The coming national carbon tax gap

By: on November 28, 2016 |

Taylor - Main

Consider it the curious incident of the dog that didn’t bark, fed/prov edition.

In October, Prime Minister Justin Trudeau announced the most significant federal intrusion into provincial jurisdiction in decades: a new national carbon tax. And Quebec, that ever-vigilant guardian of provincial rights – a province that’s never encountered an imposition from Ottawa, real or imagined, that it didn’t denounce as a grave insult to its dignity and fundamental threat to its right to self-determination – had nothing to say. Well, that’s not entirely accurate… Quebec Premier Phillipe Couillard called the new federal tax a “positive” move. And at a meeting in Montreal, when the environment ministers of Saskatchewan, Nova Scotia and Newfoundland walked out on their federal counterpart to protest the tax, Quebec’s David Heurtel stayed put, saying he welcomed the announcement.

Ottawa plans to invade a policy area that’s so far been the exclusive responsibility of the provinces. With a new tax. And Quebec is okay with this? What in the name of maître chez nous is going on here?

The attempt to answer that question reveals much about the inconsistencies and confusions at the heart of Trudeau’s current national climate change policy. And hints at a coming fracture in the federation over variable carbon price rules that threaten a much heavier burden on some provinces than others.

What Trudeau calls his “pan-Canadian approach to pricing carbon pollution” will see a $10 a tonne tax applied to carbon emissions starting in 2018, rising by $10 per year until it hits $50/t in 2022. This will be imposed on all provinces that are not already pricing carbon at an equivalent rate. British Columbia is collecting its own carbon tax and Alberta is introducing one in January, so both will be exempt as long as they meet or exceed the federal rate. Also exempt will be provinces operating a cap and trade system, provided certain conditions are met. Currently Quebec is a partner with California in a cross-border carbon trading system called the Western Climate Initiative (WCI), which Ontario plans to join shortly. Nova Scotia says it will be setting up its own stand-alone cap and trade system.

This sorting of provinces, with some selecting cap and trade and others choosing a tax or having it imposed upon them, reflects the distinct characteristics of the two carbon pricing options. Provinces with fast-growing economies and/or a focus on carbon-intensive industries (B.C., Alberta) will lean to a tax, since overall emissions can rise as the tax is paid. Provinces with slow or declining economic growth (Quebec, Nova Scotia) will prefer cap and trade, since deindustrialization automatically reduces emissions and makes the cap easier to reach.

In place since 2013, Quebec’s cap and trade system has a current price of $16/t, which is well above the minimum federal tax rate for 2018 of $10/t. And Quebec will presumably benefit from a level playing field when all other provinces are forced to price carbon at the national rate. Still, Couillard’s nonchalance seems strikingly out of character for Quebec premiers, given their historical hostility towards federal intrusions of any kind. In 1959, for example, the province prevented its universities from accepting federal grants. It famously refused to sign off on Pierre Trudeau’s constitutional amendments in 1982, citing their offensiveness to Quebec’s interests. In 1999 it rejected the Social Union Framework Agreement because it enshrined the right of Ottawa to intrude into areas of provincial responsibility. Quebec still operates its own provincial pension plan rather than allow its citizens to participate in a federally-run CPP. In short, la belle province has never met an offer from Ottawa it couldn’t refuse. Yet now it thinks a massive new federal tax in an area that’s so far been provincial jurisdiction is a good thing?

The obvious explanation is that Couillard expects a national carbon tax to have no impact on Quebec or it’s participation in the WCI, regardless of any conditions Ottawa may have in mind. Last summer in a French-language interview with Huffington Post he said he wouldn’t object to a potential federal carbon tax “as long as it does not conflict with our carbon market.” But what happens to Trudeau’s sunny contention that cap and trade can co-exist side by side with his tax if these different approaches start to produce radically different costs? How will Quebec’s insistence on carbon price sovereignty be reconciled with Trudeau’s vow of a consistent coast-to-coast carbon tax?

With its annual $10 hikes, by 2020 the planned federal carbon tax will reach $30/t. At that time, the floor price for permits in Ontario and Quebec is projected to be approximately $19/t. So the cost of a tonne of carbon emissions in carbon tax provinces will be more than 50 percent higher than the price paid in Quebec and Ontario after just three years. And this gap is likely to grow. According to projections by CaliforniaCarbon.Info, an online carbon market research firm, by the time the national carbon tax hits $50 in 2022, the WCI permit price is estimated at just $23.

“This is potentially a big problem,” admits Mark Cameron, executive director of the pro-carbon tax lobby group Canadians for Clean Prosperity. “Substantial differences in price suggests a major disparity in effort.” No kidding. Carbon price gaps of this size pose a major threat to constitutional harmony, particularly for those provinces that will have the federal tax imposed upon them, such as Saskatchewan. Regional political conflict would inevitably result. Imagine westerners’ fury if they were paying much higher carbon taxes than easterners, especially if Quebec was still opposing a pipeline delivering western oil to the east coast.
Table 1: Carbon Prices by Province from 2016 to 2022
(per tonne of emissions, see footer for notes)

2016 2017 2018 2019 2020 2021 2022
Quebec $16.45 $18.09 $18.10 $18.82 $19.86 $22.13 $23.70
Ontario n/a $18.09 $18.10 $18.82 $19.86 $22.13 $23.70
Alberta n/a $20.00 $30.00 $30.00 $30.00 $40.00 $50.00
B.C. $30.00 $30.00 $30.00 $30.00 $30.00 $40.00 $50.00
Federal n/a n/a $10.00 $20.00 $30.00 $40.00 $50.00

 

Before considering what a carbon price gap will do to national harmony, however, we need to understand what’s causing it.

Advocates of cap and trade claim that focusing on differences between permit prices and carbon tax rates oversimplifies and misunderstands the allegedly unique economic characteristics and benefits of emissions trading. Ontario’s environment minister Glen Murray argues that trading in carbon permits creates efficiency gains not available with a tax as firms bargain between themselves to lower the cost of reducing emissions. He further contends that his government’s new Green Fund, fuelled by permit auction revenues, will invest in important new technologies that will unleash further efficiency gains. Those who argue the federal carbon tax and WCI permit prices should be the same “don’t understand carbon trading,” Murray said in an interview this fall.

“This is nonsense,” rebuts Cameron. “Any economist will tell you there’s no difference between a carbon tax and a cap and trade system. If you set the price for carbon at $30/t, you’ll get a certain level of reduction. And if you set it at $50/t you’ll get a bigger reduction.” The reason WCI carbon prices are expected to be substantially below Ottawa’s carbon tax rate has nothing to do with economic efficiency. Rather it’s all about the Golden State.

Largely to assuage local political sensitivities, the California government has deliberately created a massive oversupply of emissions permits. In addition to huge giveaways of free permits to the state’s electrical utilities, these firms have also benefitted from a deceptive game called “resource shuffling.” California participates in a regional electricity grid with neighbouring states, which means its utilities buy electricity from plants in Arizona or New Mexico, where coal-burning is prevalent. California legislation specifically allows utilities to swap their ‘dirty power’ contracts for cleaner electricity obtained elsewhere from the regional grid. This enables electricity providers to dramatically lower their recorded emissions; yet they still receive permits based on their old coal-based energy profile. Resource shuffling does nothing to reduce overall U.S. emissions, since the swapped-out plants are still generating coal-fired electricity for other states. But it does create a huge surplus of unused and unnecessary emission credits – driving down the price dramatically. Further, California is making available carbon offsets: projects that can be used to create even more cheap permits by planting trees, trapping methane and improving California’s rice farms. The more offsets created, the cheaper emissions permits become. CaliforniaCarbon.info predicts the state will be awash in accumulated excess permits until at least 2026.

The opportunity to harvest California’s vast crop of cheap permits is the true motive behind Quebec and Ontario’s interest in the WCI. “The only reason cap and trade is cheaper [than a tax] is because it makes available all these cheap credits from California,” says Cameron. For  proof on how the Great California Permit Surplus is skewing the Canadian carbon market, he points to recent research showing that if Ontario was denied access to California’s low-cost permits, the price for carbon emissions would rise from $18/t to a stunning $157/t by 2018. The same result could be expected for Quebec as well. Prices this high would cause immediate and devastating economic pain in both provinces.

Given the stakes, it’s obviously in Quebec and Ontario’s best interests to maintain their partnership with California in a cap and trade system. Doing so, however, promises an equally devastating impact on those provinces unable to avoid the tax or its equivalent: B.C., Alberta, and perhaps Saskatchewan and Newfoundland and Labrador. But what about those conditions Trudeau promised? Does Ottawa have a plan to ensure cap and trade doesn’t simply become a way of punishing provinces that can’t take advantage of California giveaways?

According to a backgrounder to Ottawa’s new carbon tax policy, provinces with cap and trade systems will only be exempted from the minimum tax rate if two criteria are met. The first is that the province must have a 2030 emissions target that’s in line with the federal objective of a 30 percent reduction from a 2005 base. Ontario and Quebec have already announced targets that exceed Canada’s goal. And Nova Scotia has already met its 2030 target, due to a rapid economic decline. The second obligation, however, is much more important. And far less clear cut. In order to avoid the federal carbon tax, the policy states a cap and trade province must have annual emissions targets for 2022 that “correspond, at a minimum, to the projected emissions reductions resulting from the carbon price that year in price-based systems.” This sounds like permit prices and taxes need to be the same, or at least produce the same results.

Werner Antweiler, an economist at University of British Columbia’s Sauder School of Business, interprets this second rule to mean permit prices must eventually equal the federal carbon tax rate. “If the goal is to have a national price across Canada, then the trading price in Quebec [and Ontario] needs to be at the federal tax rate,” he says, echoing Cameron. “Big discrepancies in carbon prices across provinces will be very distorting to economic activity.”

But given what appears to be intentionally vague wording, this rule could also create a loophole big enough for Quebec and Ontario to drive a carbon-belching truck through. Nicholas Rivers, an environmental economist at University of Ottawa, points out the second criteria relies on subjective calculations and economic modeling to determine if the permit price under cap and trade is delivering the same level of emissions reductions as would occur if a province had a tax. “The federal government’s second point does not have a clear metric,” says Rivers. “Every province will pick their own perspectives and their own models to argue their case. I don’t know how the federal government is going to implement this.”

This scenario opens the door for Quebec and Ontario to construct self-serving arguments and modeling which would cause any national debate over “fair” carbon pricing to become mired in competing and contradictory claims supported by ample, well-tortured data. Advocacy of this sort is something of a specialty for Quebec. Recall, for example, the province’s bafflegab in previous debates over equalization: claiming to be a net financial contributor to Confederation when its actually been the single biggest recipient of equalization and other transfer payments from Ottawa. When the Huffington Post asked if Quebec would ever consider abandoning cap and trade for a national carbon tax plan, Couillard responded bluntly: “No, that is out of the question. The advantages [of cap and trade] are very large for Quebec.” And to protect this competitive advantage in carbon pricing over the long run, we can expect Quebec, along with Ontario, to seek out new sources of cheap emissions credits, such as Mexico, once California’s surplus is exhausted in 2026. The European Union’s carbon trading regime is similarly well stocked in low-cost, dubiously-sourced emissions permits.

If Antweiler and Cameron are correct and Ottawa’s rules are meant to produce a uniform national carbon price in all provinces via a tax or cap and trade, it seems clear this won’t happen without firm intervention by Ottawa. In just a few years it will have to overrule Quebec’s claims to carbon price independence and impose a made-in-Canada floor price on WCI emissions permits to bring them up to the tax rate. Such a move could be the best thing to happen to the Quebec separatist movement since the defeat of the Meech Lake Accord. Given Trudeau’s commitment to consensus and sunny ways, not to mention his political alliances with the governments of Quebec and Ontario, engaging in such a bitter and protracted conflict seems rather beyond the realm of probabilities. (Although it is conceivable the California permit problem will solve itself if, as Cameron points out, U.S. President-elect Donald Trump delivers on his promise to withdraw from the 2015 Paris Climate Agreement, a move that could end the cross-border trade in emissions permits under WCI.)

The other possibility is that Ottawa’s vague exemption policy deliberately or inadvertently offers Quebec and Ontario the chance to maintain a cap and trade permit price that’s significantly below the rate imposed on other provinces via the new tax. In this scenario Quebec and Ontario − and any other province that finds cap and trade attractive − can be expected to produce a flood of carefully tuned reports and economic modelling exercises to bolster their case for cap and trade exceptionality. Given Couillard’s insistence on carbon price independence and his insouciance about Ottawa’s plans, this might be the outcome Quebec has been expecting all along. It certainly explains his curious refusal to bark in protest over the new federal tax. And if this gambit is successful, Quebec and Ontario could enjoy a substantial and permanent competitive edge over those other, mostly western provinces stuck with the tax: wiping away any pretence to a national carbon tax plan or the concept of equal effort across the country.
Notes to Table 1:

Quebec and Ontario carbon prices 2017 to 2020 from calculations found in Sawyer, D., Peters, J., & Stiebert, S. (2016). “Impact modelling and analysis of Ontario cap and trade program.” EnviroEconomics, Navius Research, & Dillon Consulting.

Quebec and Ontario carbon prices 2021 to 2022 from calculations found in Kumar, C., Rana, R., Nongpiur, R., Horner, H. (2016) “The Impact of Ontario on WCI Carbon Market.” Californiacarbon.info. Registration required. Conversion from US dollar figures at current Can/US exchange rate.

Federal carbon prices from Government of Canada (2016) “Pan-Canadian Approach to Pricing Carbon Pollution.”


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About Peter Shawn Taylor

Peter Shawn Taylor is editor-at-large of Maclean’s. He lives in Waterloo.