Canada puts a price on carbon: what the move means

Canada isn't the first to do this, but the move is a landmark one for its scale and regional flexibility – and because the country is a major fossil fuel producer.

The Explainer

The Canadian government has a new framework to put a price on carbon emissions nationwide – a sign that international momentum to tackle climate change isn’t evaporating despite a possible US withdrawal from the global climate fight when Donald Trump becomes president.

The idea behind a carbon price is rooted in basic economics: Make people pay to do something (in this case, emit carbon dioxide) and they’ll do less of it. There are many ways of designing such pricing systems, a tax on carbon emissions being one.

Canada’s plan, with a framework agreed late last week, would place a C$10 ($7.63) tax per metric ton of carbon in 2018, then increase by C$10 per metric ton a year until it reaches C$50 ($38.16) in 2022. Provinces can either implement a carbon tax or a system for trading a finite and gradually shrinking number of emissions permits (also known as cap-and-trade), and many already have.

Carbon pricing systems are becoming increasingly common around the world – several European countries implemented carbon taxes in the 1990s, and Mexico and Chile implemented them in 2014; China is en route to enacting a nationwide cap-and-trade scheme.

So in a way, Canada is just the latest in a trend. But in terms of the plan’s scale and scope – and given that the country is a major fossil fuel producer and America’s largest trading partner – the development is a landmark moment.

Why have a carbon price?

Economists see carbon pricing as the most cost-effective way of reducing greenhouse gas emissions. Most climate scientists say rising levels of those gases, by trapping more heat in the atmosphere, have become the main driver of climate change.

Prime Minister Justin Trudeau, the driving force behind establishing a national carbon price, has framed it as a key component of Canada meeting its emissions reduction commitments under the 2015 Paris Agreement.

“Incentives matter,” says Trevor Tombe, an assistant professor of economics at the University of Calgary. “We’re providing incentives to households and businesses to find the lowest cost ways of lowering our use of fuel, lowering our emissions.”

How aggressive is Canada’s carbon price?

If enacted, the $7.63 (rising to $38.16) tax per metric ton would be more aggressive than some.

Measured in US dollars per metric ton, Mexico and Chile both introduced a $5 price in 2014. The European Union has an $8 price, but individual European nations have gone further. Ireland’s is at $21, while Sweden introduced a carbon tax in 1991 that now sits at $146.

Some experts believe that, for the tax to carry most of the load in meeting Paris-promised reductions, it would have to be in the $150 to $200 region. But as in most other jurisdictions, economic and political realities have required governments to start small.

“What we find in the real world is the road to weaning ourselves off fossil fuels is riddled with political potholes and different constituencies one needs to satisfy,” says Thomas Pedersen, an oceanographer at the University of Victoria in British Columbia, who chairs the research group Canadian Climate Forum.

How is the revenue used?

That can vary. Canada is delegating those decisions to the provinces, so each can match the answer to its politics, with potential priorities ranging from personal and corporate tax cuts, to helping to offset the disproportionate costs of a carbon tax on low-income households,  to investment in low-carbon technologies.

Are there exceptions or loopholes?

In practice, yes, for now at least. One reason is that, so long as there are jurisdictions without a carbon pricing scheme, those that do price carbon will have to seek a balance: taxing carbon enough to make a difference on emissions, while also watching against “leakage” of carbon-emitting activities to other jurisdictions.

One method, which the EU has adopted, is to exempt some emissions-intensive industries. Canada is trying to give extractive industries an incentive to reduce emissions without reducing their output. The response from Alberta – home to the carbon-heavy tar sands projects – has been to give companies “allocations” (or subsidies) based on their production output. The more one produces, the more one pays in emission taxes but also receives in allocations, according to the Ecofiscal Commission, a think tank.

Production may not decline that much, says Dr. Tombe, but “the incentive for oil and gas producers to adopt more efficient machinery, more efficient processes…is still there.”

The upshot: While most coal-burning plants are expected to close in Canada, infrastructure projects like the recently approved TransMountain Pipeline will continue to be built, and Canadian oil and gas will continue to be exported overseas.

So do carbon pricing systems work?

Policy experts say they aren’t a one-step answer for curbing greenhouse emissions, but they are an important tool. The Organisation for Economic Cooperation and Development found in a 2013 modeling study that taxes and trading systems “consistently reduced CO2 at a lower cost than other instruments,” like subsidies and feed-in tariffs.

That may help explain why businesses, including many fossil fuel companies, also support these measures. European energy giants BP, Royal Dutch Shell and Total have called for a carbon tax, while ExxonMobil – and its CEO Rex Tillerson, now nominated to be Mr. Trump’s secretary of State – also supports the concept (though it hasn’t fought very hard for one).

So far, on-the-ground evidence is mixed.

Sweden is the shining example, with emissions down 23 percent between 1990 and 2013, while GDP grew 58 percent in the same period. British Columbia also saw emissions decline marginally after implementing a carbon tax in 2008, while its per-capita GDP grew slightly faster than the rest of Canada. In oil-rich Norway emissions actually rose 15 percent between 1991 and 2008.

Canada will be a test case to watch. The country’s emphasis on provincial flexibility and preventing carbon leakage could provide an economic and political template for other countries to follow.

Even if Canadian fuel exports continue, “pricing carbon at the level we’re planning to do means Canada will be doing substantially more than other countries,” says Tombe. “That’s why collective international cooperation is critical. It’s not our responsibility to lower emissions elsewhere in the world.”

Not taxing exports is “potentially a large loophole,” says Nicholas Muller, an associate professor of economics at Middlebury College in Vermont, but “any developed economy that takes the step of implementing an economy-wide carbon tax is taking a big step and making a big statement.”