Climate Change: the Case for a Carbon Tariff/Tax

CLIMATE CHANGE: THE CASE FOR A CARBON TARIFF/TAX

Thomas J. Courchene and John R. Allan

The opting-on voluntarism of Kyoto, while admirable, is not adequate for addressing the climate-change challenge. This is because it excludes many of the highest polluting countries and, relatedly, because it cannot cope with the serious environmental-free-riding issues. The first of our proposed two tiers addresses free riding via a nationally imposed carbon import tariff combined with an equivalent domestic carbon tax. This “tradables” tier would engage global exporters (and importers) and not governments. The second tier would involve governments and could be Kyoto-like with commitments related to emissions, standards, cap-and-trade systems, etc. The first tier would, constitutionally, fall under federal jurisdiction, while all levels of government would hopefully play key roles in the second tier.

Certes admirable, l’adhésion volontaire au protocole de Kyoto ne suffit pas à relever le défi des changements climatiques. D’abord parce qu’elle exclut de nombreux pays très polluants et, en corollaire, parce qu’elle n’offre aucune solution au grave problème du resquillage. Les auteurs propose de s'attaquer à ce dernier problème par le biais d’un tarif national à l’importation de carbone et d’une taxe équivalente sur les émissions de carbone applicables aux exportateurs (et importateurs) mondiaux. Ce premier niveau d’intervention serait de compétence fédérale et pourrait faire l’objet de mécanismes d’échange. Le second niveau d’intervention proposé par l’auteur viserait les gouvernements et pourrait s’inspirer de Kyoto en prévoyant des engagements en matière d’émissions, de normes, de plafonds, de systèmes d’échange, etc. Sur le plan constitutionnel, tous les ordres de gouvernement joueraient idéalement un rôle clé à ce niveau.

anada’s National Round Table on the Economy and pulting climate change to the top of the global policy the Environment (NRTEE) has recently recom- agenda and may well be of signal importance in trigger- C mended that we adopt a carbon tax as the pre- ing creative and effective programs in individual nations, ferred policy instrument for addressing the climate change Bali will almost certainly fall far short of expectations. challenge. For its part, the Canadian Council of Chief This is so because while there are very substantial eco- Executives (CCCE) welcomed this NRTEE report, noting nomic costs to “volunteering,” there is no guarantee that that the proposal echoed the earlier CCCE Policy recalcitrant nations will follow through and, therefore, Declaration in recognizing the need for economy-wide sig- no guarantee the climate change challenge will be suc- nals to pressure businesses and individuals alike to reduce cessfully addressed. emissions of greenhouse gases (GHGs). Moreover, a market- based carbon tax also came in first place in IRPP’s Canadian he Harper Conservatives appear to be taking an inter- Priorities Agenda, an impressive agenda-setting and policy T mediate position between reliance on the market (and evaluation exercise involving nearly 50 of Canada’s recog- expressly on putting a price on carbon emissions) and non- nized policy analysts and designed to identify the country’s binding voluntarism. Specifically, the government is, thus top policy priorities. far at least, rejecting the NRTEE proposal for a carbon tax As a general principle, a carbon tax on all emissions in favour of a regulatory regime that would target the big is a decidedly preferable approach to the opting-in/vol- polluters in a “make the polluters pay” approach. Opera- untarism of Kyoto. And Kyoto is arguably superior to the tionally, the concerns here are that (1) the targeted com- recently embraced Bali Action Plan, which contains no mand-and-control approach could be prone to very binding commitments on signatories. While the substantial industrial and even provincial lobbying for reg- Kyoto/Bali initiatives are obviously important for cata- ulatory exemptions and (2) it would be very difficult to

POLICY OPTIONS 59 MARCH 2008 Thomas J. Courchene and John R. Allan

ensure that Canadian firms do not rifice significant economic growth to ot surprisingly, our approach to resort to the international economy to reduce our emissions, we ought at the N climate change begins with circumvent this regulatory approach. same time to ensure that the overar- addressing these international free- This latter observation leads directly ching international approach we are rider issues, and then complementing to the core difficulties with most of working within has some potential and supplementing them with appro- the existing proposals and, what is for successfully addressing the global priate domestic policies. Moreover, essentially the same thing, to the core climate change issue. We must also the target group for addressing free building blocks of our proposal. ensure that our efforts do not subject riding is not governments but, rather, Whether one relies on prices/taxes, Canadian firms to unfair competition multinational enterprises. But govern- on some version of a command-and- in domestic and external markets ments cannot be left out of the solu- control regulatory regime with finan- from firms located in non-participat- tion. Accordingly, we are led to a cial penalties or on Kyoto’s moral ing countries. two-tier approach. The first tier is con- cerned primarily to ensure Whether one relies on prices/taxes, on some version of a that the carbon footprint command-and-control regulatory regime with financial penalties of internationally traded or on Kyoto’s moral voluntarism, the bottom line must surely be goods and services attracts the same carbon tax bur- to ensure that the domestic economic costs associated with the den as that of non-traded chosen system will be validated by successfully controlled domestic goods and servic- carbon emissions. Phrased differently, success on the climate es. Readers may want to change front will be beyond our grasp unless the emerging refer to this as the “trad- ables” tier. The second tier economic superpowers like China, India, Brazil, Indonesia and deals with the whole others are effectively co-opted into the process. panoply of non-tax meas- ures to which governments voluntarism, the bottom line must Our view is that the proposals on may resort to effect a reduction in surely be to ensure that the domestic the table do not meet these tests GHG emissions. While the tradables economic costs associated with the (although the carbon tax could be tier will focus on firms, often multina- chosen system will be validated by suc- reworked to provide a Canadian ver- tional firms, the second tier will focus, cessfully controlled carbon emissions. sion of what we are proposing on a in Kyoto fashion, on governments. We Phrased differently, success on the cli- global scale). Beyond the inclusivity deal with these in turn. mate change front will be beyond our issue addressed above, the key flaw The analytical underpinnings of grasp unless the emerging economic in all the proposals is the failure to the tradeables tier exist, in an embry- superpowers like China, India, Brazil, come to grips with “free riding.” onic stage, in California’s proposal to Indonesia and others are effectively co- There are at least two sorts of free- measure the carbon footprint of its opted into the process. rider problems. The first is that firms energy imports right through to their In order to stress this point, con- in non-signatory countries, or non- source. If the resulting carbon emis- sider China. It is already the largest complying countries, will have an sions are too high, then California user of (dirty) coal and is planning to advantage in terms of exporting to will ban such imports into the state. open a new coal-fired power plant complying countries, and to interna- This California approach is also every week for the foreseeable future. tional markets generally. The second adopted in the Energy Independence Writing in the New York Times, is that firms in complying countries and Security Act of 2007, signed by Andrew Revkin reports that “even if will have enhanced incentives to President Bush in December. Section the established industrial powers outsource from, or offshore to, non- 526 of this statute precludes US feder- turned off every power plant and car complying countries, and then re- al agencies from purchasing vehicle right now, unless there are changes in export back to their home countries, fuel derived from non-conventional policy in poorer countries the con- thereby avoiding the domestic envi- sources unless its carbon footprint is centration of carbon dioxide in the ronmental regime. Moreover, as less than that of conventional petro- atmosphere could still reach 450 parts China, Brazil, India and the others leum. How will Alberta and the oil per million — a level deemed unac- continue their economic ascent, sands producers react? We think that ceptably dangerous by many scien- these free-riding concerns of comply- it is a very safe bet that the energy tists — by 2070. (If no one does ing countries will be correspondingly patch (and the province) will not anything, that threshold is reached in magnified and will surely test the want to lose access to US government 2040.)” The message that we draw resolve of those countries to hold to agencies and the California market from this is that if we are going to sac- their commitments. (and potentially to the entire US mar-

60 OPTIONS POLITIQUES MARS 2008 Climate change: the case for a carbon tariff/tax ket as more states follow California’s tries will actually be on the products to export into the huge US or EU mar- lead). Hence, they will take signifi- of corporations headquartered in the kets, as one assumes that they will, cant measures to conform to the G7 and other developed industrial will be subject to the carbon tariff. California standard. But the defect in countries. By way of a relevant exam- They will thus have an incentive to the California approach is that it is a ple here, Sunday Times economics reduce the carbon footprint of their “binary” model — Alberta either editor David Smith notes (in Growling products in order to maintain their would be able to export energy from Tiger, Roaring Dragon) that were Wal- competitiveness in the US/EU mar- the oil sands to California or it would Mart a country it would be China’s kets. Even if China decides not to be not be able to do so. There needs to be fourth-largest trading partner. Under part of the tier-1 system (i.e., decides a middle ground, as it were. Much this first tier, products imported into not to have a domestic carbon tax), better, then, would be for California the US by Wal-Mart would be subject exporters of both intermediate and (had it the legislative power) to in the US to a carbon tariff on the final goods from China will, under a impose an import tax or tariff on the carbon emissions of their entire pro- destination-based system of carbon carbon content of the oil or gas. duction processes. Even with a car- tariffs and taxes, still be taxed in the Thus, the tradables tier of our bon tariff in place, outsourcing or US/EU and other markets. Therefore, proposal reworks the California locating production offshore, with its this first tier is more about ensuring approach by converting the regime attendant job loss and related prob- environmental compliance by inter- into a national carbon tariff or a car- lems, will no doubt continue to be nationally oriented firms than it is bon import tax that would be levied economically efficient for some about ensuring that countries, per se, on the carbon footprint of all are onside. In addition, since imports from all countries Several further related tax issues are the proposed carbon tariff/tax (including on the carbon system is destination based, it emissions components relat- best dealt with in this context. The would ensure that producers ing to the logistics compo- first relates to whether the carbon located in complying nations nent, especially shipping, tax should be levied on imports or would not, as a consequence throughout the supply chain). on exports. That is, should it be of this system, suffer any com- Consistency, as well as com- petitive disadvantage when pliance with the international administered on a destination or selling into non-complying trading regime, would require origin basis? Properly administered, nations. that a concurrent carbon tax both bases would provide effective While the first tier deals be applied to all domestically incentives for firms producing largely with companies and the produced and consumed use of the tax and tariff systems products. Without this, a internationally traded goods to both to reduce GHG emissions non-complying nation could reduce their carbon footprints. and achieve equity between use a carbon tariff to protect domestic and internationally domestic producers from import firms. But outsourcing to take advan- traded goods and services, the second competition, a practice for which tage of lax environmental policies in tier would address the whole panoply countervail would be an appropriate pollution havens will be subject to of non-tax measures that governments remedy. The impact of this first tier this carbon footprint tariff. The and countries may use to effect emis- obviously would be greater the larger intent, and the result, will be that sion reductions beyond those sought the number of participating coun- environmental free riding will not be by tax measures. These could include tries. Applied globally, it would make rewarded. such disparate measures as Kyoto-style a major contribution to meeting the reductions, cap-and-trade systems, climate change challenge. The mech- e presume that this tradables automobile mileage standards, conser- anism, however, would be a powerful W tier will be much more vation measures, incentives for the use and effective policy instrument amenable to the US than was Kyoto, of energy-efficient appliances, carbon whether utilized globally, regionally because both types of free-rider issues sequestration requirements and ener- — for example, within NAFTA or the are addressed. Indeed, were the US gy-conserving infrastructure, to name EU — or by a single country. and the EU to agree to this carbon but a few. Since the operation of tier 1 Note that this import tariff import tariff (with this usage validat- largely eliminates international free would be levied against foreign-based ed by domestic equivalents on non- riding, a Kyoto-type approach may exporting firms’ products, not traded goods), a formal international work quite well for tier 2 initiatives. against countries per se. Indeed, the agreement might not even be While it no doubt remains impor- import tariffs that will be levied on required for the functioning of the tant to strive for binding commit- many exports from developing coun- first tier. This is because firms wanting ments from all countries, developing

POLICY OPTIONS 61 MARCH 2008 Thomas J. Courchene and John R. Allan

countries may be accorded some sec- prints in a small number — say, a the self-interest of producers con- ond-tier flexibility in terms of both half-dozen or so — of broad cate- cerned to minimize their own CAT lia- commitments and timing to help facil- gories. The country panel of auditors bilities would help ensure the proper itate participation. Phrased differently, would then assign average carbon identification of the carbon footprint this is where the rhetoric adopted by levels by country for each of the ini- of their inputs. In an international many of the developing countries has tially selected categories. Since it will context, the CAT paid in one country relevance: we were not an important take a while for the first tier to be would be rebated when the product is part of the problem in the first place, so why make us a Because this is Canada, there is always a federal-provincial key part of the solution issue lurking in the background. This time it is who will collect when our real priority is the carbon tax. Since the international component would be exiting from poverty. This argument has little reso- an import tax and since the accompanying domestic tax nance with the first tier, would be an indirect tax on carbon, on both counts this falls however, since we are deal- within federal jurisdiction. ing in large measure with multinational enterprises whose home implemented, there will be consider- exported to another, and the import- countries could be anywhere. It is also able time to then undertake more ing country would apply its carbon tax somewhat disingenuous in the case of detailed carbon footprint measure- to the cumulative carbon footprint of countries such as China — which, ments. Individual firms would be the product at the time of importation. despite its high poverty rate, is already able to challenge these assigned lev- Again, this is similar to the operations the world’s largest contributor to GHG els by requesting (and paying for) of the GST, our version of the VAT: we emissions — and India, which, more firm-specific carbon auditing. There rebate the tax on exports and apply by default than by design, has pursued will, of course, be start-up difficulties the GST to the value of imports. environmentally disastrous popula- in compiling requisite carbon foot- tion policies. print data, but these should not be everal further related tax issues exaggerated. Several companies, for S are best dealt with in this context. further inducement for developing example, have already decided volun- The first relates to whether the car- A countries to commit themselves to tarily to provide environmental bon tax should be levied on imports the second tier is that reducing the car- labelling for their products. While or on exports. That is, should it be bon footprint of their domestic infra- the problems will be severe, they are administered on a destination or ori- structure and production will also serve not insurmountable. Nonetheless, it gin basis? Properly administered, to reduce the carbon content of their might be wise to begin with low car- both bases would provide effective exports and, therefore, make their bon-tax and tariff rates in order to incentives for firms producing inter- economies more attractive for export- accommodate any early growing nationally traded goods to reduce ing, outsourcing and offshoring. pains. Once up and running the rates their carbon footprints. As readers have by now realized, could then be raised to the desired And, in either case, the consumers the devil is clearly in the implemen- levels. in the importing country would tend tation details (and in particular the to bear much of the burden of the details relating to the carbon tariff). n alternative to a tier 1 compris- CAT in the form of higher prices for What will be needed is a set of “car- A ing a domestic carbon tax and a items with larger carbon footprints. bon auditors,” perhaps coming under carbon tariff on imports would be a This would have the desirable effect of the umbrella of an international version of an international value- tending to redirect consumption to blue-ribbon panel, whose job it will added tax or VAT on carbon emissions. substitute products with smaller car- be to measure carbon emissions. The Perhaps more felicitously, it might be bon footprints. The international allo- Canadian Institute of Chartered described as a CAT, or carbon-added cation of the revenues, however, Accountants has for over a decade tax. Analogously to existing VATs, this would depend critically on the admin- now turned its attention to the meas- would impose a tax on the cumulative istrative principle chosen. An export urement of carbon footprints, and we carbon footprint at each stage of the or country-of-origin tax would allo- assume that there is considerable production/transportation process, cate the revenues from the carbon tax expertise in this area in most devel- with tax credits for the carbon taxes to where the pollution occurred, while oped countries. Initially, some cor- paid previously on inputs. The net an import or country-of-destination ners may need to be cut — for result would be a tax on the carbon tax allocates the revenues to where example, putting all traded goods added at each stage of the produc- the product is consumed. Our prefer- with roughly similar carbon foot- tion/transportation process, one where ence for an import or destination-

62 OPTIONS POLITIQUES MARS 2008 Climate change: the case for a carbon tariff/tax

The Gazette, Montreal A temparature inversion in Montreal on a late winter’s day. The authors make a case for a carbon tax as a way to address climate change.

based tax follows from the possibility A second issue has to do with and imported goods, it may be that some countries, as part of a strat- how the global trading system and argued that no discrimination is egy of promoting exports, might the WTO will look upon the tier 1 involved. The tax or tariff burden decide not to institute an export tax carbon measure, whether it be a car- would certainly differ as between or, where such a tax was formally bon tariff or a CAT. So long as imports with differing carbon foot- adopted, to administer it in a lax and national environmental policies do prints, but this hardly constitutes ineffective manner. On the other not discriminate arbitrarily between arbitrary discrimination. In the case hand, it seemed appropriate to assume foreign and domestic products, or of the CAT, since there is no WTO that countries will be much more like- between products imported from dif- problem with international accom- ly to levy the import tax, since this ferent trading partners, there should modation of VATs, the fact that this will level the playing field for their be no problem: if the carbon tariff CAT or carbon-added tax can be own producers. Again, there are both matches the rate of domestic carbon designed to resemble a VAT should technical and political factors at play tax, or if the CAT is applied uniform- help its acceptance by the WTO. here that will need greater attention. ly to both domestically produced Nonetheless, the intent and the pre-

POLICY OPTIONS 63 MARCH 2008 Thomas J. Courchene and John R. Allan

sumed effect of tier 1 will be to important, in many ways, than the pliance. Such an outcome, however, reduce international trade when this jurisdictional or geographic destina- is likely as long as the federal gov- trade is based on products gaining a tion of CAT revenues is their use: ernment fails to introduce measures competitive advantage because they what is vital is that they be used to that are generally perceived as being do not embody the cost to society of facilitate the largest attainable commensurate with the seriousness GHG emissions. Other things being reduction in GHG emissions. The of the problem. In such circum- equal, for example, a case of locally CCCE wants carbon taxes to be rev- stances, is it hardly surprising, for produced beer would have a smaller enue neutral, so that other taxes example, that Quebec, Manitoba carbon footprint than one shipped should be reduced apace. This would and British Columbia are talking of adopting California’s The proceeds of the tax could be used in a variety of ways. average-fuel-economy More important, in many ways, than the jurisdictional or standard rather than the geographic destination of CAT revenues is their use: what is weaker standard adopted by the Bush administra- vital is that they be used to facilitate the largest attainable tion and subsequently reduction in GHG emissions. proposed by our federal minister of transport. from Europe. Hence, the carbon tax yield a “double dividend,” with on the imported beer would be high- reductions both to GHG emissions inally, while many of the above er, again all else except shipping and to other taxes. While personal F complications appear daunting, being equal. In the first instance, this income tax cuts may be appropriate some perspective must be main- will presumably reduce trade. What — particularly refundable credits to tained. There seems to be rather sur- happens over the longer term will minimize the impact of a CAT on prising acceptance on the part of depend on how firms react to the low-income recipients — offsetting many in the policy community of taxation of carbon emissions: the cuts to corporate income taxes the NRTEE’s proposal for a domestic foreign firm may set up local produc- (CITs) are more questionable: given carbon tax. Yet, if this proposal is to tion facilities, for example. the impact of current energy prices address the two free-rider problems Because this is Canada, there is on the profitability of the energy raised above, Canada will need to always a federal-provincial issue sector, CIT cuts may accrue dispro- supplement the domestic carbon tax lurking in the background. This time portionately to precisely those com- with the proposed carbon import it is who will collect the carbon tax. panies that are major contributors to tariff. Alternatively, if our domestic Since the international component GHG emissions. This would tend to response were to institute a CAT, would be an import tax and since the weaken the incentive provided by this would have to be applied to accompanying domestic tax would the CAT for firms to lessen their car- imported goods at the point of be an indirect tax on carbon, on bon footprints. However, there are entry. Therefore, all the complexities both counts this falls within federal other options for CAT revenues. in our proposal are also part of an jurisdiction. These could include an investment effective domestic carbon tax. If we pool to foster research on carbon- have to go to these lengths in any evying a CAT at the federal level reducing technologies, such as car- event, why not employ the expertise L has the further advantage that it bon sequestration and perhaps clean of the international community in ensures at least a minimal, effective coal technologies, and a fund to carrying out the carbon emissions GHG emissions response across the make carbon-reducing technologies auditing and in designing the insti- nation, even if, as seems likely, some available to developing countries to tutional structure that will be need- provinces choose to pursue exces- help them adhere to the tier 2, com- ed for a system of global carbon sively tolerant carbon policies or to mitments. Very importantly, rev- tariffs? In this way Canadians can rely primarily on tier 2 initiatives. As enues from a CAT could also be used have more confidence that our with the GST, however, there would to underwrite tax credits to firms efforts will be part of a global action certainly be an opportunity for that undertake carbon-reducing plan that will succeed in taming the provincial CATs harmonized with investments. climate change challenge. the federal CAT; harmonizing Finance Minister Flaherty has provinces would simply add their expressed concern about a piecemeal The authors are the director and associate provincial rate (dollars per tonne of approach to GHG emissions and the director, respectively, of the Queen’s Institute carbon) to the federal rate. environment. Certainly a patchwork of Intergovernmental Relations. Courchene is The proceeds of the tax could be quilt of environmental measures also senior scholar at IRPP and a used in a variety of ways. More complicates greatly the issue of com- Contributing Writer to Policy Options.

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