Carbon Pricing, Fairness, and Fiscal Federalism: a Cost-Sharing Proposal for Canada

Queen’s Policy Review Volume 2, No. 2 (Fall 2011) Carbon Pricing, Fairness, and Fiscal Federalism: A Cost-Sharing Proposal for Canada Monica Tang Carleton University, Freie Universität Berlin ABSTRACT Carbon pricing has been proposed as a mechanism to reduce carbon emissions in the efforts to mitigate the impacts of climate change. However, the potentially uneven distribution of costs between provinces and regions across Canada has stalled progress on the issue. This paper examines the possibility of implementing cost-sharing arrangements and revenue recycling within the Canadian intergovernmental context to address issues of fairness and fiscal capacity and recommends the coupling of ecological tax reforms with adjustments in intergovernmental transfers. Introduction The setting is a First Ministers Conference, where the Prime Minister and provincial and territorial ministers have gathered to discuss what Canada’s approach should be for reducing carbon and other greenhouse gas emissions in order to mitigate and adapt to the effects of global climate change. Similar to other intergovernmental discussions on issues such as healthcare or education, the questions of fiscal capacity, distribution, and fairness will likely arise. There may be heated debate about which level of government should be responsible for service provision. There may be pleas for special accommodation or exemption for particular provinces. Past disagreements may be revisited about real or perceived unfair treatment of provinces in previous First Ministers Conferences. 17 Queen’s Policy Review Volume 2, No. 2 (Fall 2011) This scenario, while fictional, is certainly plausible. The challenges with addressing climate change on a national level arise from differing provincial economies, emissions profiles, and fiscal capacities. Addressing the issues of equity and fiscal capacity within the Canadian federation are crucial to the success of a national strategy to address climate change and overcome federal-provincial stalemate. This paper proposes an approach to carbon-pricing that is compatible with Canada’s federalism framework. The principle of fairness in federal-provincial relations will be a central focus in this discussion, as will be considerations of fiscal capacity and revenue distribution. Finally, the paper will discuss how environmental federalism will become increasingly important in intergovernmental discourse and how a national carbon price and its framework can contribute to the development of institutions and processes for environmental federalism. The Importance of Pricing Carbon on a National Scale The issue of carbon emissions and climate change is a global public good problem that can be classified as the Tragedy of the Commons. The atmosphere of the planet is the global commons – the cost of carbon emissions has not been borne by emitters and the effects of climate change are worldwide. Greenhouse gas (GHG) emissions have steadily increased by 70 percent from 1970-2004. 1 The net effect of warming has resulted in observed changes with increases in sea levels, decreases in snow and ice extent, higher temperatures in the Northern hemisphere coupled with higher instances of tropical cyclones, as well as placing certain areas under stress of either increased precipitation or drought. 2 Climate change has an environmental, social, and economic impact on Canada, although the estimated effects may vary across regions. Reducing carbon and other GHG emissions will decrease the rate of climate change as well as the magnitude of its impact, which in turn increases the likelihood of successful adaptation and reduces associated adaptation costs. 3 The reduction of carbon emissions is essential to managing climate change in Canada. Currently, carbon emissions can be termed as a negative externality . Carbon emitters and consumers do not pay the full costs of the actions, while the effects of carbon emissions are borne by society. The consumption of carbon-based goods and services has a greater cost to society in the form of environmental damage than what is currently paid by consumers. 4 The carbon content of what Canadians consume in terms of goods and services is therefore not reflected in the prices they pay. This 18 Queen’s Policy Review Volume 2, No. 2 (Fall 2011) distortion of price signals encourages consumption of carbon-based goods and services and results in GHG emissions that cause climate change. Leading public policy research institutions, including the National Roundtable for the Environment and the Economy and the Conference Board of Canada, recommend setting a price for carbon as an effective solution to reducing greenhouse gas emissions. Putting a price on carbon internalizes these current environmental externalities and corrects the current market distortions that encourage carbon emissions. A price in carbon also promotes shifts to non-carbon based alternatives for goods and services. A number of provinces in Canada have put in place a variety of targets and plans for GHG reductions. British Columbia has implemented a consumption-based carbon tax; Alberta has implemented a climate change strategy with a hybrid system involving a tax on the production of carbon and a credit-trading scheme within Alberta. Ontario and Quebec have plans to implement a cap and trade system with a potential harmonization of policy in North America. The initiative of provinces to tackle the issue of climate change is commendable, especially in the absence of overarching federal leadership. However, provincial initiatives are not sufficient as a Canadian response to mitigating and managing climate change. The current patchwork also yields inefficiencies in pricing and regulatory regimes and creates inequalities across Canada. While some Canadians pay for their consumption of carbon-based goods and services, others continue to enjoy the same goods and services without paying the true environmental cost. The phenomenon of carbon leakage is also present as firms can currently move production away from provinces with carbon prices or regulations to provinces without them, so that GHG emissions are not actually abated, but simply shifted to another jurisdiction. Finally, the longer a patchwork approach remains in place federal-provincial and interprovincial dynamics become more entrenched and intractable in future climate change discussions. 5 A national approach to pricing carbon is recommended for several reasons. Given the substantive harmonization that is required in order to avoid inefficiencies, an overarching federal presence and leadership is desirable in order to eliminate duplication and to promote coordination and harmonization. 6 Carbon leakage between provinces is also eliminated since carbon emissions cannot be shifted from one jurisdiction to another. The federal government, with its constitutional powers over federal trade and commerce also has the authority to ensure import/export neutrality that is essential for maintaining competitiveness in a national carbon tax 19 Queen’s Policy Review Volume 2, No. 2 (Fall 2011) for domestic and international trade. 7 Pricing carbon can occur through the implementation of a carbon tax, a cap and trade system, or a combination of both. It should be noted that an emissions tax – a cap and trade system where all permits are auctioned off, or a combination of both, could reduce excess carbon emissions and correct the distortions. The use of a carbon tax is recommended for several reasons. The first is that the Canadian intergovernmental fiscal framework is based upon taxation and the application of a tax can be more easily harmonized within the current taxation structure. The second is that a carbon tax is easier to implement than the design of a cap-and-trade system, including the lengthy process of determining and allocating the initial levels of permits. 8 Third, a carbon tax can be readily applied to both smaller and larger polluters, as emissions from large final emitters only account for half of Canada’s emissions. 9 Fourth, price can certainly spur investment from businesses that seek to develop and adopt low carbon technologies. 10 Finally, a carbon tax is transparent about the costs and the distribution of these costs, which is helpful in designing strategies to redress the economic impact on those with low incomes. 11 The Canadian Context and the Importance of Fairness Canada’s GHG emissions are unevenly distributed between provinces and territories. Canada’s total emissions for 2008 were 734 MT of CO2 equivalents. 12 Eighty-one percent of Canada’s GHG emissions are derived from energy production and consumption, which includes electricity and heat generation, fossil fuel production, and transportation. 13 Canada’s GHG Inventory shows that the provinces of Alberta, Ontario, and Quebec have the highest emissions of 244, 190 and 82 MT CO 2 equivalents. 14 Emissions can be linked to the energy and economic profile of these provinces: an examination of Canada’s GHG Inventory reveals that Alberta’s GHG emissions can be attributed to its primary reliance on coal-based electrical generation and the development of the tar sands, while Ontario’s GHG emissions are attributed to fossil fuel dependent electricity generation and transportation. 15 Economic performance and ability to develop fiscal capacity is also uneven across provinces, but there is a correlation of development of natural resources and economic growth. Ontario, with the size of its economy and its strong manufacturing base, has traditionally

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