The campaign for the 41st Parliament got me thinking about Canadian Environmental Policy. Inspired by Stephen Dion’s ‘green shift,’ the last federal election generated the most vibrant debate on environmental policy ever seen at a national scale. Two spectacular crashes later, that of Stephen Dion and the World Economy, this election campaign will at best, pay marginal attention to environmental issues.
My theme for the first series of posts on this blog: what would I like to see in environmental policy announcements from the major political parties?
The first item on my wish list, a national carbon tax, that is, a tax on the carbon content of fossil fuels. Clearly, I am not easily discouraged by reality.
Most economists know that a carbon tax is the best instrument to address climate change. It is cost-effective, that is, it reduces carbon emissions at the lowest cost. The revenue collected provides the best chance for a government to reduce the burden imposed by the tax on the poor. It is the best policy instrument if we are uncertain of the cost of reducing carbon emissions in the future. This cost depends on unpredictable fuel prices, energy demand, or the growth of energy saving technologies. Finally, it is the simplest climate policy to administer. Institutions to tax fuels are already in place in most countries, including Canada.
A cap and trade system is not too bad either. Eventually, anything that puts a price on carbon emissions is an improvement over our status quo. However, to measure up to a carbon tax, the cap and trade proposals in most policy initiatives, including the Western Climate Initiative (WCI), need a major overhaul.
It is unlikely the costs of building and administering a cap and trade system would ever be lower than that of an equivalent carbon tax. But theoretically, a cap and trade system can be as good as a carbon tax in all other criterion discussed above. If the cap and trade covers as many as the tax, and it allows the banking and borrowing of allowances, it is at least as cost-effective. Simple modifications can render it as good as a carbon tax in case of uncertainty of the future cost of reducing emissions. Finally, if each allocation of permits occurs in an extremely well designed and competitive auction, the government should have as much revenue as under the carbon tax.
However, there are two major problems with all cap and trade proposals in circulation. The first is that they target users of fossil fuels. While this seems sensible as users create emissions, the cost to bring most users into the program is prohibitive. In the first compliance period of the WCI (2012 – 2015) only 40% of British Columbia’s sources are included. Even in the second compliance period, most small producers will not be included due to minimum size provisions. Thus to achieve reductions equivalent to a carbon tax, a much smaller subset of users are targeted. This raises the cost of reducing the same amount of emissions significantly. The second problem is that current cap and trade proposals give away most of their emissions allowances. This is thought of as being a useful way to win political support. The WCI will auction at most 25% of its allowances. Research suggests that at least 50% of allowances be auctioned to prevent creating windfall profits for firms receiving them. By auctioning such few allowances, not only do the programs restrict their ability to help the poor, they are also making firms receiving these allowances richer than before.
Sensible carbon taxes, and cap and trade proposals would target producers upstream in the fossil fuel chain. This would be coal mines, imported and produced petroleum products and natural gas. Even in a economy as large as the USA or Europe this would require regulating only 2000-3000 entities. The administrative costs would be minimal and, directly or indirectly, all consumers of fossil fuels would be included in the system. Further, if a majority of allowances were auctioned in a competitive system, the government would generate revenue that could defray the increased burden of the tax on low income households.
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