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The Manitoba Carbon Tax two step…

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Design matters. Just take a look at Manitoba. The government’s April 09, 2008 budget introduced a carbon tax on coal of $10/tonne starting in 2011. The casual observer, depending on their particular bias would say either: it is not enough; it is a good start; or why introduce another punitive tax? So, which is right? Well, none actually.

Coal accounts for about 1.3% of all energy consumed in Manitoba, 80% of which is in the electricity sector. For the province, coal totals about 2% of all energy and 7% of all carbon emissions from energy. So, at best a low carbon price will be targeted at about 7% of all emissions.

And oh did I mention the following (see here)

The decision comes as Crown-owned Manitoba Hydro prepares to phase out its last coal-fired electrical plant in Brandon.

So, I suspect we are seeing the emergence of the carbon tax coming full circle on the political acceptability front. Indeed our baby is growing up. It is taking its rightful place amongst other notable ineffective Canadian climate polices such as voluntary inaction, soft cap and rule (a description of the current federal cap and trade plan) and now the great disappearing carbon tax.

Which is why, as we all know, design matters but political will rules. Sure we can debate cap vs tax, allocations or revenue recycling design, but political will sets stringency. Period. So, without a push from the electorate, or that sudden and rare political epiphany as in the case of BC’s Premier Gordon Campbell, inaction will continue to define Canadian climate policy.

Drink anyone?

Written by Dave Sawyer

April 10th, 2008 at 1:33 pm

Political Will and Effective Policy….The BC “Tax won’t be adjusted”

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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.

Written by Dave Sawyer

April 7th, 2008 at 1:12 pm

The Rise of the Safety Value — Cost Containment and Rising Emissions

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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.

tech_fund.JPG

Written by Dave Sawyer

March 21st, 2008 at 3:25 pm

Canadian Climate Policy — An Emerging Jungle of Taxes and Regulations

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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.

Written by Dave Sawyer

March 20th, 2008 at 1:25 pm

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With Soft Cap and Rule, Equivalency Looks oh so Much Brighter

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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.

Written by Dave Sawyer

March 15th, 2008 at 4:13 pm

“The price gap will close,”…which is the whole point of carbon taxes

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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.

Written by Dave Sawyer

March 7th, 2008 at 1:58 pm

Posted in carbon tax

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“We need to do that for our economy,” …add unnecessary costs that is

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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.

Written by Dave Sawyer

March 6th, 2008 at 1:39 pm

BC’s Carbon Tax Shift — Revenue Neutral is a matter of perspective

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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.

Written by Dave Sawyer

February 29th, 2008 at 2:20 pm

Yoda advocates a carbon tax….he wants a level playing field cause he is smart

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David Suzuki today released a carbon pricing and revenue recycling report today authored by Nic Rivers and myself (suzuki-carbon-report-en-web.pdf). In the report we apply a carbon price of varying levels within a general equilibrium model of the Canadian economy and then test alternative revenue recycling and tax shifting options. We find that with smart revenue recycling that the GDP impact can be halved if other taxes are reduced. How much? Well lots actually.

At $100 per tonne, the Government’s Turning the Corner target is more or less achieved with a GDP loss in 2020 ranging between 1.3% and 0.5%. If taxes are reduced like payroll or income, the GDP impact is lower, and in the range of 0.5%. With a carbon tax or fully auctioned permits, but with no recycling, the GDP impacts are higher, and could double the cost of attaining the same target. Again design matters to the efficiency outcome.

What else happens?

The economy continues to grow. Even with carbon pricing, the Canadian economy will continue to grow and expand;

Income taxes could be halved from an average rate of 22% to 13% (not the marginal rate)

Exports fall but so do imports and thus Canada’s balance of trade actually improves.

And Canada’s exchange rate improves.

So, lots of outcomes to explore, but I think the most interesting finding is that even with carbon pricing the costs of the policy can be very different. And if we implement regulations as the primary policy, I suspect all bets are off, with very high costs indeed.

What this report really does is highlight that with carbon policy there are more questions than answers. I am just glad folks like Dr. Suzuki are asking questions.

Written by Dave Sawyer

February 25th, 2008 at 4:25 pm

“Provinces free to tackle climate”…cause the Federal Policy is Priceless

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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.

Written by Dave Sawyer

February 21st, 2008 at 2:13 pm