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The Progressive Economics Forum

Carbon taxes, distribution, and politics

In his rabble.ca column, Duncan Cameron raises some concerns about carbon taxes:

When Liberal leader, Stéphane Dion, floated the carbon tax idea in Toronto recently, Layton responded that such a tax would cause severe problems for poor and low income Canadians. May and Suzuki both support a carbon tax, and think its impact on the poor can be remedied through new tax credits.

Layton is right: a carbon tax would reduce income for all people, and would hurt those with the least income the most. Worse a revenue-neutral carbon tax — supported by May and Suzuki, as well as Dion — by denying governments additional revenues, would force governments to re-allocate existing spending in order to fund cleaner energy initiatives.

The best argument for a carbon tax is that governments could invest the additional money to make the economy green. Restructuring transportation systems, retrofitting buildings to conserve energy, and redistributing income from rich to poor in order to share the costs according to ability to pay, these ideas have been raised by Layton, and additional tax revenues are necessary to make them happen.

… May, Suzuki and Dion say there is no reason to worry about introducing a new carbon tax that will accentuate growing income inequality, because it can be fixed later with income tax credits.

But, if we have not made an effort to redistribute revenue from rich to poor over the last 25 years, indeed have done the opposite, why are we now to believe that bringing in a carbon tax will suddenly transform corporate Canada, and the wealthy into practicing social democrats?

Company shareholders, and the wealthy want more income not less. The people with economic power in this country understand the threat of global warming, and see it as a profit-making opportunity. The cost of going green is to be passed on to consumers just like every other business cost. People at the bottom will just have to do without, as has always been the case.

For its academic and think tank proponents, the carbon tax is part of the microeconomic market utopia idealized by believers in efficient markets. If only we could each pay the real cost of emitting green house gas, proportionate to our use of carbon, through a dedicated carbon tax, we would have an incentive to reduce our use of carbon, in proportion to our consumption of carbon. “If only” indeed.

For a real world perspective we need macroeconomics. When the price of fuel goes up, most people consume the same amount for a considerable time. Unfortunately, the higher price reduces the amount of discretionary income available across the country to households, and businesses. This slows the economy.

What is needed is to tax the gain away from the fuel providers, and, first, compensate those distressed by the fuel increases; and, second invest in ways to reduce fuel consumption. But that requires a plan, such as the NDP under Layton has put forward, and big business do not like it when governments do their planning for them. Dion understands this, and goes along with business. It is not as clear that May and Suzuki do understand it.

Duncan is right that a carbon tax will be regressive. But what matters is what we do with the revenues. In BC, for the first year about one-third of the revenues will go to each of low income tax credits, personal income tax cuts and corporate income tax cuts. The result is that the regime as a whole ends up being slightly redistributive primarily because low income folks get more back in credits than they will pay in tax. This changes over the years so that the system becomes on balance regressive by 2010. Toby Sanger and I have done the math on this and are presenting our (preliminary) findings next week at the Canadian Economics Association meetings.

The key point is that if one-third or more of the carbon tax revenues go back to low income households then we effectively deal with the problem of regressivity in the carbon tax. But at the same time, a carbon tax will make it more expensive on the margin to consume fossil fuels, and people can respond to those higher prices by changing their behaviour. If anything, the BC carbon tax should be higher, as at 2.4 cents per litre the impact on behaviour is going to be teensy weensy.

I would abandon revenue neutrality beyond the low income credits and use the remaining funds to expand public transit and lower fares, subsidize energy efficiency retrofits for low income folks and renters, and accelerate the diffusion of greener technologies in general. PIT and CIT cuts are well down my list of priorities, and it seems to me that the whole package of revenue neutrality is reflective of elite perceptions that the public hates taxes, so the only way a carbon tax could be sold is with offsetting other taxes. At this point E. May goes on about the economic benefits of these other tax cuts, a point for which I am deeply skeptical.

Where Duncan and I differ is on where to next. His argument is concerned more with the politics of how a carbon tax plays out rather than the economics. I have trouble endorsing Layton’s position, which is essentially the same as Harper’s position (yes, federal politics has gotten that weird), in favour of cap-and-trade instead of a carbon tax. While cap-and-trade sounds nice (set emissions targets then let the market determine the price) the devil is in the myriad details of implementation, and a lot of it looks nightmarish from an administrative point of view.

That said, I could see a role for cap-and-trade system to complement a carbon tax, but not replace it. The type of cap-and-trade system under development under the Western Climate Initiative, for example, is only looking at large industrial emitters, meaning a large share of GHG emissions will not be covered, and even then the coverage may be spotty due to the negotiation process. And if permits under the system are given away rather than auctioned, the government loses its ability to offset regressive impacts when costs are passed along to consumers. Indeed, my spies tell me that the NDP plans to give permits away which could lead to the costs being passed along to consumers anyway but windfall profits for recipient companies, which is what happened in the EU trading system.

In other words, the same politics that Duncan is critical of for a carbon tax also apply to cap and trade. To be clear, Duncan does not come out endorsing cap and trade, leaving one other stylized option, regulation. There is certainly some scope for regulations as part of the package of solutions, but I’d be wary of attempts by governments to impose technologies on industry from up on high. But regulations that raise the bar for energy efficiency could indeed press the market towards greater innovation. More importantly, however, regulation will impose costs on industry that will also get passed on to consumers via higher prices, and like cap-and-trade without an auction of permits, will not provide the revenue to governments to offset regressive distributional impacts.

Any way you slice it, emitting GHGs is going to get a whole lot more expensive over time. But that is a good thing so long as we address distribution at the same time. In the same vein we need to get some policy gears moving to offset the adverse distributional impacts of the existing market-driven jump in prices at the pump. An excess profits tax on oil and gas companies (call it the anti-gouging tax), redistributed to low and middle-income earners (perhaps through the GST credit, as was the case with the 2001 federal home heating rebate), would be a much better platform for Jack Layton or Stephane Dion to be standing on.

UPDATE: Eric de Place at Sightline says I overstated on WCI:

You write: “The type of cap-and-trade system under development under the Western Climate Initiative, for example, is only looking at large industrial emitters…”

But that’s not strictly true. So far, WCI has said that it will include electricity (generators and importers), stationary combustion sources (meaning industrial plants), and residential and commercial natural gas. In addition, they’re still holding the door open for coverage of transportation fuels, which is by far the largest source of emissions in the region. Admittedly, they’re being a bit cryptic about transportation, but in their latest draft they went so far as to say something on the order of “most WCI partners have a strong interest in including transportation fuels under the cap.” That’s consistent with what my sources tell me is going on behind closed doors. Anyway, you can read all about it here: http://www.westernclimateinitiative.org/ewebeditpro/items/O104F17390.PDF.

Enjoy and share:

Comments

Comment from Stephen Gordon
Time: May 27, 2008, 5:27 pm

A very nice post.

Comment from Powell Lucas
Time: May 27, 2008, 6:58 pm

In the face of skyrocketing energy prices why we need any kind of a carbon tax is beyond me. Direct Energy has just applied for a 33% increase in natural gas rates. Gasoline is at $1.30 per litre. Airline, rail, and trucking rates are all increasing. We have yet to see the full impact of these additional costs at the supermarket, nor have we felt the hammer blows of rising fuel prices on our electricity rates. If anyone believes this won’t change consumption habits then they have no concept of even the most basic of economic theories. When consumers have to cut back on discretionary purchases to meet the costs associated with energy increases our economy will take enough of a hit without adding on additional taxes.

Comment from Travis Fast
Time: May 27, 2008, 7:24 pm

Wow and you think federal politics is weird. Stephen Gordon is agreement with you and Sam Gindin this month. A new big tent perhaps? I jest.

Seriously, how about cap + tax then redistribute and no trade. That is where Jack should have been.

The notion that all of this has to be revenue neutral has to go. It is going to cost money to fix this problem and on this Duncan is right. There needs to be policy in place that decides who is going to pay the extra cost. And if we have a trickle up economy, which it is impossible to argue we do not, then let the costs trickle up as well. The cap and trade scheme is ripe for all sorts of gaming. The carbon tax seems more straightforward, easier to police (I am still laughing at Jack’s ombudsman) and in theory easier to redistribute in the case of regressive effects.

The NDP got this one wrong. Oh no! That is the second time this week I have agreed with Gordon. Weird world.

Comment from Kevin Dorse
Time: May 28, 2008, 10:53 am

Love the blog, Marc.

But I have to disagree when you say “I have trouble endorsing Layton’s position, which is essentially the same as Harper’s position.” That’s just false logic.

Sure, Layton is opposed to carbon tax, but being against a carbon tax doesn’t put Layton in the same camp as Harper. By this logic, Senator Obama (who also favours cap-and-trade over carbon tax) is no different than Harper. Layton has been consistently in favour of a cap and trade carbon market where Harper absolutely is not.

In the 1980s we had a vigorous debate in this country over consumption taxes. The early Reformers opposed what they saw as infringing on property. New Democrats opposed the GST’s regressively. Did the far-right and the centre-left have the same position? Hardly.

Layton and Harper’s GHG reduction plans are fundamentally different:

Layton’s plan calls for absolute targets. Harper’s plan has intensity-based targets.

Layton’s plan starts with a 1990 base year. Harper’s plan uses 2006 as its base year

Layton’s plan is science-based. Harper’s plan is based on something considerably more arbitrary.

Layton’s plan would fully auctioned credits. Harper’s plan would not fully auction credits.

Layton’s plan puts a price of $35 per MT on carbon. Harper’s plan has no price on carbon.

Layton’s plan will generate $2.5 per year for solutions. Again, from Harper? Nothing.

Layton’s plan estimates that 2020 Canada will emit only 450 mt per year. Harper’s plan leaves us belching 600 mt per year.

All the details of Jack’s Pricing Carbon Reducing Emissions plan are right here: http://www.ndp.ca/page/6448

You guys are doing a great job to keep economics accessible and progressive, Marc. Keep it up.

Comment from Kevin Dorse
Time: May 28, 2008, 12:10 pm

That should say: “Layton’s plan will generate $2.5 BILLION per year for solutions … ”

Whoops. Thinking way faster than I was typing.

Comment from Darwin O’Connor
Time: May 28, 2008, 12:19 pm

I’ve been looking at the little information available for Layton’s plan, and all I see a $35 carbon tax for industrial users. No cap and no trade. I don’t get it.

The targets are good, but setting targets are the easy part.

Comment from Ted Hsu
Time: May 28, 2008, 6:18 pm

I agree that there is too little information for the NDP cap and trade plan. Wwww.ndp.ca says that the “projected” price for credits when they are auctioned off will be more than $35/tonne. I’d be interested in how they get that figure. How certain can you be of it? If you are planning to spend the auction proceeds on new government ‘green’ programs, how much money will you have?
Will the different provinces be upset and want to interfere (a very big political headache) because the auction process will be sending hundreds of millions of dollars from Alberta (where almost all electricity is generated from coal and other fossil fuels) to, say, Quebec (where almost all electricity is generated from Hydro)?

Comment from Marc Lee
Time: May 28, 2008, 8:58 pm

The bigger problem that the NDP are going to face is that the general public generates one big blank stare when the term “cap-and-trade” is uttered. So while I appreciate the differences in the Layton vs Harper plans elaborated, none of these nuances will matter from the perspective of the general public.

This contorted positioning seems to be driven by what is happening in BC, where the Liberals have run the table with their climate change plans (whatever their shortcomings in policy terms, on the politics they have blown the NDP away). In BC, it looks to me like the NDP is tying itself up in knots trying to oppose an agenda that they kinda wish they had done, and are looking mostly to score cheap political points with essentially a non-position on moving forward.

Does any of this matter? If the Dems get in and a US cap-and-trade system gets set up, both the WCI and whatever is being cooked up in Ottawa will get sucked into that orbit because companies are going to want as large a market as possible for permit trading.

Comment from Paul T.
Time: May 29, 2008, 10:58 am

I think your last point Marc is the most relevant of this entire debate/blog.

The political arena for this kind of policy response has got to be North American. Unlike the EU with it power sharing and decision making abilities, we in Canada regardless of what we do will ultimately be determined by those south of the border. At least on the commercial interest’s side of GHG emmisions. The consumer will consume regardless of revenue neutral and all the rest of the debate on carbon taxes. And I still believe no matter what accounting and redistribution system, we use, a carbon tax is still regressive. (In fact the markets seem to building in their own forms of carbon taxes, given the rise in resources prices, the whole impact of carbon tax seems to be moot at this point)

I think we need to move a lot of the policy solutions back onto the backs of the original production of GHG, whether it be in the actual production process, or the design end of consumption. Cap and trade is more like a religiosity issue really, do your business the dirty way and say your hail mary’s for redemption, and if you can afford to pass it on to consumers do it. In a monopoly or oligopoly form of capitalism that w we have, it will just be passed onto consumers in the end. That way when the big dog south of the border finally decides that politically the environment is indeed an issue, we can work towards shaping it. Unfortunately unlike the EU, it will forever be from outside the fortress.

So cap and trade, while maybe setting an incentive or motivation for innovation, will mainly result in passing the cost through and making it all the more regressive.

It is at the paradigm level we need an adjustment in the progressives thinking. We haven’t figured it out yet, but give us some time, some resources and a large group of smart people and I bet we could.

I have yet to see a sustained effort in the left to come up with a truly progressive economic/environmental plan.

I hate to offend any of you who think you have the vision, but I have yet to see it. And I have been looking.

pt

Comment from Stuart Murray
Time: May 29, 2008, 12:53 pm

I totally agree with Marc’s critique about the BC NDP’s position on Gordon Campbell’s carbon tax. It’s not like they can say they would go further, because they never did. And the cost-to-the-poor argument isn’t very convincing. The BC NDP is just trying to make them the opposites on a good liberal policy, which puts them squarely in the position of bad public policy. Pity, and in an election year to boot. I guess they’ll get a larger margin of victory in their northern seats, but that’s about it. I’m embarrassed by all those unfortunate validators who see it as their duty to dream up ways the BC NDP’s position is a good one.

There is an obvious left solution to environmental issues, which is to first diagnose that this is an issue that is the result of market failure and therefore requires public sector intervention. Then a series of taxes, subsidies, regulation, and unionized public service measures need to be brought in to correct for the market failure. I would say expanding public bus service (alongside the higher gas taxes) would be one example. But Paul you are right, we would need something far more comprehensive than just transit boosterism.

Another challenge is that this puts a bigger onus on the left to reconcile the beef-and-taters unionism with the granola volunteerist urban arts major counterculture environmentalist crowd. Somehow that always breaks down, and a lot of beef-and-taters types try to pretend they can do without the others. Once again, pity, and in an election year to boot.

Comment from Darwin O’Connor
Time: May 29, 2008, 1:23 pm

“And I still believe no matter what accounting and redistribution system, we use, a carbon tax is still regressive.”

Balderdash. We have complete flexibility with what to do with the money raised from a carbon tax. I think it should go directly back individual Canadians in a monthly check. That way it
can be very progressive. Also, it means the program can be smoothly phased out as GHG production drops.

The fact is consumers can’t be spared and are going to have to change. Almost 50% of GHG is produced directly by their activities, and most of the rest of the GHG is released make goods they consume. Unless you want to regulate their day to day decisions, you have to use price to regulate them.

Comment from Paul T.
Time: May 29, 2008, 1:56 pm

No Darwin, you take the harder route, changing human behaviour at a mass level when a majority of people on the planet do not eat enough and the environmental concerns are not even on their radar is not is a lot harder than changing the design of products. Kind of hard to tax something when a majority of the people out there do not live within a system that even provides enough food.

However redesign of the consumable is key and the production process that produces it.

It is the focus that I am concerned with, sure a carbon tax of different stripes and there may help influence a component of consumption behaviour, and if you can effectively design some kind of efficient transfer it may have an impact on making it less regressive. But ultimately it is not the change that is going to do it. It is simply a little bit more than window dressing on looking at a quite dramatically altering reality.

I an starting to think that rationality is but just another emotion. Have you ever got into a debate with a right winger about climate change recently . You wanna see some emotive rationality being regurgitated upon a clean looking progressive. You better bring yourself a couple of spare changes of clothes to such debates.

Consumers are not going to change, the cultural space of our economics will never survive. That is unless you see some optimism in the misguided capitalist argument about innovation. Well if so, I am waiting for the innovation. I don’t see it rolled up in the the current fabric that covers us.

pt

Comment from Brent
Time: May 29, 2008, 9:17 pm

Marc,

I don’t know if you are still following this thread, but I have a couple of questions stemming from your post.

Let me be up front and say that I prefer cap and trade with an absolute cap. However, you do make some compelling arguments for supporting a carbon tax.

OK, on to my questions:

“While cap-and-trade sounds nice (set emissions targets then let the market determine the price) the devil is in the myriad details of implementation, and a lot of it looks nightmarish from an administrative point of view.”

How is a carbon tax any less problematic to implement and administer? I presume self-reporting by polluters is not an option in either case.

Here is a toughy for you and anyone else wanting to take a stab: How can we trust the Liberals to design a plan that is not regressive in nature? This issue is about trust as much as it is about the environment or anything else. So far, the Liberals have talked about tax shifting with a little pot o’ gold left over for investment in green technology. However, you point out that in BC it will not take long before we see the shifting of money from the poor to the rich. Can progressives trust Dion and the Liberals to do the right thing? I apologize in advance for sounding negative with this one.

Finally, how will Canada’s output of GHGs go down sufficiently enough that we meet our international obligations without an absolute cap? Knowing that with Pigovian (sin) taxes, those who can afford to continue their bad habits will.

And a few of comments:

“Does any of this matter? If the Dems get in and a US cap-and-trade system gets set up, both the WCI and whatever is being cooked up in Ottawa will get sucked into that orbit because companies are going to want as large a market as possible for permit trading.”

I agree with your premise. Given that neither option will be implemented in Canada until 2010 at the earliest, it does not make sense to me to go the carbon tax route when our neighbors to the south will likely go in a different direction. I think it would be easier to plug into a readymade system and save a bit on the implementation costs.

Having said that, I would be happy to see an *equitable and effective* made-in-Canada solution.

Marc, while we may disagree on this particular issue, I really appreciate your efforts with this blog. As an economics student, I have and will continue to learn a lot from your posts. Thank you.

Comment from Marc Lee
Time: May 30, 2008, 10:12 am

Brent,

For monitoring emissions in a carbon tax or cap-and-trade regime I think you are right that there would not be much difference. By implementation and administration, I’m thinking more of the complexity of cap-and-trade as revealed by WCI in terms of offsets, allocations, coverage.

As for the Liberals, who knows? But my point in the post is that all of the major tools will end up creating these distributional problems. It’s just that carbon tax is the one with the direct link to revenues that can be banked on to (at least potentially) address the problem. There is a tendency to think that income tax cuts are a good use but low income people pay very little in income tax, so we need to insist on credits of some sort of address distribution.

Absolute cap? Absolutely. We’ll have a whole bunch of policies attacking the climate issue and we’ll need the discipline of hard annual caps to make sure we are on the right path.

Comment from Rod Smelser
Time: July 7, 2008, 4:33 pm

“Indeed, my spies tell me that the NDP plans to give permits away which could lead to the costs being passed along to consumers anyway but windfall profits for recipient companies, which is what happened in the EU trading system.”

Mark, the source provided by Kevin Dorse states that:

“The NDP plan sets absolute caps on major industrial emitters, which account for 50% of Canada’s greenhouse gas emissions. These emitters would be required to purchase emissions credits at market-based prices. In year one alone, with carbon prices projected to exceed $35 per ton, auctioning credits would generate at least $2.5-billion. All of these funds would be invested in developing green technologies and making them affordable for the average consumer.”

So it looks like your “spies” have intentionally misdirected you. That must be a total shock!

Comment from Phillip Huggan
Time: July 7, 2008, 10:10 pm

I don’t understand why transit, where average bus ridership would be at least carbon breakeven 7 passengers per bus, isn’t free in a country like this. I mean apart from sneaking on an unstaffed Skytrain or the middle of a Toronto trolley.
I hate calling up examples from my past because it seems like cheating, but I’ve been at a casual labour agency in Vancouver, and some people didn’t have busfare and couldn’t take a day position that became available. Who cares, the Conservative (or insert whatever party is for flattening taxes enough to make transit only partially subsidized) would ask? Well, these are the people who dig holes in your house foundation to reach leaky drainage pipes. Who dig runoff treaches in your backyard. Who unload food in warehouses. What Conservative hasn’t been touched by home and food inflation?
Is the Conservative position really that Canada will never have to cut GHGs? Or is the hope to delay changing the platform until it becomes politically optimal? Or do the Conservatives really believe Canada will be in stronger position by stranding so many newly constructed assets (esp in AB/SK)? No. Conservatives would rather compound all these efficiencies on so many levels, for a few extra % points of high earner income. This is the part where Canada starts to experience American-style social problems.

I agree with a lot of J.Layton’s policy positions, and having a municipal background doesn’t hurt as that is the level of government most in need of cash (unless toll roads because politically viable), until boomers get sickly. But a carbon tax (ignoring low income rebates) doesn’t hurt the poor. A carbon tax hurts the poor in Canada. I’ll taking being poor in Canada over being upper middle class in most of the world. A carbon tax is already foreign aid to the world’s poor, and this will only compound in the future, barring agri or aquifer/desalination breakthroughs. Experts think we are already at the multi-stage flash desalination limit.

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