Revenue Recycling: Six Position Papers on the Options for Recycling Carbon Pricing Revenue

Revenue Recycling: Six Position Papers on the Options for Recycling Carbon Pricing Revenue Commissioned by Canada’s Ecofiscal Commission April 2016 Revenue Recycling: Six Position Papers on the Options for Recycling Carbon Pricing Revenue Introduction ............................................................................................................................................................ 3 1. Transferring revenue to households: We All Own the Air: Why a Carbon Fee and Dividend Makes Sense for Canada .................................................... 5 Lars Osberg 2. Reducing income taxes: Environmental Tax Shift: Arguments for Using Revenue From a Carbon Tax to Reduce Existing Taxes .......... 24 Kenneth J. McKenzie 3. Investing in emissions-reducing innovation and technology: Using Carbon Pricing Revenues to Accelerate the Transition to a Low-Carbon Economy ................................ 43 Vicky Sharpe and P.J. Partington 4. Investing in critical public infrastructure: Using Carbon Tax Revenues to Support Climate Action: The Case for (Green) Infrastructure .......................... 65 Marc Lee 5. Reducing government debt: Recycling Carbon Pricing Revenues to Reduce Public Debt ................................................................................ 83 Jean-François Wen 6. Providing transitional support to industry: The Political Economy of Free Allocations ......................................................................................................... 103 Mark Purdon, David Houle, and Blake Shaffer 2 Commissioned by Canada’s Ecofiscal Commission April 2016 Introduction Provinces are increasingly moving forward with carbon pricing to reduce their greenhouse gas emissions in a cost-effective way. Yet a price on carbon is only half of the policy story. Pricing carbon also generates revenue for governments, so governments need to decide how best to “recycle” this revenue back to the economy. A new report from the Ecofiscal Commission explores the options for provinces in recycling revenue from carbon pricing policies. The report is called Choose Wisely for a reason: the trade-offs between options are complex. No single option outperforms the others on all dimensions. In short, there are many opportunities for revenue recycling. But there are also lots of trade-offs. Some approaches to revenue recycling are better for economic efficiency. Others can drive more emissions reductions, above and beyond those from the carbon price itself. Some approaches address concerns around the fairness of carbon pricing, while others address concerns around the competitiveness of emissions-intensive and trade-exposed industries. And still other approaches might make carbon pricing more politically practical. To complicate the choice even further, differences between provinces mean that the right mix of revenue recycling in one province will not necessarily work best for another. To help inform our analysis, but also to frame these trade-offs, we commissioned six position papers from smart policy thinkers across the country; these papers are presented here. Each makes the case for a different approach to revenue recycling. They are entirely the work of their authors. While the Ecofiscal Commission provided comments and suggestions on early drafts, the analysis and positions presented are exclusively those of the authors. The six papers are as follows: • Lars Osberg makes the case for a “Carbon Fee and Dividend” approach in which revenue is returned to citizens as lump-sum cheques. He suggests this approach is fair, but can also build a constituency for carbon pricing, allowing for more ambitious policy. • Ken McKenzie makes the case for using revenue to reduce existing tax rates. In particular, he highlights reductions in corporate and personal income taxes as the best way to minimize the costs of carbon pricing policy. • P.J. Partington and Vicky Sharpe argue that revenue should be invested in the development of low-carbon technologies in order to complement the carbon price by driving more emissions reductions at lower costs. • Marc Lee argues that carbon revenue should be invested in public infrastructure. He suggests that these investments could lead to long-term improvements in productivity, but also to additional emissions reductions if infrastructure projects are chosen wisely. 3 Introduction April 2016 • Jean-François Wen suggests that provincial governments should pay down their public debt, thus giving future generations fiscal flexibility, but also reducing the economic costs associated with public debt. • Mark Purdon, David Houle, and Blake Shaffer explore the case for providing transitional support to industries to address competitiveness concerns. They show that forgoing revenue by providing emitters with free permits can reduce the extent to which economic activity and emissions relocate to jurisdictions with weaker climate policy. As a collection, the papers highlight the strengths of different approaches to revenue recycling. They also illustrate the range of perspectives on this issue: smart policy analysts can—and do—disagree as to how carbon revenue should be used. By presenting a diversity of views, we hope to help provincial governments think through and determine their own policy priorities. Considering the full range of these perspectives in designing revenue-recycling approaches can help them to choose wisely. Commissioned by Canada’s Ecofiscal Commission 4 Commissioned by Canada’s Ecofiscal Commission April 2016 1. We All Own the Air: Why a Carbon Fee and Dividend Makes Sense for Canada Lars Osberg, Economics Department, Dalhousie University ABSTRACT This paper argues that the opponents of carbon pricing have successfully framed it as a “tax grab by government,” while its advocates have neglected the very real financial pressures facing middle-class Canadians. The Carbon Fee and Dividend (CFD) proposal, therefore, is that a fee be charged per tonne of CO2 equivalent emissions for all greenhouse gas (GHG) emissions and that all fee revenue be refunded as an equal cash dividend to all citizens. It is a “fee” rather than a “tax” because the underlying idea is compensation for a property right. Unlike taxation, whose purpose is to transfer resources to the control of government, the moral rationale is that collectively, we all own the air, so those who use and degrade the air (i.e., GHG emitters) should compensate the owners (i.e., all citizens) for the damage caused. By reframing carbon price revenue as deserved compensation for degradation of the property of citizens, a CFD fundamentally shifts the frame of debate. Like other property income, carbon dividend income would be taxable for income-tax purposes—hence, the net after-tax benefits of a CFD would be greatest for low- and middle-income households (the majority of the population), and revenue would be available for other environmental investments. With a broad constituency of support, the CFD could thus increase over time, instead of “stalling out” at a level essentially irrelevant to climate change. INTRODUCTION In Canada, the urgency of reducing greenhouse gas (GHG) emissions and slowing down climate change is widely recognized (Angus Reid Institute, 2014).1 Economists have been saying for many years that the most efficient way to do this is to make polluters pay for the “negative externalities” they are imposing on others. In the environmental, policy analysis and business communities, many agree that “putting a price on carbon” would be an efficient and effective method. There is a consensus that although the carbon price might start small to minimize adjustment costs, it should increase over time until it fully reflects the social cost of carbon, taking into account all the costs of global climate change. However, despite all this agreement, there is little carbon pricing in Canada. Starting from the understanding that carbon pricing would help reduce GHG emissions and slow down 1 When asked in September 2014 how much of a threat climate change poses for the planet, three-quarters of Canadians (75%) said the threat is either very serious or serious (38% and 37%, respectively). Nearly two-thirds (62%) agreed that “Global warming is a fact and is mostly caused by emissions from vehicles and industrial facilities.” See: http://angusreid.org/majority- of-canadians-call-for-more-robust-efforts-to-curb-climate-change-2/. 5 1. Transferring Revenue to Households April 2016 climate change, this paper therefore asks: Why is carbon pricing now seen as “good policy but bad politics” in Canada? How can carbon pricing be designed so that it can become “good politics”—and thus actually happen? An unfortunate reality in Canada in 2016 is that the opponents of carbon pricing—most importantly, the federal government from 2006 to 2015—have inaccurately framed it as a “job-killing tax,” whose implementation will “hurt the economy.” This framing feeds on the insecurities and financial anxieties of lower- and middle-income households in Canada, which have seen little change in real incomes in recent years. Soft labour markets and weakened employment insurance coverage have heightened economic insecurity, and many Canadians feel pressured financially. Promises that a carbon price, which visibly adds to the day-to-day cost of living, will be somehow offset by invisible benefits sometime far in the future require a lot of trust to be believed. However, the advocates of carbon pricing have not been sensitive to the immediate economic stresses

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