Update: Ontario just announced that it will introduce a carbon price, in the form of a cap and trade system. We congratulate Ontario for getting serious about addressing climate change while the federal government continues to do so little.
As we outline below, and as proven by British Columbia’s carbon tax, when it comes to regulating carbon emissions, a carbon tax is easier, quicker and more efficient than a cap and trade approach. However, the most important thing is that Ontario will now have a carbon price as well. Between Quebec’s cap and trade system and with B.C.’s existing carbon tax, Ontario’s move means that more than 60 per cent of Canadians will be using a carbon price to help tackle climate change.
With the United States and China, two of the planet’s biggest greenhouse gas (GHG) emitters, recently acknowledging that they will both have to cap their emissions, there is increased talk once again in Canada and abroad about putting a price on carbon.
This is encouraging. It’s reassuring to hear most major Canadian political parties as well as serious commentators squarely confronting the fact that Canada must act on climate change. But even as more and more leaders set aside distractions to confront global warming and the number of climate deniers dwindles, there remains an unfortunate cleavage among those who are prepared to act.
That cleavage is about which policy option is best to cut Canada’s emissions: A carbon tax or a cap and trade system?
Fortunately, in choosing which carbon pricing approach to adopt Canada has the benefit of being able to look to the experience of other jurisdictions internationally as well as here at home, to British Columbia. Fundamentally, the choice of instrument must rest on which approach will most effectively and efficiently reduce GHG emissions.
In theory both a carbon tax and a cap and trade system are capable of delivering a significant and sustained reduction in GHG emissions. However, a carbon tax has a key advantage over a cap and trade system. Crucially, it is much easier and transparent to implement a carbon tax. That is what the government of British Columbia did in 2008, moving from announcement to the implementation of its carbon tax all within the same year.
Conversely, experience has shown that cap and trade systems are highly complex, heavily influenced by powerful vested interests, and require an extensive regulatory regime. America’s proposed `Waxman-Markey’ cap and trade legislation is 1,427 pages in length. By contrast, the legislation establishing B.C.’s internationally-renowned carbon tax is less than 50 pages long.
A cap and trade system also presents two inherent difficulties: a) maintaining accurate emissions data, and b) auctioning of permits.
The availability of accurate emissions data is fundamental to the operation of a cap and trade system. Accurate data affects the market value of tradable permits and builds confidence that the price of permits is a genuine reflection of market factors. However, the incentive for facilities to underreport their emissions is always there, particularly in the face of lax enforcement and high permit prices.
Underreporting of emissions weakens demand for permits and reduces their price. The lower price, in turn, reduces the financial incentive for other facilities to find cost effective ways to reduce their emissions. Additionally, other facilities emitting above their compliance cap will have no financial incentive to reduce their own emissions if it is more cost-effective for them to buy artificially discounted permits. Perhaps most importantly, the ability to underreport emissions reduces the likelihood that the overall GHG emission reduction cap will be genuinely achieved.
Under cap and trade there are two ways for government to distribute emission permits: free of charge or via an auction. The latter approach is fairer for all emitters and more transparent and simple – but both approaches involve difficulties and complexities that are not present with a carbon tax.
If permits are given away free of charge, there is no recognition of those companies that have already decreased emissions in previous years. Companies that acted to reduce their emissions before the introduction of the cap will be able to purchase fewer permits to remain below the cap than those companies that chose not to act on emission reductions. By contrast, the free distribution of permits fails to benefit those companies who took early action and would only reward those who waited until the last minute to act.
If permits are not given away free of charge, government must design an elaborate auction system for the annual distribution of emission permits. Under such a system emitters decide how much the permits are worth, though government can choose to set a floor price below which the permits will not be sold.
Like the far simpler carbon tax, auctions provide an important source of revenue for governments. Instead of leaving the money in industry’s hands, government can use the revenue to address shortcomings in policy coverage and to reduce income taxes.
By contrast, with a carbon tax, these additional complexities do not arise. For this reason, as well as simplicity and speed of implementation, the introduction of a national carbon tax is the preferred route for Canada to take in addressing the global climate change imperative.