The case for pricing carbon

There were respectable reasons to vote against the Liberals in the recent federal election. Doing so because of their carbon taxing proposals was not one of them. That many Canadians voted against Stéphane Dion’s “Green Shift” and that both Jack Layton and Stephen Harper thought it electorally advantageous to oppose carbon taxing says something deeply depressing about Canadians’ refusal to grapple with a major international problem.

For two decades, Canadian politicians have combined earnest rhetoric on the threat posed by climate change with a refusal to endorse any effective policy response. We Canadians pride ourselves on having signed the Kyoto Accord and deride the Americans for refusing to do so. But what is our record on curtailing emissions? The honest answer is “abysmal.” The year 1990 is the benchmark from which the accord measures countries’ progress. Since then, emissions in Canada have risen at a faster rate than the world average, faster than in the United States – where emissions grew at a rate well below the world average. No one expects Canada to meet its Kyoto target of 6 per cent below 1990 levels by 2012.

Over the last decade, federal and provincial politicians have tried unsuccessfully to reconcile the imperative to act with the reluctance of Canadian consumers to change energy consumption patterns or Canadian producers to invest in less carbon-intensive ways of supplying energy. Governments have announced targets for reduced emissions – targets far in the future that require no immediate change in corporate or individual behaviour. (On this theme, I invite readers to turn to the contribution to this section by Mark Jaccard, Nic Rivers and Jotham Peters.) Simultaneously, as a salve to our collective conscience, governments have devised ad hoc “green” subsidies and have financed rhetorical appeals to take the bus, turn down the thermostat and so on. (Rick Mercer’s “one tonne challenge” television ads come to mind.)

If you don’t, why should we?

Canada is one country among many. And as figures 1–3 illustrate, it is not alone in having an abysmal emissions report card. In 2005, the top ten emitters – Canada ranked seventh – were responsible for two thirds of all emissions, with more than 40 per cent attributable to just two countries, the United States and China. That year, the United States ranked first and China second, but since 2005 China’s rapid industrial growth has inverted this ranking: it now exceeds the United States in total emissions.

In economists’ jargon, public goods are those whose services cannot be denied to anyone once they are in place (think lighthouses). Since no one can be denied access to public goods, private firms cannot readily charge a price for their use, and markets undersupply them. An adequate supply requires government intervention. A stable earth atmosphere, a necessity for survival of life on the planet, is the ultimate public good. But denying access to the atmosphere as a “dump” for greenhouse gases is an exceedingly difficult collective coordination problem for governments to tackle. Reducing world emissions to levels consistent with acceptable – if still disruptive – temperature increases will require international diplomacy of a high order.

It is tempting for Canada to enter into this diplomacy with a self-serving reading of figures 1 and 2, and to ignore the implication of figure 3. Using figure 1, we can make the argument that, at 2 per cent, our emissions are a small share of the total. Our behaviour is of minor importance; what matters is what the larger emitters do – China and the United States in particular. Referring to figure 2, we can argue that the post-1990 growth of Canadian emissions, while above the world average, is far below the growth in emissions among rapidly industrializing countries, most of them in Asia. Starting from a low base, Vietnam, for example, has increased its emissions by 317 per cent since 1990. From much larger bases, China has increased emissions by 137 per cent, and India by 103 per cent.

To make such arguments is to invite cynicism among developing countries, particularly in the rapidly growing countries of Asia. Many remain poor in Asia, but in the last two decades nearly a billion people – in China, India, Malaysia, Thailand, Indonesia, Vietnam and elsewhere – have begun to enjoy lifestyles that hitherto were the prerogative of those in the wealthy club of OECD members. The support of Asian middle classes is crucial if diplomats are to succeed in the coming decade in striking workable deals that engage all major emitters in credible commitments to cut emissions – which Kyoto was not.

Confronted with their responsibility for impending climate change, the public response of Asian governments is measured: they acknowledge the problem and the impact on their respective countries. However, from Seoul to Shanghai, Ho Chi Minh City, Singapore, Kuala Lumpur, Bangkok and Mumbai, the private response among the Asian middle class is infused with a sense of historical injustice. It could be phrased as follows:

You in the West have enjoyed two centuries of industrial prosperity; finally, some of us are enjoying it, and many more of us want to do so. For two centuries, you used the atmosphere as a “dump.” You are responsible for the overwhelming majority of the increase in atmospheric carbon dioxide. Despite our rapid industrialization, our per capita emissions remain far below yours. Per capita emissions in the United States and Canada are five times those in China, 20 times those in India. If we are to make wrenching adjustments in our energy markets, you make the first moves to dump less into the atmosphere. If you act, we will – probably – do likewise. If you don’t, why should we?

It is a powerful argument. An international agreement that commits all major emitters to a schedule of reductions will no doubt require wealthy countries – Canada among them – to assume significant costs. Those with large per capita emissions (see figure 3) will have to accept larger relative reductions than Asian countries, and be prepared to offset some of their emissions by buying reductions in newly industrializing countries. The sooner the United States and Canada undertake effective climate change diplomacy themselves, the sooner the world’s major emitters will reach agreements.

How to “dump” less

There are two ways to “dump” less: incur a prolonged economic recession or make people pay to emit greenhouse gases. Russian emissions have declined since 1990 (see figure 2). This has little to do with environmental policies pursued by Moscow; the reason is the contraction of the Russian economy over the 1990s. There is near-unanimity among economists that, without dramatic reductions in economic activity, the necessary foundation for successful climate change policy is paying for emissions. (On this subject see the accompanying open letter published during the federal election campain and signed by 255 economists.)

Pricing emissions is not sufficient as policy; it is, however, the indispensable foundation. Pricing induces consumers to reduce activities that cause emissions, and it encourages firms to develop new technologies to supply energy without emitting carbon dioxide. There are several strategies for pricing emissions:

• Carbon tax with schedule of escalating rates over time. A carbon tax geared to greenhouse gases emitted per unit of hydrocarbon fuels consumed has the advantage of precise targeting of the pollutant to be reduced.
• Cap-and-trade system of emission permits with schedule of declining permit volumes over time. The overall goal of climate change diplomacy is agreement on a schedule of reduced aggregate world greenhouse gas emissions over coming decades. An emissions cap combined with tradable permits obviously addresses this overall goal.
• Discretionary taxes targeting a schedule of rising prices for hydrocarbon fuels. Given high volatility of oil prices due to short-term fluctuations in international supply and demand, some have argued for using taxes to target a schedule of rising domestic oil prices. Subject to a schedule of rising prices over time, lower taxes if world prices rise precipitously, and raise taxes if they fall.

There are advantages and disadvantages to each strategy:

• Administrative complexity of policy implementation. A tax is administratively easier to introduce than a cap-and-trade system and can be designed to cover a larger share of emissions. In practice, as a result of the complexity of measuring emissions, a cap-and-trade system is applicable only to large emitters.
• Volatility of hydrocarbon prices: Because of lobbying over which sectors are to be covered or what procedures will govern auctioning of permits, cap-and-trade systems may generate high volatility in emission permit prices. (This has been the experience with the European Union Emissions Trading Scheme.) Since the cost of emission permits contributes to hydrocarbon costs paid by firms, volatility in permit prices augments whatever volatility arises from international oil markets. A carbon tax offers certainty as to the impact of government intervention on future hydrocarbon prices. A carbon tax does not, however, offset international oil market price volatility; a discretionary tax targeting a schedule of domestic prices does.
• Achieving greenhouse gas emission targets: The impact on greenhouse gas emissions of a tax depends on both the demand responsiveness of energy consumers and on the supply responsiveness of firms supplying energy services from sources other than hydrocarbon fuels. Given uncertainty as to market response, no one can predict with confidence the tax schedule required to achieve any particular greenhouse gas emissions target. However, given their administrative complexity and incomplete coverage, neither can one be sure to meet specified aggregate emissions targets by means of existing or proposed cap-and-trade systems.

Figure 2 illustrates performance by three of the EU countries that have been most successful in reducing their emissions since 1990: Denmark, Germany and Britain. All three have combined participation in the EU cap-and-trade scheme with carbon taxes and complementary “green” policies. Admittedly, country-specific events figure in the story. Availability of less-polluting North Sea gas enabled Britain to reduce use of more-polluting coal. Germany’s absorption of the energy-wasteful command economy of East Germany presented easy reductions in energy intensity.

Marvin Shaffer adds a discussion of what is required beyond carbon pricing. Carbon pricing strategies in the EU have a better immediate potential to cut emissions than their equivalent in North America because EU governments are doing more of what is required if the economy is to adopt less carbon-intensive ways of doing things. The Europeans are investing in “green” transportation infrastructure – from fast interurban rail to networks of bicycle-only urban pathways. They are using price incentives, beyond carbon pricing, that provide multiple benefits of which lower emissions is one. London’s road pricing scheme has simultaneously reduced traffic congestion and reduced emissions. Requiring utilities to source a rising share of electricity from non-hydrocarbon sources has obviously reduced emissions; it has also spawned a growing EU market in non-carbon energy sources.

Statistical estimates of North American price responsiveness in the recent past do not provide much cause for optimism. In the short run, a 10 per cent increase in crude oil prices (whether due to international market dynamics or carbon pricing) may generate no more than a 1 to 2 per cent reduction in consumption. In the long run, the responsiveness is greater. But how great will the response be, and how long is the long run? To meet targets for lower greenhouse gas emissions, Canadian governments must do more than price carbon. We must be prepared to copy best practices from elsewhere.

The politics of pricing carbon

Starting last July, British Columbia implemented North America’s first significant carbon tax.¹ The tax begins at a low rate ($10 per tonne of carbon dioxide emitted), with a scheduled commitment to ramp up the price of emissions in future years. It is a broadly based tax that gives firms and consumers ample time to adapt. The tax is accompanied by tax reductions to ensure revenue neutrality. The reductions are designed to favour the poor and thereby offset the regressive implication of increasing the cost of activities such as home heating. The federal Liberals’ Green Shift proposals were broadly similar.

Both initiatives deserve support; both initiatives became mired in partisan controversy. Underlying the opposition has been politicians’ willingness to play on Canadians’ antipathy to new taxes. The Tories damned the Liberal Green Shift as a scheme to thwart Alberta’s prosperity and return Canada to discredited “tax and spend” traditions. During the campaign, the federal NDP disingenuously attempted to maintain environmental credibility while joining the Tories in opposing carbon taxes. They proposed an alternative cap-and-trade system to “make big polluters pay” with, the NDP implied, no impact on prices paid by consumers. The Pembina Institute politely made the obvious point:

Mr. Layton said that carbon taxes are “unfair for ordinary working families,” while his alternative of cap-and-trade “targets the big polluters.” In reality, the proposals for federal carbon taxes and B.C.’s existing tax cover both industry and consumers. And regardless of whether companies are subject to a tax or a cap, in many cases they will pass on increased costs to consumers.²

When the Tories issued their platform, in the last week of the campaign, it contained a cap-and-trade proposal indistinguishable from the NDP’s. The Pembina critique of the NDP applies equally to the Tories.

Here in B.C., the provincial NDP is the official opposition in Victoria. Its leadership has proved tactically clever by mounting a high-profile campaign to “axe the carbon tax” in favour of future participation in a cap-and-trade system. B.C. is one of four provinces participating in the California-led Western Climate Initiative, a worthy cap-and-trade venture involving a coalition of states and provinces. It is scheduled to be phased in after 2012, but it may be overtaken by political events.

A post-Bush administration in Washington may well subsume the Western Climate Initiative in a nationwide cap-and-trade scheme. To avoid potential trade sanctions, Canada and Mexico will be obliged to join in. There is serious discussion in Washington of “green tariffs” – tariffs that seek to impose indirectly a carbon tax on goods imported into the United States that are not, in their country of origin, subject to carbon pricing. Such a policy has obvious appeal to both environmentalists and Americans worried for their jobs.

In his new postelection cabinet, Stephen Harper appointed Jim Prentice, perhaps the most competent of his senior cabinet colleagues, as environment minister. Prentice is from Calgary, he knows the oil industry, and he may well be the central figure as Ottawa and Alberta come to grips with the necessity of more credible climate change policy. However, the B.C. NDP has not discussed any of these possible outcomes. The B.C. government faces a general election in 2009, and the NDP’s “axe the tax” campaign may unfortunately play a role comparable to the Tory-NDP opposition to the Green Shift in the recent federal election.

Five centuries ago, Machiavelli observed, “There is nothing more difficult to carry out, nor more doubtful of success, nor more dangerous to handle, than to institute a new order of things.” Implementing a climate change policy that works will no doubt be difficult to carry out, doubtful of success and dangerous to handle. But if Canadians are to make a contribution to reduced emissions – even a modest contribution relative to the task at hand – and lower the cynicism surrounding international climate change diplomacy, it is long past time to “institute a new order of things.”

Notes

¹ British Columbia, Budget and Fiscal Plan 2008/09–2010/11 (Victoria: Ministry of Finance, 2008), retrieved September 26, 2008, from: www.bcbudget.gov.bc.ca/2008/default.htm

² Pembina Institute, “Layton’s Attack on Carbon Taxes,” retrieved September 26, 2008, from: www.pembina.org/election2008/20080925