Assessing Canadian Carbon Pricing Pathways

Revised draft paper downloadable here.

Summary by Clean Prosperity here

Canadians for Clean Prosperity[1] asked Deep Decarbonization Pathways Canada (DDPC)[2] to assess how carbon pricing alternatives might contribute to Canada’s 2030 target of reducing greenhouse gas emissions by 30% below 2005 levels, and how the economic costs of that effort might be minimized. The analysis has relevance to a number of important carbon pricing choices and questions under discussion in Canada today, namely:

  • What carbon pricing approach can be most cost-effectively scaled up to align with deeper GHG aspirations: a broad-based carbon tax, cap-and-trade, or some hybrid of the two?[3]

  • What emission sources are to be targeted by the carbon price?

  • Can economic activity be protected while pursuing deeper GHG reductions?

  • What do we do with the revenue: shift taxes, increase program spending, or reduce deficits?

  • How might new federal policies interact with existing provincial initiatives?

We constructed a set of comparable scenarios to model and analyze the relative performance of different carbon pricing options. The purpose of the comparison is to identify the policy with the potential to deliver the most greenhouse gas (GHG)[4] reductions, at the lowest economic cost, with the highest level of political acceptability. Since deeper GHG aspirations mean increasing cost, it will also be important for the policy to protect economic activity. The preferred policy should also, presumably, fit within the current patchwork of regional and federal policies, minimizing the risk of unwinding tailored provincial efforts. A tall order, but a good set of criteria to frame Canada’s carbon policy choices.

The analysis uses an economy-wide, provincially and sectorally disaggregated economic model, R-GEEM, to forecast economic activity and GHGs to 2030. We assess the relative economic and emission performance of an economy-wide carbon tax (eg. the British Columbia approach), and an economy-wide carbon tax paired with a cap-and-trade system with output-based allocation (OBA) for large industrial emitters (eg. the Alberta Climate Leadership Plan[5]). We also compare allocation of governments’ carbon tax proceeds to tax cuts versus program spending. The analysis reveals that:

  • Carbon taxes, cap-and-trade, or hybrid systems can all be scaled to cost-effectively align Canada’s emissions trajectory with deeper GHG reductions.

  • Modest impacts on GDP can be expected as carbon prices climb in an orderly, nationally consistent fashion towards $100 per tonne CO2e[6] by 2030.

  • The current jurisdictionally fragmented approach to reducing GHGs leads to higher costs, particularly as carbon prices approach $100 per tonne CO2e.

  • Regional economic impacts are minimized when the carbon tax is complemented by a discrete cap-and-trade system for large industrial emitters (EITE), based on a tradeable intensity standard with allocations linked to production (output-based allocations).

  • With the large array of current and developing subnational GHG strategies, applying new GHG policies to emissions covered by existing plans can lead to unintended consequences. Policy makers must develop a better understanding of these policy interactions.

  • Revenue recycling produces a range of outcomes. A revenue-neutral tax shift offsets policy costs by reducing tax distortions. Program spending incurs additional costs, but generates deeper GHG reductions.

  • The selected revenue recycling approach has less impact on emissions or the economy than the choice of policy instrument, either carbon tax or a hybrid approach.

[1] Mark Cameron and Kaitlin Szacki provided detailed comments and additions to this document. But any errors and omissions are the sole responsibility of the authors.

[2] Thanks to Noel Melton of Navius Research for ongoing support.

[3] Note we do not compare other types of policies such as renewable portfolio standards that may have similar shadow prices. As our DDP work has indicated, we support a portfolio of policies with the following merit order: remove perverse subsidies, price carbon, use regulations particularly in vehicles, buildings and methane; use R&D to drive down long-term technology costs, and provide information to aid with decision-making.

[4] Several major greenhouse gases contribute to global warming. Carbon dioxide (CO2), methane/natural gas (CH4), and nitrous oxide (N2O) are the most significant sources, followed by CFCs and HCFCs, high atmosphere ozone (O3), perfluoroethane, and sulphur hexafluoride (SF6).

[5] Some cap-and-trade allocations in Québec and Ontario have very similar characteristics to output-based allocations (OBA), and could also be considered OBAs.

[6] Carbon dioxide equivalent.

[5] The price schedule was provided by Canadians for Clean Prosperity.

[6] Carbon dioxide equivalent.

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