best assigned to the provinces are those that do not interfere much with the free flow of goods and services within Canada, are relatively easy for provinces to collect and are related to their spending powers, such as regarding health, education and infrastructure. Gasoline excise taxes, for example, have been viewed as a relatively good tax to assign to provinces since their payment is (albeit imperfectly) related to the use of roads and highways, and does not disrupt much the integration of the Canadian economy…A carbon tax, such as the one recently imposed in British Columbia, is a typical excise tax, as it is applied to carbon emissions generated by fossil fuels consumed by consumers and businesses within the province.

Broadly, economic instruments can be transitional, that is work within existing structures such as taxation or resource (water) pricing or transformational, which requires a wholesale change in how governments manage, say to a cap and trade system with new administrative functions.

Administrative simplicity is important since governments have limited budgets, and well adding new administrative functions generally means that other priorities such as toxics or water management are left cannibalized. This is particularly the case for municipalities and provinces, but if one speaks with folks managing the environment at the national level, and designing climate policy in particular, it is clear that there is a real lack of resources to get the job done.

So, with Canada’s new soft cap and rule program, the transformation required for implementation can’t be overstated – it will continue to chew up resources from Environment Canada and other priorities will suffer. Toxics management, species at risk and water issues all come to mind. In all policy there are trade-offs, and it is important that we recognize these. In Canada’s emerging jungle of carbon pricing and regulations, many will get eaten.

I had the good fortune of being briefed on the details of the federal government’s climate plan this week. What is interesting is that the briefing occurred during a break in discussions of how a carbon tax might be applied nationally and might complement cap and trade. As I sat listening to the government official, and all the complexity of the new federal plan was revealed, all I could think about was the equivalency clause. Simply, equivalency allows the provinces to implement their own plan if it is somehow equivalent to the federal program. While this will need some sorting out, the comparisons between the elegance of the BC climate plan based primarily on a carbon tax shift and the sheer complexity of the “soft cap and rule” federal plan led me to think of equivalency as the great hope for Canadian climate policy. That is, provinces and their industries will look to the federal plan, try to get their head around all it entails and I suspect instead will start planning their own simplified approach.

The other big observation is that of cumulative emissions, where the latest additions, and especially the focus on Carbon Capture and Storage (CCS) and the technology fund extension called “certified projects” will result in a step change in reductions around 2018 or 2020. And this points to a problem with targets in a GHG setting – target attainment says nothing about cumulative emissions. One can emit like crazy and then hit a target with a step change reduction in a single year, and voila the target is attained. But total emissions over the proceeding period will be high, which is why early and sustained action reduces total emissions and hence the climate risk. And modelling also shows early and sustained action is cheaper since technology decisions that are not influenced today are expensive to deal with later.

Which is why equivalency could be good for Canadian climate policy. In the face of a soft cap and rule regime, a carbon tax shift looks oh so much brighter.

What I now see as a primary goal of climate policy researchers is to address one by one the important climate policy questions that are oft cited as reasons for inaction. Competitiveness of course tops this list. Simply, folks argue that with domestic climate policy our exporters and other domestic producers will be unfairly disadvantaged given the lack of a carbon signal in most of the world’s economies. And one does not hear questions of competitiveness mentioned without the requisite decry of China and leakage. Leakage involves transferring production to China, either in the form of increased market share, or by putting our manufacturing base on a slow boat to China.

And then along comes a reporter who pulled one of the few nuggets out of a recent conference in Ottawa. I know because I was at the Conference, A Way Forward, hosted by IISD. The main reasons there were so few nuggets may seem surprising but the conference focused on a post-2012 climate policy world and well, the Bali Roadmap really raises more questions than answers and thus it was hard to sort our all the conjecture.

So, when Peter Gorrie published this in the Toronto Star I was truly amazed. This is a good piece of reporting and really addresses a fundamental question and roadblock to domestic action—namely China is doing nothing so why should we? Here is the gist of the article,

No gasoline-powered car assembled in North America would meet China’s current fuel-efficiency standard.
Even vehicles produced under California’s proposed, and much praised, efficiency law – being fought tooth and nail by the U.S. and Canadian governments and the auto industry – wouldn’t come close to the Chinese mileage limits.
If that’s a shock, take a deep breath. There’s more…

To be sure, China faces massive environmental problems…Still, it is doing far more than Canada, the U.S. or just about any other place to clean up its act. It has begun to impose regulations and targets for car emissions, renewable fuels, carbon storage, forest renewal, energy efficiency and industrial pollution. It’s investing heavily in new technologies, including “clean” coal and alternative power sources. In many ways it’s putting us to shame.

So, next time someone brings up the China competitiveness refrain quietly remind them that China may not have a binding cap under Kyoto, but they don’t need one. They see value in burning less fuel. And quietly, China is doing more than Canada.

The climate science skeptics are turning into climate policy skeptics with each new climate policy announced. The basic argument is that the policy will be ineffective at reducing emissions and so is a waste of effort and money. There is a particular focus on the ineffectiveness of carbon taxes to reduce emissions (here),

At the same time, the mill’s managers have thumbed their noses at the global warming theme, replacing natural gas as a supplementary energy source with dirtier, but cheaper, coal…. It’s opposite from the behaviour that Mr. Campbell’s new carbon tax is supposed to produce.

While many policy skeptics decry that carbon taxes do not work, they are ignoring some simple policy truths. First, not all taxes are designed to create an incentive function, where changing behaviour is the objective of the policy. The Quebec carbon tax is a clear case of a tax designed for fiscal reasons, to raise money for other purposes, and in this case for investments in low emitting technologies.

Second, transition costs can be expensive and inefficient. Page one of that first year environmental economics textbook says that the tax should be phased in time to minimize dislocations and transition costs. One wants to go slow to get the cheap reductions first and then work up in time to the more expensive reductions. In cap and trade the same principle holds, where the initial cap is set low and ratcheted down in time.

So the quote in the above mentioned Globe article is a good one,

“The price gap will close,” the official said.

It may be cost-minimizing for that pulp mill to burn coal for the next five years given the level of the tax, but in time this will change. And that, my friends is why policy certainty matters – you know those folks burning coal are looking to the future and trying to figure out when that lump of coal ends up in their stocking. Expectations matter and good climate policy makes clear that the price gap will close. It is just a matter of when, and not if.

The federal Minister of Finance again needs to be commended for his statements that Canada needs some sort of climate policy consistency at the federal and provincial levels (here),

“It’s probably inevitable we have some different approaches now that don’t fit together,” Mr. Flaherty told reporters at a news conference, after a speech to the Vancouver Board of Trade…But he said it will be in Canada’s interest to eventually reconcile the various approaches. “We need to do that for our economy,”

The problem is that Canada does not have leadership on this issue,

Mr. Flaherty did not speak to the question of who would lead this convergence.

But perhaps even more troubling is the shots at Ontario, the praise for BC, and the incongruence between economic policy and climate policy in the federal government’s mind

“It’s not helpful for Ontario to be the jurisdiction in Canada with the highest business taxes and I am going to continue to say to the government of Ontario that, ‘You’re discouraging business investment,’ ” he said, calling those policies “unhealthy” for Ontario’s economy and the Canadian economy as a whole.
He praised B.C. for its move to cut the corporate income tax rate from 12 per cent to 11 en route to 10 per cent by 2011.
“Congratulations to the government of the province of British Columbia for doing that. It will help brand Canada. It will help attract investment to Canada, but the province of Ontario has shown no indication of going in that direction to reduce their business tax.”

The current federal plan provides no mechanism to raise revenue and therefore there is no chance for further drops in federal corporate income tax. Add to this the observation of many that the federal cupboard is bar due to unproductive tax relief such as the GST cut and unchecked federal spending and well, there is no room for the Ministers prized policy – that of further reducing corporate taxes.

So, not only is the current federal plan likely to be high cost, due to its focus on regulatory approaches, subsides and offsets, but there is no opportunity to further reduce unproductive taxes on corporations and personal income. Simply, climate policy is not being integrated with economic policy, a shortcoming that will necessarily lead to higher costs.

Perhaps when the minister asks “ Mirror, mirror on the wall, who has the lowest climate policy cost of all” the minister will be surprised to find that he has the urge to send poison apples to more folks than just Premier McGuinty.