The Carbon Tax

Will it reduce pollution?

By Michael McCullough

Rafael Baston is no climate change denier. A supply chain manager with TransCanada Corp. and a father of four, he broadly agrees with the Alberta government’s decision to impose a carbon levy on the province’s consumers.

Yet he says the carbon levy is unlikely to prompt his family to reduce their fuel consumption. The Bastons put some 25,000 km per year on their car and live in a 2,400 ft2 home in the Evergreen neighbourhood of south Calgary. Before the levy was announced, Rafael had already decided to take the CTrain to work, and the family traded in their vehicle for a smaller, more fuel-efficient one. Energy-saving upgrades to their home will have to wait until “the price is right.”

Very little of the carbon levy debate so far has grappled with what would seem to be the central question: Will it work? Will the increased cost of energy as a result of the levy prod ordinary Albertans to actually reduce the stream of carbon dioxide they habitually discharge into the atmosphere?

Economists predict Albertans will change their habits—not a lot, at the current level of carbon pricing, but more than they would without the policy. Experience in other jurisdictions suggests that regardless of whether Albertans oppose the levy (as many say they do), they will, bit by bit, shrink their carbon footprint. The degree to which it works, however, depends on a number of variables.

Economists love carbon taxes partly because they aren’t as arbitrary as other emissions-control measures. “Putting a price on a negative externality—pollution—is always the best way to go, because then the market can adjust to the pricing and implement the most effective response,” says Werner Antweiler, a professor of economics at the University of British Columbia.

“Putting a price on carbon provides an incentive to reduce the greenhouse gas pollution that causes climate change.” –Environment Minister Shannon Phillips

Rather than trying to measure the tonnage of carbon dioxide issuing from your tailpipe or chimney, carbon taxes are applied at the source of the carbon—the fuel you pump into your vehicle and the natural gas you use for heating, hot water and cooking. As the price of these things goes up, along with energy-intensive goods and services (unfortunately including fresh food), people cut back, buy more-fuel-efficient vehicles and upgrade insulation in their homes.

Some jurisdictions have made their carbon levies universal and “revenue neutral”—i.e., the government rebates as much as it collects—but Alberta’s system is a “hybrid,” says Antweiler. It’s not really universal and it’s not really revenue neutral. It does not apply to the large-emitter sector covered by the provincial carbon pricing system set up in 2007. It also shields trade-exposed industries (read: oil and gas) that might be put at a competitive disadvantage by providing subsidies to the most efficient companies. It also exempts the entire electricity sector, which is being dealt with separately through a plan to phase out coal and boost renewable sources to one-third of the province’s generating capacity by 2030.

In practice, the levy is like using a chainsaw to undertake an operation better performed with a scalpel, says Dan Woynillowicz, policy director for Clean Energy Canada, a not-for-profit aimed at accelerating the energy transition away from fossil fuels. “You kind of have to throw the textbook out when you’re actually doing it in the real world.”

The provincial government currently levies $20 per tonne of carbon dioxide emitted, rising to
$30 next year. The levy adds 4.5¢ to the cost of a litre of gasoline, rising to a total of 6.7¢ beginning January 1, 2018.

For many economists, the price increase is enough. “I don’t think we should actually care too much about what the specific effect on emissions will be,” says Trevor Tombe, assistant professor of economics at the University of Calgary. “The question to me is, in any market-based approach, the price being placed on the emissions should be comparable to what we estimate the environmental costs will be.” Environment Canada estimates this “social cost of carbon”—representing the cost imposed on other people in the form of things like land lost to sea level rise, adaptive measures, lost agricultural output, and health risks—and comes up with the figure of $40.70 a tonne of CO2 for 2016, rising to around $50 by 2025.

The revenues raised over the levy’s first three years (an average of $1.3-billion annually) will in part be returned to lower- and middle-income households in cash rebates. A qualifying family of four will get $360 this year paid out in quarterly instalments and $540 next year after the levy rises. The rebates are a matter of debate. “The price on carbon is just as effective with the rebates as without,” says Sara Hastings-Simon of the Pembina Institute. Environment Minister Shannon Phillips says: “People ask me, ‘Why do you give it back in a rebate? Won’t that make people just continue to make the same decisions as before?’” Her answer is that the rebate is fixed, whereas the tax you pay depends on how much fuel you use. If you stop driving your kids to school or purchase a more fuel-efficient vehicle, you pay less tax while your rebate stays the same.

Politically, the policy creates a constituency of beneficiaries. Any government that attempts to repeal the carbon levy will have to contend with the almost two million eligible voters who might not want to lose those quarterly cheques. And though the rebates don’t return all the money collected in the levy, the people who do receive them are more numerous than those who do not. An inordinate share of the carbon levy will be borne by the one-quarter of Alberta households (with combined net incomes above $95,000) which won’t receive any rebates at all.

Treasury Board estimates that a single person on average will pay $191 this year in additional direct costs—affecting what they pay for home heating and transportation fuel—and $286 in 2018; for a family of four, the numbers will be $338 and $508 (in all cases less than the rebate for those fully eligible). The Board estimates indirect costs—price hikes in energy-intensive goods and services—of $50 to $70 per household this year and $70 to $105 next. Estimates by economists Tombe at the University of Calgary and Nic Rivers at the University of Ottawa are that the average household will see direct costs increase about $200 ($300 in 2018) and indirect costs of $110 ($155 in 2018).

“The current carbon price on its own isn’t high enough or rising fast enough to do the job. “ –Dan Woynillowicz, Clean Energy Canada

The academics note, though, that real-world experience will likely differ. First, and as intended, people will reduce their consumption. Newfoundland hiked its fuel excise tax a whopping 16.5¢ a litre in June 2016; since then, fuel use is estimated to have declined 10 per cent.

Second, the market tends to respond to these drops in demand by lowering prices. If business is slow at service stations, for example, a gas war is more likely to break out. As Tombe and Rivers noted, the Consumer Price Index (excluding energy) in BC actually trailed the Canadian average in the four years following the imposition of a carbon tax there.

Alberta chose a carbon levy over two possible alternative ways to curb emissions: cap and trade, which allows polluters to buy credits from the government or other emitters, and what Antweiler calls “command-and-control” policies, which rely on governments to mandate a solution (e.g., federal fuel economy standards for cars). The carbon levy has advantages over both. Economists and business leaders consider it the least disruptive to the economy; big oil companies like the fact that end users pay their share; it’s easy to tally up who paid how much and where the money went; and we’ve known for a long time that price hikes discourage consumption.

“We have centuries of data proving that,” says Nancy Olewiler, a professor of economics at Simon Fraser University and co-author of the textbook The Economics of Natural Resource Use. “Economics works.”

Perhaps the best comparator to Alberta’s carbon levy is BC’s carbon tax. A number of surveys since that tax was implemented in 2008 point to dramatic results in the first five or six years, followed by a levelling off—perhaps even a small increase—in per-capita fuel consumption and emissions in the years since. A 2013 study by Sustainable Prosperity (now the Smart Prosperity Institute) showed fossil fuel use in BC declined 16 per cent in the first five years of the carbon tax, while it rose 3 per cent in the rest of the country. A 2015 study by the Carbon Tax Center in the US indicated emissions in BC declined 13 per cent between 2008 and 2013.

Some of that involved less driving. In 2014 tracking by the City of Vancouver indicated only about half the trips taken by residents involved a car. The city’s condo boom and the carbon tax were both factors.

BC’s carbon tax started at $10 per tonne and rose by $5 a year until 2012, when the government (under a new premier) capped it at $30 a tonne. “Our per-capita emissions fell nearly 19 per cent relative to the rest of Canada over the five years when our carbon tax was increasing annually,” says University of Victoria professor Tom Pedersen, chair of the Canadian Climate Forum. (This also occurred at a time when a global recession caused emissions to take a pause.) SFU’s Olewiler says when the tax was capped, momentum was lost. Since 2010, total emissions in BC have increased 4.3 per cent.

The most cited difference between BC’s carbon tax and Alberta’s levy is the matter of revenue neutrality. The BC tax’s debut on July 1, 2008, was accompanied by what was meant to be an equivalent cut to personal and corporate business taxes—perhaps not surprisingly, coming from a politically right-of-centre government. With the exception of a one-time low-income tax credit and benefits for northern residents, the proceeds were not directed to rebates for consumers, green infrastructure or emissions-reduction technology as they are in Alberta. BC’s measure is a straight tax. As OECD secretary-general Angel Gurria put it: “The implementation of British Columbia’s carbon tax is as near as we have to a textbook case” of a carbon tax.

With its rebates, the Alberta carbon levy is partially revenue-neutral. But about 65 per cent of the revenue raised is earmarked for investment in green infrastructure such as transit, renewable power, transitional assistance for affected industries and technology development. In theory this boost for low-carbon alternatives should help Alberta’s levy outperform BC’s. “Green infrastructure helps individuals overcome structural barriers to change,” argues Marc Lee of the Canadian Centre for Policy Alternatives. “When has the marketplace ever provided any transit lines? The transition off coal [-fired electricity] is not something individuals can do. It requires centralized action.”

“In any market-based approach, the price placed on emissions should be comparable to the estimated environmental costs.” –Trevor Tombe, Economist, U of C

Free-enterprise economists frown on such green slush funds, which tend to enlarge the public sector. “Green fund allocations are often inefficient,” says UBC’s Antweiler. “They just create money that has to be spent, often on projects that don’t meet the cost/benefit test.” For example, repeated studies have shown the corn-based ethanol content in gasoline, mandated by the governments of George W. Bush in the US and Stephen Harper in Canada, did nothing for the environment and may in fact have done harm.

For all their conviction that carbon pricing will reduce emissions, few economists are willing to say by how much. “For every percentage point increase in the tax, we get a roughly 1 per cent reduction in fuel consumption,” offers Antweiler. He also notes that eight to 10 years is about how long it takes for the economy to fully respond. Hence, it’s reasonable to expect the extra 6.7¢ tacked on to every litre of gasoline in January 2018 to play out as a decrease in per-capita fuel consumption in the high single digits by 2024 or so.

The Carbon Tax Center has developed a spreadsheet model to predict how a US carbon tax might affect emissions in that country. If you initiated a tax this year that ramped up to US$20 per short (imperial) ton of CO2 in 2020—roughly equivalent to Alberta’s $30 per metric tonne next year—the model forecasts a 10 per cent drop in carbon dioxide emissions by year 10 (2026) compared to what they’d be without the policy. “It’s something, but not much,” says CTC co-founder and director Charles Komanoff, who wrote a 2015 analysis of BC’s performance.

A few factors bode ill for Alberta’s ability to achieve even those reductions, he says. First, Alberta has had carbon pricing for large emitters since 2007, meaning its baseline emissions would be lower than if there had been no previous carbon pricing. Second, a carbon tax imposed in just one province will be less effective than a nationwide one, because there will be fewer network effects among businesses and less impetus for cultural change.

A percentage drop in emissions in the high single digits may be an improvement, but it won’t help Alberta meet its 2030 emissions target of 270 megatonnes, much less meet Canada’s commitments under international climate accords. (Alberta alone accounts for around 40 per cent of national emissions.) “The current carbon price on its own isn’t high enough or rising fast enough to do the job,” says Clean Energy Canada’s Woynillowicz.

Yet reduced energy consumption is one small part of Alberta’s Climate Action Plan. The Climate Change Advisory Panel, chaired by U of A economist Andrew Leach, said its recommendations—virtually all of which the government intends to implement—would save Alberta 20 megatonnes by 2020 and 50 megatonnes by 2030. That’s mostly from components of the plan other than the carbon levy. “Unlike in other jurisdictions, the bulk of our emissions come from industrial process activities of various kinds,” says Phillips (transportation and buildings accounted for just 19 per cent of Alberta’s 2013 emissions).

The Alberta levy’s biggest shortcoming may be the brevity of its phase-in, and the sense of closure at the end. Any increases after 2018 are to track the rate of inflation (though that may not meet the federal government’s demand for carbon pricing to hit $50 a tonne by 2022).

“Behavioural change takes time and the right signals. I’m not sure if the two-year increase in Alberta is enough to send the right signal,” UVic’s Pedersen says. “I would like to have seen at least a five-year legislated schedule, like we did in BC.”

In BC it was the sense that fossil fuel use was only going to get more expensive, year after year, that contributed to the tax’s success, Olewiler says. “There’s a lot of psychology at work here,” she says. “The crucial thing to me is the knowledge that the price increase is permanent and it’s going to get more costly over time.”

Adherents are optimistic that raising carbon prices may actually reap increasing returns. “Once you get to much higher levels of carbon pricing, then you’ll see systemic changes,” Antweiler says, adding that the availability of affordable substitute technology—electric vehicles, for example—is a bit of a wild card. “Eventually you are going to see a trigger point where new technology becomes cheaper on an amortized basis than fossil-fuel technology.”

So how high is high enough to trigger rapid change? A study by environmental economists David Sawyer and Chris Bataille released in March set the bar at $150 per tonne for Canada to meet its commitment to reduce emissions 30 per cent below 2005 levels by 2030. Some economists, such as SFU’s Mark Jaccard, one of the architects of BC’s carbon tax, have suggested $200 a tonne—meaning 45¢ per litre of gas. Recognizing the political cost of such tax hikes, Jaccard now favours a combination of more modest carbon pricing—say, $40 a tonne—with complementary standards and regulations.

One poorly understood variable in the carbon levy’s prospects is the impact of culture. British Columbians were broadly supportive—if not of a carbon tax specifically, then of action, personal and political—to fight climate change. They were ready to consider a more fuel-efficient or electric vehicle and just needed a nudge to take the plunge.

Are Albertans of the same frame of mind? The opposition to the carbon levy suggests not. Neither is the one-quarter of the population (the highest proportion in Canada) that is not even convinced that human activity contributes to climate change. But a price signal doesn’t need moral support to be effective—look at the yo-yoing demand for heavy-duty trucks and SUVs across North America in response to oil prices. “I would be surprised if Albertans who don’t accept the evidence of climate change or don’t like the carbon tax choose to expose themselves to higher costs. That’s a high personal price to pay,” Woynillowicz says.

One psychological factor that could really undermine the levy’s efficacy, though, is the sense that it could be repealed. Here uncertain NDP re-election prospects come into play. Still, the levy may end up a bit like Obamacare: Any new government will have a tricky time withdrawing the rebates and may instead be disposed to reform or replace the levy rather than scrap it. And then there is the federal carbon pricing protocol announced in fall 2016, which requires provinces to charge a minimum of $10 per tonne next year and rising by $10 each subsequent year to $50 in 2022. “Alberta signed an agreement,” Olewiler says. “Are they going to pull out?”

It is also possible that the levy will change people’s behaviour and reduce emissions more than the models project. And that isn’t so far-fetched. BC’s carbon tax exceeded expectations, and Alberta’s economy has a higher carbon intensity to begin with—British Columbians drive 38 per cent fewer kilometres per capita than Albertans. The upshot? “There’s absolutely more potential for improvement” in Alberta, Woynillowicz says. “When BC introduced its carbon tax there was probably less low-hanging fruit.” In the improvised tournament that is climate change mitigation, the top prize doesn’t go to the most valuable player, but to the most improved.

Former Albertan Michael McCullough is editorial director for Canada Wide Media in Burnaby, BC.

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