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A new proposal for a federal carbon tax

In a new report released today for Sustainable Prosperity (a new research institute), Jack Mintz and Nancy Olewiler pitch a federal carbon tax constructed by broadening the base of the federal excise tax (which currently raises over $5 billion per year based on a tax of 10 cents per litre of gas and 4 cents per liter of diesel) to include other fuels that emit CO2 and other pollutants. The authors more generically call it an “environmental tax” – they make their calculations based on carbon but argue that it could be broadened to include SO2 and NOx. Below is an excerpt from the summary on the proposal (full report here):

The report recommends that the federal government, in co-ordination and consultation with the provinces, replace the federal fuel excise tax with a more broadly based environmental tax designed to reduce emissions of greenhouse gases and air contaminants. Since the federal tax applies narrowly to gasoline and diesel used for vehicles, it can be broadened to cover other fuels. Leaving the existing excise tax rate on gasoline unchanged, this would be equivalent to a tax on the carbon in fuels of approximately $42 per tonne CO2.

… The restructured tax would raise approximately $12 to $15 billion in new tax revenue annually. This substantial increase in revenue could be used to reduce taxes or fund government tax credits related to climate change technologies. The authors support a revenue-neutral tax shift: the incremental tax revenues should be returned to the economy in the form of lower taxes. In other words, there should be no net increase in taxes associated with this proposal.

The report estimates that the additional revenues from this broader environmental tax would allow the federal government to reduce corporate and personal income taxes by 10 percent in the short run and eight percent in the longer-term (given that the tax revenue should diminish with lower fuel consumption over time). This is a substantial tax cut. The form of the tax cut can help mitigate impacts on low-income individuals or businesses and to accelerate the development of clean technologies. For example, the tax rates on the lowest brackets can be cut the most, as was done in British Columbia’s carbon tax.

… An environmentally based fuel tax could also be combined with a cap and trade system for carbon emissions, as is being by pursued by the federal government and some provinces. This would complement and improve on such a system by ensuring that there is a price on carbon across the entire economy (given that cap and trade systems typically cover only carbon emissions from large industries). Moreover, provinces could also pursue this proposal by converting provincial fuel taxes into environmentally based taxes and using the revenues for other provincial tax cuts.

Reforming the fuel tax would be a first step towards more comprehensive tax reform that would broaden tax bases while shifting away from income and other taxes that discourage savings, investment, employment and innovation—towards more consumption and user-pay taxes, such as environmental taxes. This restructuring of the tax system would promote sustainable economic growth and incomes, and protect our natural environment today and for generations to come. In short, it would be good for the environment and the economy.

I would take some issue with the language in the last paragraph. I’m pretty skeptical about whether those tax cuts woud actually enhance one or all of savings, investment, employment and innovation. These are the standard claims of environmental tax-shifting and I think the evidence is pretty thin. And the comparator of what economic benefits could result from public investment is dismissed before we get there – arguably a program of public transit infrastructure, industrial policies, targetted subsidies for home retrofits, etc. could be a more productive use of funds. In support of such a program, I will recite a great Statscan study from a few years ago that found 17 cents per year benefit to business for every dollar of public infrastructure investment.

My quibble is allayed somewhat by the actual proposals for tax cuts in the report. One element I dislike is a push for yet more corporate tax cuts. There are already multi-year tax cuts in place, and they will not likely produce much in the way of new investment given the way corporations are already socking away their record-high profits (as a share of GDP). It is assumed that corporate tax rates are a disincentive to new investment and employment, so it is hard to take the conclusion that cutting them must remove that disincentive.

That said, the other measures are not so bad. One is to accelerate capital cost allowances, which is a measure that would be better at achieving the boost to investment but at much, much lower revenue cost to the treasury. Ditto for another proposal to implement tax credits for environmental technologies. On ther personal tax cut side, Mintz and Olewiler want to reduce the high marginal rates faced by low income people transitioning from income support to employment. This is a legitimate concern and addressing it could at the same time heed off the regressive impact of the broader based carbon tax. I’m glad to see that Mintz and Olewiler did not call for upper-income tax cuts.

They also make an important public finance point that tends to get lost in the generic “tax shifting” argument that calls for “taxing the bads not the goods”:

A significant concern that we have with the environmental tax option is that the revenues should decline over time as emissions decline. If this is the case, governments cannot become too reliant on the revenues.

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Comment from Dave
Time: May 13, 2008, 1:30 pm

Just picking up on that very last point. There are solutions to the anticipated (and hoped-for!) decline in revenues from a given environmental tax.

The first is to place those revenues (or a portion of them) into a permanent fund, which would yield steady levels of earnings in perpetuity.

Another solution when the fuel tax base start to diminish is to increase taxes on other things that create negative environmental or social externalities – like waste, toxins, tobacco, gambling, liquor, Hummers, Fraser Institute publications, monster homes, suburban sprawl, etc. There is a long list. If we ever ran out of negative externalities to tax, that would truly be cause for celebration! And then we can reinstate higher other taxes to backfill.

Comment from Michael Barkusky
Time: May 17, 2008, 12:12 am

Way to go Dave …

As Herman Daly says, externalities are pervasive !

(and failing to deal with externalities [for fear, possibly, of taxing them to extinction] is not good for children and other living things; in the long-term, it is not even good for economies ….)

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