BC’s Carbon Tax Shift — Revenue Neutral is a matter of perspective
BC’s carbon tax has folks talking about tax incidence or who will see what carbon price, and recycling incidence, or who will get what back. BC business will see 2/3 of the overall incidence and consumers will see 1/3, but the recycling incidence is reversed with 2/3 going to consumers and 1/3 going to business. This is plainly wrong for a number of reasons, but mostly on economic grounds, which will ultimately lead to distributional concerns and hence political opposition (see here for early indications),
One part is the deliberate decision by the provincial government to have business pay two-thirds of the carbon tax, but to give consumers two-thirds of the resulting “revenue-neutral” tax breaks. Translation: For every dollar business as a whole pays in the carbon tax, it gets back 50 cents. The carbon tax is only revenue neutral from the government’s point of view….And the carbon tax has become one more added cost on the back of an industry struggling under the weight of a higher dollar, the softwood export tax and outdated mills.
Governments can recycle the revenue either directly through rebates and subsides, like the BC carbon dividend to households, or indirectly though reducing other taxes, say income taxes. Of course they can choose to not recycle at all and therefore grow the budget for other program spending. But this is really political suicide. Modeling and theory suggests that recycling to reduce other distortionary taxes is preferred economically. Period. There are two principle reasons for this,
First subsides and rebates tend to be inefficient, with in either “freeriders” take the money and don’t change behaviour or use the rebates to simply buy something thereby increasing consumption.
Tax shifting on the other hand deletes one tax and adds another and thus leaves the economy in a better “net” position, where one inefficient tax is replaced by another – instead of one more distortionary tax being added to the economy in the form of a tax on carbon.
In the BC case there is a mix of the two, and thus the BC plan leaves some lost opportunities to reduce tax inefficiencies on the table but all in all is good sound policy.
But perhaps of larger concern, and one that may bite the BC government in time is their reluctance to return the carbon tax receipts in proportion to payment. In chatting with the BC government prior to their announcement, it became clear that they thought returning the tax to business would not play politically. But I think they miscalculated here and missed an opportunity to reduce the competitiveness concerns over the carbon tax.
How? In modelling revenue recycling (see last post), Nic Rivers and I found that recycling back to industry in proportion to their emission intensity (emissions/output) both maintained the price signal but importantly reduced the carbon tax incidence, which lowered the cost impact and hence reduced losses in export markets (or maintained profitability). In our national carbon tax case, returning the carbon tax as an output payment decreased the GDP impact relative to a lump sum payment to households by almost three times, from 1.3% to 0.47% of GDP in 2020 (under a $100 carbon price). Output effects on industry were even more divergent, with a drop in national output under a lumpsum scenario (rebate to households) of -1.2% and an increase under output based recycling of 0.8%. Clearly, from a competitiveness perspective output based recycling is preferred, but we also found it is preferred from a national welfare perspective (that is we would be better off on aggregate).
So while BC is to be applauded for advancing smart and cost-effective carbon policy, I suspect that the early grumblings will grow as the inequities are revealed. As is always the case, playing politics with policy is distortionary. It also highlights the challenges of policy development…it is simply very hard to get it right and a lot easier to get it wrong.
And oh yes, the press will always crucify you.