Rethinking Revenue Neutrality of Carbon Pricing

Rethinking revenue-neutrality of carbon pricing systems

Carbon pricing is expected to result in significant revenue for governments. In Ontario, auction of emissions permits in the cap-and-trade system is expected to generate $2 billion a year by 2020.1 How these revenues should be used is the subject of much debate. Many economists/academics and some organizations have advocated for a revenue-neutral carbon price. Here, we briefly explore if a such a carbon price advances the goal of meaningful reduction in greenhouse (GHG) gases or improves sustainability of the system, and if not, how revenues may be used to achieve meaningful reduction of GHG?

A revenue-neutral carbon tax where the government retains little, if any, tax revenues raised2 by reducing labour or other tax rates3 or returning them to household in the form of regular dividends4 has been touted as a win-win. It has been suggested that it provides a “double dividend” by achieving economic and environmental benefits, the former by lowering taxes that distort the economy and reduce output.5 However, other economists have questioned the robustness of the double dividend.6

But given the urgency of the climate crisis what should be the goal of carbon pricing?

The most important feature of any carbon price policy is that it should offer a significant contribution to the meaningful reduction of GHG emissions.  This can be based on and compared against a science-based reduction target. Or at a specific jurisdictional level, it should make an appropriate contribution to keeping global temperatures from rising beyond 1.5oC relative to pre-industrial levels.7

Does a revenue-neutral carbon tax contribute to meaningful reduction in GHG emissions in real life?

It really depends on the design of the carbon price. British Columbia’s carbon tax is a premier, and perhaps, the only example of a revenue-neutral carbon tax. It was legislated to be revenue neutral in that all the revenue raised via the tax was to be used to decrease personal income tax or corporate taxes or provide low-income credit.8,9 Furthermore, it represents the highest rate of carbon tax in North America. While an analysis of the BC carbon tax suggested that there was evidence for a weak form of double-dividend, does it meet the test of contributing to meaningful GHG emissions?

The answer may not be a resounding “yes” given that British Columbia is not on track to achieving its modest 2020 targets. The province had set a goal of reducing GHG emissions to 33% below 2007 level by 2020 (45 Mt).10 However, as of 2015, the province’s emissions are projected to increase by 11% over 2007 levels (69 Mt by 2020).11-14

In contrast, in Quebec, which implemented a non-revenue-neutral cap-and-trade system in 2012, emissions are expected to decrease relative to 2005 levels.12,13 However, unless additional policies are adopted, it will not meet it’s more ambitious 2020 target of 37.5% below 1990 levels.15 Nonetheless, its emissions are headed in the right direction.

It can be argued that a cause-and-effect relationship cannot be inferred in either case, or that a specific reduction in GHG emissions was not the goal of the BC carbon tax, and that increased stringency is needed (and planned) which would increase the effectiveness of the policy. However, given the urgent need for significant GHG reductions, it is imperative that carbon pricing be designed to significantly contribute to meaningful emissions reduction targets. Or it should be combined with strong and smart regulatory policies that will enable achieving this goal such as the shutting down of coal-fired power generation in Ontario.16

If a revenue-neutral carbon tax does not meet the test of meaningful GHG reductions, does it get more public support, thus potentially improving potential sustainability of the policy?

A revenue-neutral carbon price has been suggested to be more politically palatable as result of increased public support for such a policy, however others have argued that it has diminished support. Washington State Governor Jay Inslee remarked that revenue-neutrality does not provide additional support in legislatures or in the public, instead it may have diminished support.17 In examining British Columbia’s carbon tax, Kathyrn Harrison of UBC, argues that the delayed and infrequent nature of tax deductions in combination with the potentially exaggerated awareness of the cost of carbon pricing on a regular basis may not lead to increased public support.18 Public opinion polls in BC on the carbon tax have shown mixed results. Opposition to the tax decreased from 2008 to 2013, but increased in 2014 and 2015.19

On the other hand, in Ontario, where cap-and-trade system is set to begin in 2017, a recent poll indicated that approval of policy increased from 27% to 46% among respondents when they were informed that revenue generated would be used to fund GHG reduction programs. They preferred a revenue-raising model to a revenue-neutral model by a slim margin (27% to 22%).20

The options, the choices for use of carbon pricing revenue and their popularity may be jurisdiction-dependent. In Ontario, with its deficits, using the revenue towards reducing the deficits may be more popular in this province than elsewhere.

So, can we do better than a simple revenue-neutral carbon price?

Marc Lee has argued that revenue neutrality is a bug of the BC carbon tax system21 saying that most of the carbon tax revenue (two-thirds) go towards corporate tax cuts. He suggests that most people would like their taxes to go towards “building stuff,” stuff that be could used to decrease our reliance on fossil fuels. These include building public transit, energy-efficient buildings, zero waste systems, renewable energy, and fostering forest conservation and stewardship measures, which would not be possible with matching tax cuts. He further suggests that the ability of many people and organizations to respond to carbon price is constrained by their circumstances. For example, many in suburbs have no option but to drive. And renters cannot make energy efficiency investments. In contrast, use of these revenues for public investment are a better approach since multipliers for these are higher than tax cuts.21

Given the urgency and the magnitude of the matter at hand, the goal should not always be economic efficiency but maximizing the potential for greenhouse gas reduction. Or we should explore other ways of achieving better environmental outcomes while not adversely affecting economic output. By using carbon pricing revenue to fund green/clean projects - those that are evidence-based to reduce GHG emissions - are deeper reductions in GHG emissions possible?22 Analysis of the economic and environmental impact of the cap-and-trade systems in Quebec and California may provide some clues.

It is also possible that a regularly-increasing revenue-neutral carbon price designed with few exemptions may lead to meaningful reduction in GHG. A study of a revenue-neutral carbon fee -- starting at $10 per ton CO2 and increasing by $10 every year -- that returns most, if not all, revenues to US households in the form of monthly dividends (“Fee and Dividend”) suggests that emissions would drop to less than 5000 Mt CO2.23 This would be lower than the target adopted by the US: 17% below 2005 levels (5335 Mt of CO2).24 But, whether there is political will to implement such a carbon fee without exemptions and other tax cuts for emitters is unknown. In any case, at its current proposed carbon fee levels, it may not achieve a more ambitious and meaningful reduction such as 20% below 1990 levels.

On the other hand, a combination of modest carbon pricing and smart regulations, as advocated by Mark Jaccard,16 may be necessary and more politically feasible.

In any case, we ought to a take another serious look at how we use carbon pricing revenues if we are to achieve meaningful carbon emissions reduction goals.

References:

1. Ministry of Environment and Climate Change. Ontario Posts Cap and Trade Regulation. 2016. Available from: http://news.ontario.ca/ene/en/2016/02/ontario-posts-cap-and-trade-regulation.html

2. Carbon Tax Center. No tax increase? How? Carbon Tax Center. Available from: http://www.carbontax.org/no-tax-increase-how/

3. Pearce D. The Role of Carbon Taxes in Adjusting to Global Warming. The Economic Journal. 1991;101(407):938–48.

4. Citizens’ Climate Lobby Canada. Carbon Fee and Dividend. Available from: https://canada.citizensclimatelobby.org/carbon-fee-and-dividend/

5. Goulder LH. Environmental taxation and the double dividend: A reader’s guide. Int Tax Public Finan. 1995 Aug;2(2):157–83.

6. Beck M, Rivers N, Wigle R, Yonezawa H. Carbon tax and revenue recycling: Impacts on households in British Columbia. Resource and Energy Economics. 2015 Aug;41:40–69.

7. Climate Analytics. 1.5°C - key facts. Available from: http://climateanalytics.org/hot-topics/1-5c-key-facts

8. Environment Ministry of Climate Action Legislation - Province of British Columbia. Available from: http://www2.gov.bc.ca/gov/content/environment/climate-change/policy-legislation-programs/legislation-regulations  

9. Government of British Columbia. Carbon Tax Act. 2008. Available from: http://www.bclaws.ca/Recon/document/ID/freeside/00_08040_01

10. Legislative Assembly of British Columbia. Bill 44 — 2007: Greenhouse Gas Reduction Targets Act. 2008. Available from: https://www.leg.bc.ca/pages/bclass-legacy.aspx#/content/legacy/web/38th3rd/3rd_read/gov44-3.htm

11. Government of Canada Environment and Climate Change. Environmental Indicators - Greenhouse Gas Emissions by Province and Territory. 2012. Available from: https://www.ec.gc.ca/indicateurs-indicators/default.asp?lang=en&n=18F3BB9C-1

12. Government of Canada Environment and Climate Change Canada. Canada’s Emission Trends 2014. 2014. Available from: https://www.ec.gc.ca/ges-ghg/default.asp?lang=En&n=E0533893-1&offset=5&toc=show#toc56

13. Environment Canada, Government of Canada. Canada’s emissions trends. Ottawa, ON: Environment Canada; 2014. Available from: https://ec.gc.ca/ges-ghg/E0533893-A985-4640-B3A2-008D8083D17D/ETR_E%202014.pdf

14. Kieltyka M. B.C. failing to meet greenhouse emission targets: Federal government. Metro News, Vancouver Metro. Vancouver, B.C., Canada; 2015; Available from: http://www.metronews.ca/news/vancouver/2015/05/10/b-c-failing-to-meet-greenhouse-emission-targets-federal-government.html

15.  The Ministère du Développement durable, de l’Environnement et de la Lutte contre les changements climatiques. Consultation particulière relativement à l’établissement d’une cible de réduction des émissions de gaz à effet de serre (GES) pour le Québec en 2030 de l’ordre de 37,5 % par rapport à 1990. 2002. Available from: http://www.mddelcc.gouv.qc.ca/changementsclimatiques/consultations/cible2030/index-en.htm

16. Jaccard M. Want an effective climate policy? Heed the evidence. Policy Options. 2016. Available from: http://policyoptions.irpp.org/magazines/february-2016/want-an-effective-climatepolicy-heed-the-evidence/

17. Roberts D. The greenest governor in the country tells Grist about his big climate plan. Grist. 2015. Available from: http://grist.org/climate-energy/washington-governor-jay-inslee-cap-and-trade-carbon-tax/?utm_reader=feedly

18. Harrison K. A tale of two taxes: The fate of environmental reform in Canada. Review of Policy Research. 2012;29(3):383–407.

19. Murray, Brian C., Rivers N. British Columbia’s Revenue-Neutral Carbon Tax: A Review of the Latest “Grand Experiment” in Environmental Policy. Ottawa, ON: Sustainable Prosperity; 2015. Available from: https://nicholasinstitute.duke.edu/sites/default/files/publications/ni_wp_15-04_full.pdf

20. The Forum Poll. Majority say budget bad for Ontario. The Forum PollTM. Available from: http://poll.forumresearch.com/post/2471/free-tuition-sin-taxes-liked-not-so-cap-and-trade/

21. Lee M. The case against a revenue-neutral carbon tax. CCPA Policy Note. 2015. Available from: http://www.policynote.ca/the-case-against-a-revenue-neutral-carbon-tax/

22. Partington, P. J., Sharpe V. How to price carbon so that emissions go down and citizens don’t go crazy. Canada’s Ecofiscal Commission. 2016. Available from: http://ecofiscal.ca/2016/03/24/price-carbon-emissions-citizens-dont-go-crazy/

23. Nystrom, Scott, Lucknow, Patrick. The economic, climate, fiscal power,  and demographic impact of a national fee-and-dividend carbon tax. Washington, DC: Regional Economic Models, Inc. (REMI); 2014. Available from: http://citizensclimatelobby.org/wp-content/uploads/2014/06/REMI-carbon-tax-report-62141.pdf  

24. US EPA. Greenhouse Gas Inventory Data Explorer. Available from: https://www3.epa.gov/climatechange/ghgemissions/inventoryexplorer/