EnviroEconomics.ca

When a government commits to a policy, any policy, one can usually expect some deviation from the initial stance as the constituent’s line up with their grievances. That is after all how public policy is implemented. Which is why there are some surprising words coming from the BC Finance Minister on how the BC carbon tax will be implemented and why BC may get cost-effective carbon policy (see here):

“There are so many sectors, not just geographic, that have been asking for some sort of special treatment or exemption that … if you go down the road of starting to make exceptions and exemptions then you would have to, at some point, just give up on the idea of pricing carbon,” Ms. Taylor said in an interview yesterday.

Excluding some from the carbon policy is expensive as it transfers the burden of reductions to some and not others. These policy “carve-outs” can ultimately increase costs since low cost options are not sought from all, which is also inequitable. Randy Wigle a professor at the University of Wilfred Laurier has a nice paper from some years ago on why exclusions are expensive for a given abatement target (see a short summary here). He states,

If any carbon restrictions are focused narrowly, the resulting plans can be extremely costly when all abatement occurs within Canada. The narrower the focus of implementation plans, the higher the cost to Canada…In the case where the most energy-intensive sectors alone are targeted, the welfare cost roughly doubles, but this result relies on the availability of a backstop technology which could provide added abatement at constant cost.

Twice as expensive you say? Hmmm…now where have we seen a plan that targets large emitters alone and relies on a backstop technology such as CCS?

And then there are these additional comments from the BC Finance Minister to further indicate that the BC policy may just be implemented with style:

“From our point of view, putting in a broad-based tax so it is equal for all users of carbon-emitting fuels, and doing it at a very low level so people have lots of time to think about whether or not they want to make any adjustments, is the right policy and we will stay with that policy.”

A broad-based application is central to cost-effective reductions. Plus ramping up the policy allows folks to plan capital upgrades to more closely align with normal capital stock turn-over. So, some strikingly clear words from a government facing pressure over a new policy.

Politicians are not known for weathering a barrage of grievances, and so if BC’s deeds echo their words, climate policy in Canada may just have that gold carbon standard from which other policies are compared. While it is early days for the BC policy, they seem to keep getting it right.

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.

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.

Carolyn Fischer sent me a news story that went on something like this,

“Cap and trade is a charade to continue business as usual,” said Angela Johnson Meszaros, director of the California Environmental Rights Alliance.

Environmental justice groups instead favor carbon fees on polluting industries, a strategy endorsed by many economists as simpler and more transparent, although politically tough to enact.

Her hilarious response was this,

Buying your way out of pollution reductions with permits = bad.
Buying your way out with taxes = good.
Logic = priceless.

Once I stopped laughing I started crying, cause this, unfortunately sums up the federal government’s position, although their logic is reversed and slightly more distorted,

Taxes = bad
Permits = good
Regulations > good
Logic = priceless

BC has demonstrated that a carbon tax shift is politically feasible. The reactions in the press are not bad, and are actually downright supportive (when the only complaint is that ferry tickets will go up, BC has hit a home run). Why? I suspect the carbon tax shift. In Canada the reason is simply, I think, that folks despise income taxes more than carbon taxes. So, if you throw a few dollars my way though a tax credit, and then reduce my income tax, well, that sounds rather nice. And people start to think, “hey, this BC carbon tax thingy is not a money grab after all”. Kewl stuff.

And it makes economic sense. Nic Rivers and I have just finished a revenue recycling assessment of a national carbon tax and found that GDP impacts could be considerably reduced with smart tax shifting. This is the main thrust of a David Suzuki Foundation paper to be released this Monday (keep an eye out, and check back, I will post it here).

So, carbon tax with recycling is economically efficient, results in real reductions and can be politically acceptable. So, why are the provinces going it alone (see article here). Well cause the federal logic is priceless. But don’t let me sway you, let’s let minister Baird speak,

“We have a different focus, our approach is on industrial regulation”

You can’t script this stuff. We have a left leaning province implementing a carbon tax shift, a perceived left leaning organization, the David Suzuki Foundation, supporting a national carbon tax shift and a conservative government preferring regulations. Only in Canada, Eh. Priceless.