How Did We Go So Wrong on Carbon Taxes?

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Let me preface by saying that the greenhouse effect is real.  Therefore, I am for sensible policies that reduce global emissions.  

Sadly, carbon taxes aren’t a sensible policy if our goal is to reduce global emissions.   They cost too much and do too little.   So how did we go so wrong on carbon taxes?

Carbon taxation was originally a right-wing, free market theory.  The simple idea, to paraphrase Milton Friedman, is that if you tax something, you get less of it.  It could elegantly allow the markets to find the most efficient ways to reduce carbon without the need for government regulations.  

Many respectable conservative-minded people bought into this theory.  Let’s look at the reality in practice.

Theoretically, carbon prices are supposed to reduce regulation.  However, in every jurisdiction where carbon pricing has been implemented, it doesn’t reduce regulation – it increases it. 

Carbon pricing schemes in Europe, California and Canada are all very complicated.  The Canadian government just recently introduced 500 pages of legislation and regulation.  Another example, the Alberta Climate Leadership Plan, has a carbon tax credit program, but acknowledges the cost of regulatory compliance is likely too high for all but the largest companies.

Another problem is carbon leakage, which occurs when production and investment simply move to jurisdictions without a carbon tax.  In this case, emissions are simply displaced in whole or in part.

Carbon leakage is worse than you think, as it can actually increase global emissions.   Take the case of Canadian aluminum, which produces only 2 tonnes of carbon per tonne, versus American aluminum at 11 tonnes of carbon per tonne.  In practise, no one should have to explain to an aluminum worker that they lost their job because “after all, we all need to do our part,” only to have global emissions increase 550% as a result. 

(To generalize this example, Canada’s economy is 70% reliant on trade, and 80% of our trade is with the United States, which has not imposed a carbon tax.)

To try and mitigate carbon leakage, every carbon pricing scheme uses output-based allocations (OBAs).  Industries that are energy intensive and trade exposed (‘EITE’) are given free permits to emit or a carbon tax rebate to allow them to compete.  For example, we would give the aluminum industry a tax exemption for carbon taxes based on their output.

However, as carbon tax enthusiasts like to point out, people like to avoid taxes, so everyone will lobby for a tax rebate based on complicated formulas and models.   Since government determines who will receive these massive subsidies, and how much they will receive, the process is inevitably politicized.

The other problem we find in practice: demand for hydrocarbons is very inelastic.   People will pay what it takes to heat their homes and get to work.  

The Conference Board of Canada found that even a $200/tonne carbon tax would only reduce 12MT of Canadian emissions before carbon leakage.   Global carbon would likely only be reduced by 70% of this amount.

Just one large LNG plant could achieve more by replacing coal in China with natural gas. 

Canada has a global comparative advantage in carbon in many industries because of our high environmental standards.   A global approach to capitalizing on Canada’s environmental advantage would yield a double dividend of a stronger economy and a cleaner global environment.

Carbon pricing, on the other hand, may create a green paradox – policies meant to reduce emissions, that not only eliminate some people’s jobs, but increase global emissions. 

So why do our left-wing friends love carbon taxes, when they say reducing emissions is their concern?  The answer is the epitome of Reagan’s description of government, all wrapped up in one simple, marketable policy: “If it moves, tax it.  If it keeps moving, regulate it.  And, if it stops moving, subsidize it.”   Even many conservatives have let themselves be convinced that carbon pricing is an efficient, market-based policy.  An acceptance of the theory without examining the practice is what got them there.

The difference is, upon thinking about it, conservatives are realizing the problem. As for our left-wing friends – the more they think about it, the more they like it.