…environmental economics and the implications of environmental policy

Archive for February, 2008

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more added cost on the back of an industry struggling under the weight of a higher dollar, the softwood export tax and outdated mills.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

Why Design Matters: Flexibility in Cap and Trade and Carbon Taxes

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Ok, so in taking a look at the CBO document a couple of points are worth mentioning.

First the report’s main conclusion that a carbon tax is five times more efficient than cap and trade is based on a policy comparison that is unreal. Essentially the inflexible option compared is unlike any cap and trade system that would be seriously contemplated. The poorly performing “inflexible” cap and trade policy has no design features for price certainty, like a safety valve, banking or borrowing. Most designs allow for intertemporal shifting of abatement effort to allow for efficiency in time. When these are added, the efficiency approaches that of a tax in the CBO document (see Figure 1-2). This assumed policy inflexibility seems excessive and is not therefore a real option. Yet the report makes the inefficiency argument strongly based on this comparison. This is not quit right.

Next, the report does make some good points on why a cap and trade program is less desirable. The case about administrative complexity is a good one, where cap and trade requires a number of design features that need to be tweaked in time to enable price certainty. This seems like a heavy administrative burden and thus the tax seems to be more desirable.

I think the authors of the report could have done us all a better service if they had highlighted one single point – design matters. In designing these programs effort is required to get things right – balancing price certainty through containing costs is important, but so is getting emission reductions. The report argues that reductions later are ok, and thus price certainty is more important (based on Weitzman’s argument that marginal costs are rising but damages are flat and somewhat uncertain and thus price certainty is preferred). But this does not mean that a tax is preferred, but rather that price certainty is important and can be achieved in cap and trade and a carbon tax.

While this report is worth the read, a critical eye seems warranted.

Written by Dave Sawyer

February 19th, 2008 at 8:39 pm

“Depressing facts about climate change: The best policy is the one that’s going nowhere”

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The CBO report (see my last post) has a number of folks talking. But I like this reaction, (here)

Good Climate Policy, Bad Politics.

A new report from the Congressional Budget Office confirms one of the most depressing facts about climate change: The best policy is the one that’s going nowhere in Washington.

The CBO report concludes that a tax on carbon emissions “would be the most efficient incentive-based option for reducing emissions and could be relatively easy to implement. If it was coordinated among major emitting countries, it would help minimize the cost of achieving a global target for emissions by providing consistent incentives for reducing emissions around the world.” But the major presidential candidates aren’t supporting such a tax, and the few proposals on Capitol Hill to impose a tax are not expected to go anywhere anytime soon.

I still plan to take a closer look at the report, and don’t totally support the whole sale adoption of the report’s conclusion without a closer read. But still, even if cap and trade is as efficient given similar design, the post’s inference holds…carbon tax is a four letter word in politics.

Written by Dave Sawyer

February 15th, 2008 at 10:03 pm

I am confused….a carbon tax is five times more efficient than cap and trade?

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The US Congressional Budget Office has just released a report that argues that a cap and trade system is much less efficient than a tax. Download the report here (02-12-carbon.pdf) and see coverage by the Wall Street journal (Here).

At first glance it seems we have an apples and oranges issues where the reductions are not similar for the two scenarios. Or the design elements diverge significantly. So, one would expect lower costs if one is comparing lower targets or a less flexible policy. But these folks at the CBO are not dumb, and they consulted some big brains on this (Billy Pizer of RFF and Weitzman from Harvard) so the report needs a closer look. More to come…

Written by Dave Sawyer

February 14th, 2008 at 11:06 pm

Every Molecule Matters…but does it?

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BC’s speech from the throne had some interesting words on climate policy (see here), but the line that got me chuckling was this one,

“Every molecule of carbon dioxide released into our atmosphere by human activities matters”

While this is a great line to counter the argument that Canada’s share of global emissions are only 2% and therefore inconsequential, more fun perhaps is that it echoes a great Monte Python Sketch (see YouTube here).

And indeed there are already signs of farce. A Globe Article today (here) has this to say about the BC Liberal Party’s internal maturations,

A number of Liberal MLAs have tried to bring the business community’s concerns forward as well. They echoed concerns that the government has created uncertainty by announcing carbon-cutting targets before the planning has taken place.
“I ask what the cost of this is going to be,” said Ralph Sultan, MLA for West Vancouver-Capilano. “I’m waiting [for an answer].”…there has been “lively discussion” within the Liberal government caucus on the climate-change agenda, and he noted that uncertainty around the government’s plans is hurting business….The environmental community is clamouring for a carbon tax, I don’t hear anyone else clamouring for one,”

Pressure here comes in part from the downturn in the provincial economy, which is linked strongly to the US and international markets like China,

Recently, representatives of industries have pointed out to Mr. Campbell that the economy is not as strong now as when he announced his plan a year ago.

But never mind that on the same day there is an article on BC’s booming economy (here)

Even so, the concern over afforabiltiy and uncertainty are linked. If the climate policy is designed to float with economic circumstances there is an erosion of expectations. Simply, folks will not know where they are going and perhaps more importantly will avoid taking action if they know a downturn provides an escape clause. The result of this gaming would be higher costs and fewer reductions. Better to provide flexibility to allow for unanticipated outcomes like recessions. And better perhaps to ramp up the policy so that incremental costs are smooth and not lumpy.

And from next door in Alberta there was another take on affordability from the leader of the Liberal party who is posturing for an upcoming election. He had this to say on mitigation (see here),

And if it costs a billion, so be it. This fabulously rich province has a gross domestic product of $242-billion, he says, and “we’re willing to bet Albertans will be willing to have one dollar out of 242 invested in addressing climate change.”

Kind of puts it all into perspective. But still, the affordability card in the climate game is a trump card and the ongoing challenge for climate policy is that the deck is stacked full of them.

Written by Dave Sawyer

February 13th, 2008 at 3:11 pm

Carbon tax or cap and trade? Bad economics is muddling the debate

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There are two articles in the Globe today that perpetuate bad thoughts on carbon policy and carbon costs. The first article (see here) pegs costs way too high by assuming that every single molecule of carbon results in a uniform costs at the highest carbon price, say $50,

At $15 a tonne, if Keephills were to fail to cut 12 per cent of its emissions, or 360,000 tonnes, the price tag on the facility’s emissions would be a mere $5-million…But at $50 a tonne, the price for Keephills would rise to $18-million. For all of TransAlta’s Canadian operations, the total penalty at $50 a tonne would rise to about $170-million.

But, there will be lower cost opportunities at the facility. So they will take abatement action and make carbon reducing investments up to the point where they can either get cheaper reductions elsewhere through trading or pay some sort of fee like that enabled under the Technology Fund or a carbon tax. And if there is recycling even this cost would be reduced on remaining emissions.

As a very general rule of thumb, since the marginal cost curve is rising (that is more reductions are more expensive), the total cost of reductions is total emissions times the carbon price divided by 2 or

Total costs = ~(Qemissions * Pcarbon)/2

This is essentially the area under the marginal abatement cost curve fixed by the price (tax) or quantity (cap/allocation) constraint. So, in the example cited, the costs are more like $8 million for the facility and $85 million for all TransAlta’s operations. And most likely there is a facility target and therefore no cost for remaining emissions of if the target emissions are achieved the fee on remaining emissions is returned (as in the case of Sweden). Suppose there is a 25% reduction required from 360,000 tonnes. This then lowers actual costs of about $2.25 million. Not trivial but not nearly as high as reported.

And where to start on the second article (see here). Here are a few samples from the article,

A much better, more effective route is a cap-and-trade system with auctioned allowances, under which government sets the future target for emissions – the cap – and turns to free market mechanisms to achieve those targets… government then has to make a guess as to where to allocate all of the carbon-tax revenues, hopefully avoiding the appearance of pork barrel politics and special interests.

With auctioning of permits, the firm must buy their allocations, which transfers cash to the regulator, and thus the cap and trade behaves a lot like a taxes. Government still has to deal with the revenue.

And then this,

A tax is simply not the best way to create effective incentives to cut emissions, and it’s not the right mechanism for promoting innovation that will abate human-caused climate change.

This argues that taxes will not result in continuous improvement, that is an ongoing incentive to reduce emissions. Not likely, since the firm will continue to see the tax and thus seek ways to avoid paying it though making investments that lower emission while minimizing the tax burden.

And perhaps most challenging,

…That’s because a carbon tax puts the government into a nearly impossible Goldilocks scenario: It must set the price of carbon just right. Not too high, meaning everyone overpays and the economy is damaged. And not too low, in which case emissions reductions are not maximized. Additionally, as we move forward, we cannot afford a system where carbon prices remained static in such a dynamic environment.

But if we set a cap too high and there is no cost constraint (i.e. price cap), costs emerge that are unanticipated. Government then has to release more permits to reduce compliance costs, which dilutes the cap (more emissions) and reduces the real value of permits (like printing money and causing inflation). In practice, the regulator will have to adjust either the cap or the tax rate as new information on climate science, cost and abatement responses emerge.

Both cap and trade and a carbon tax have challenges that need to be sorted out. But we need better reporting on this stuff. Otherwise we will continue to muddled and mired in debate…but then again that suits some folks just fine.

Written by Dave Sawyer

February 11th, 2008 at 3:22 pm

The Great and Honourable Target Bun Fight: The Standing Committee “Debates” Deep Carbon Reductions for Canada

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The Standing Committee on Environment and Development is currently debating a private members Bill on deeper targets for Canada (Bill C-377). The Bill is all about more aggressive targets relative to the government’s plan. But, in actuality, these targets are in line with the Bali Footnote for 2020 (-25% below 1990) and not too far off from the Government’s Current Plan (Turning the Corner). The current plan calls for -20% below 2005, which is about minus 35% in 2020 below the business as usual, and the Bill is -50%.

Since Parliament is in a minority position, this Bill has not died and is given some due process. But, make no mistake, this Bill will not live to see the day given election fever.

I had the pleasure of seeing the target bun fight up close. My testimony to the Members is here: Standing Committee Testimony – Sawyer, including a cost estimate for the targets contained in both Turning the Corner Target and Bill C-377 (using C-GEEM, a CGE model and CIMS, the UBER Canadian emissions and energy model).

In a nut shell, carbon prices will need to be in the order of $100 for Turning the Corner and about $200 for Bill C-377. GDP impacts would then range between 0.6% and 1.2% annually, which is less than the forecast rate of growth (2% to 2.5%). While these impacts may not seem large, there are also impacts on groups, such as low income households and energy intensive exporters, that are much much larger. These impacts need to be better understood and policies devised to address the income hit while maintaining the emission signal. Energy prices would then rise, with electricity by something like 25%, petroleum products on average 15% and natural gas 10%. Or something like that.

All this assumes domestic action, a cap and trade system for large emitters, a carbon tax for you and me, performance regulations for vehicles and buildings, some subsidies to renewables and carbon capture and storage, and importantly a reduction in income tax to offset the carbon revenue. Whew.

And since costs rise rapidly after abatement of about -20% below the BAU, access to lower cost and real international reductions is critical if costs are to be contained and distributive impacts minimized.

My one observation from the Standing Committee was that most, but not all, of the Honorable Members were more interested in getting on record their own thoughts and not interested in probing the witnesses for information or insight. Which made me wonder what I was doing there?

And debate is a funny term for some of these folks. It was mostly a bun fight reminiscent of grade six…” your climate policy is stupid…of yah yours is even stupider and your shoes are lame”…..and that’s when I piped up and pointed out that, well, actually both of your targets are very similar and if you think his will wreck the economy, then so will yours. But that is not quit correct either, and if we do it right, and get going today, we can likely muddle through without killing the Canadian Golden Goose.

Written by Dave Sawyer

February 8th, 2008 at 3:10 pm

An Inventory of Canadian and Provincial Climate Mitigation Policies — Carbon taxes, trading and a whole lot of targets.

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The Canada West Foundation just released a nice comprehensive inventory of Canadian provincial and Federal policies on climate mitigation. The document can be found here: Building on Our Strengths: An Inventory of Current Federal, Provincial, and Territorial Climate Change Policies. It is a nice tight survey that provides both the announced targets as well as thematic approaches to implementing the targets.

I like the second paragraph,

The rapidly changing policy environment surrounding climate change initiatives poses a challenge to an up-to-date inventory of climate change efforts. The authors have done their best to include policy developments to the end of 2007. It should also be noted that many government initiatives overlap, both across programs and across jurisdictions. For example, some initiatives that may have an impact upon GHG emissions may be presented in other sections of the report, as they are lodged in other policy areas.

Overlap, uncertainty and a rapidly changing policy environment…all threats to sound policy that will need to be sorted out. This is why the governance issue may be one of the most important elements to address if Canada is to implement cost-effective mitigation.

My Coles Notes summary of the document goes something like this: a single carbon tax in Quebec, lots of talk about trading, a whack of subsidies to renewables and tables and tables of targets. The authors did a great job with what little they had to work with.

Written by Dave Sawyer

February 6th, 2008 at 5:21 pm