Effect of carbon pricing on the economy

Carbon pricing through either cap and trade or carbon tax is expected to affect the economy. The design, structure and implementation of the system will also affect the economy with different carbon pricing mechanisms having different effects.

In a policy brief "Carbon exposed or carbon disadvantaged? Thinking about competitiveness in carbon-constrained markets" the Ottawa-based think tank, Sustainable Prosperity conducted an economic analysis examining the potential impact of Ontario joining the Western Climate Initiative -- a collaboration between some US states and Canadian provinces to develop a multi-sector, market-based program to reduce GHG emissions -- and developing a cap-and-trade system for Ontario.1 It explored the impact of carbon pricing that would grow to $40/tonne COe in 2030, and the 100% revenue recycling (30% back to households in the form of labour tax reduction and 70% to manufacturing and services via capital tax reduction). The analysis suggested that while average production will experience a small drop of 0.22% in 2030 compared to business as usual i.e. without carbon pricing, production levels will vary by industrial sector. Ninety per cent of Ontario's total economy is estimated to have an increased ability to produce; however, 80% of the goods- and services-producing sectors (not including the government sector) will have a decreased ability to earn. Most of the economy (79%) will have an improved ability to compete. Furthermore, 78% of the goods-traded sector will have increased ability to compete in North American markets in 2030 in the context of carbon pricing. Overall, while Ontario's economy will continue to grow, it will be minimally impacted by a carbon tax of $40/tonne CO2e: a 0.6% reduction compared to business as usual in 2030.1


Effect of a $40/tonne CO2 on Ontario's GDP in 2030 compared to business as usual


Source: Carbon Exposed or Carbon Advantaged? Thinking About Competitiveness in Carbon-Constrained Markets1


In other analysis, for Canada as a whole, adoption of a national carbon price of $40 per tonne of CO2e (in 2011) that increases to $100 per tonne by 2020 would continue to allow the Canadian economy to expand at the rate of 2.3% per year compared to 2.4% per year in the absence of any carbon pricing. Other studies show similar results: the effect of carbon pricing would lead to a small 0.2% reduction in annual GDP growth. Furthermore, other GDP growth forecasts suggest that the Canadian economy would grow by 39% by 2020 and 144% by 2050 relative to 2006 in the absence of any carbon pricing policy, and under a carbon pricing policy the GDP will grow by 34% and 133% by 2020 and 2050, respectively, relative to 2006.2,3

In other words, Ontario’s and Canada's economy will continue to grow with a carbon pricing policy almost at the same rate as in the absence of carbon pricing policy. The impact is projected to be smaller if Canada acts in concert with some trading partners (growth by 38.5% and 132.2% by 2020 and 2050).3


GDP growth with and without carbon pricing


Source: National Round Table on the Environment and the Economy. Achieving 2050: A Carbon Pricing Policy for Canada


As in the Ontario analysis described earlier, the net effect on Canada's competitiveness is likely to be small, however, some sectors may be positively impacted while others are affected negatively. For example, electricity generation, office machinery and equipment sectors are expected to be positively impacted, while others such as natural gas, refined petroleum and crude oil sectors are expected to be negatively impacted.


In a carbon priced economy, it is expected that the composition of the economy would change with expansion of less energy-intensive sectors such as light manufacturing and contraction in energy-intensive sectors. And, when accompanied by cuts in corporate, labour and payroll taxes, can further reduce the minor impact on GDP and mitigate impacts on wages and households. The reduction of income tax may also increase the wage rates and size of labour force.3 When carbon pricing is combined with tax cuts on investment, GDP increases have been projected. And, according to projections in the UNEP Green Economy Report in 2011, while GDPs in the business-as-usual scenario are higher in the short term (1-5 years), GDP in the presence of green investment scenario progressively outpaces the former in the following decades.4

A recent study by Regional Economic Modeling, Inc. (REMI) explored the potential impact of a modest $10/tonne CO2e revenue-neutral carbon fee which would increase by $10/tonne CO2e each year.5  It suggested that (1) personal real disposable income, (2) GDP, (3) employment would increase in most US regions, and CO2 emissions would decrease by 33% and 52% after 10 and 20 years, respectively. It would also prevent premature deaths related to air pollution to the tune of 13,000 and 227,000 by 10 and 20 years, respectively.


Source: The Economic, Climate, Fiscal, Power and Demographic Impact of a National Fee-and-Dividend Carbon Tax5


Evidence for effect of carbon pricing on the economy

Carbon taxes combined with tax-shifts in Denmark, Finland, Germany, Sweden, and the Netherlands have been shown to have led to modest economic gains.6


Effect of Environmental Tax Shifts on GDP in European Countries



Source: Competitiveness Effects of Environmental Tax Reforms (COMETR). Final report to the European Commission.6

There are several studies of other real world examples that suggest that carbon pricing doesn’t negatively affect the economy.


British Columbia has had a revenue-neutral carbon tax since 2008 that was combined with income and corporate tax cuts. Between 2008 and 2013, while Canada’s real annual GDP grew by 0.4%, British Columbia’s grew by 0.5%. As a result of recycling of the carbon tax revenues, household welfare in the province were relatively unaffected (Beck 2015) as was the province’s economic growth (Metcalfe 2015). In terms of employment, while some industries (emissions intensive, trade exposed industries) experienced negative employment effects, there were positive effects for the overall labour market (Yamazaki 2015).


In 2009, ten Northeastern and Mid-Atlantic states in the US introduced the Regional Greenhouse Gas Initiative (RGGI), the country’s first cap and trade program for GHGs. An analysis of the economic impact between 2012 and 2014 indicated the program resulted in $1.3 billion of economic value to the RGGI states. The program also offset the impact of increased electricity prices through local reinvestment in energy efficiency and renewable energy programs. Overall, consumers including households, businesses, etc. experienced a net gain of $460 million because of overall decrease in energy bills over time.



1.      Sawyer, D. Sustainable Prosperity | Carbon Exposed or Carbon Advantaged? Thinking About Competitiveness in Carbon-Constrained Markets. (2013). at http://www.sustainableprosperity.ca/dl949&display

2.      National Round Table on the Environment and the Economy. Achieving 2050: A Carbon Pricing Policy for Canada – Technical Report. (Ottawa, 2008). at http://collectionscanada.gc.ca/webarchives2/20130322143407/http://nrtee-...

3.      Achieving 2050: A carbon pricing policy for Canada. (National Round Table on the Environment and the Economy). at http://nrtee-trnee.ca/wp-content/uploads/2011/08/carbon-pricing-advisory...

4.      United Nations Environmental Programme. Towards a green economy. Pathways to sustainable development and poverty eradication. (United Nations Environmental Programme, 2011). at http://www.unep.org/greeneconomy/Portals/88/documents/ger/ger_final_dec_...

5.      Nystrom, S. & Lucknow, P. The Economic, Climate, Fiscal, Power and Demographic Impact of a National Fee-and-Dividend Carbon Tax. (Regional Economic Models, Inc. (REMI) and Synapse Energy Economics, Inc, 2014). at http://citizensclimatelobby.org/wp-content/uploads/2014/06/REMI-carbon-t...

6.      Andersen, M. S. et al. Competitiveness Effects of Environmental Tax Reforms (COMETR). Final report to the European Commission. (National Environmental Research Institute, 2007). at http://www2.dmu.dk/Pub/COMETR_Final_Report.pdf


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