What’s wrong with a revenue neutral carbon tax?

The political appeal of a revenue neutral carbon tax is clear. The tax provides an incentive to reduce fossil fuel use, and the revenue neutrality — reducing income or other taxes in amounts more or less equal to the amount of carbon tax revenues that the government receives — makes the whole exercise rather painless.

There may be some costs in adjusting to the carbon tax, but average after-tax incomes remain much the same. Whatever we pay in carbon taxes we get back in tax breaks elsewhere.

The problem, however, is that a revenue neutral carbon tax at anywhere near current or proposed tax levels won’t work. In terms of standard public policy criteria, it will neither be effective in meeting our greenhouse gas (GHG) objectives nor equitable in terms of who bears the costs that our GHG emissions will cause.

It is commonly asserted that the carbon tax experience in British Columbia demonstrates it works. A recent review of studies that compare per capita fuel use trends in British Columbia versus the rest of Canada concludes that B.C.’s $30 per tonne carbon tax has reduced gasoline and natural gas use by 5 to 15%. A prominent letter to the Globe stated that the reduction has been even greater.

But there are limitations in those studies and the reduction estimates they suggest. The higher end of the estimated impact of B.C.’s carbon tax requires that people respond as much as four times more to price changes due to taxes as compared to price changes for other reasons, for example, an increase in costs.

The high impact estimates may be the result of a failure in some of the studies to control for all of the determinants of fuel use, making it impossible to attribute differences in trends to the carbon tax alone. A study examining the effect of the carbon tax on gasoline use in MetroVancouver, for example, takes into account the opening of the Canada Line among other things and found a much lower impact — less than 1%.

No doubt there are limitations in this study as well, and its estimate of impact may be too low. However, the point is that the impact of B.C.’s carbon tax is not entirely clear, and may not be nearly as large as some proponents would suggest.

More importantly, even if one were to accept the high end of the estimates, an estimated 15% impact does not mean there has been and will continue to be an actual reduction in fuel use due to the carbon tax. The estimated impact is the difference between fuel use with the tax versus an estimate of what hypothetically would have happened without the tax.

Over the longer term it isn’t a carbon tax in itself, rather it is higher prices that will provide a sustained economic incentive to reduce fuel use.  And in B.C., even with the carbon tax, what we are seeing as a result of the collapse in the global prices of crude oil and natural gas is that people are paying markedly less for the fuel they consume — not more.

The dramatic fall in crude oil prices has reduced gasoline prices 30 to 40 cents a litre in the province. But B.C.’s $30 per tonne  carbon tax adds only 6.7 cents to the price of gasoline. A tax some 5 times the current level — $150 per tonne — would be needed just to restore gasoline prices to former levels. And tax levels much higher than that would be needed to induce the reductions in fuel use required to meet our GHG objectives.

Unless oil and gas prices return to former levels, which virtually no one is forecasting for the foreseeable future, there will be an economic incentive for gasoline and other fuel use to increase relative to recent historical levels, even with the carbon tax. There may be some comfort that it would have increased somewhat more without the tax, but that won’t begin to help us achieve the stated goals of a 40% reduction in emissions by 2030 and 80% by 2050.

The problem, I must emphasize, is not with the carbon tax itself. A carbon tax is arguably the most logical, transparent and consistent way to make people and business recognize the cost of the GHG emissions their fuel use causes. It is far better than the ad hoc, costly and in many instances largely symbolic measures many would like to impose.

And a carbon tax of $30 per tonne, rising steadily over time as BC’s Climate Leadership Team has recommended is a reasonable, albeit low reflection of the estimated social cost of GHG emissions.

The problem is the revenue neutrality. On the one hand the carbon tax says we must pay for the costs of what we do. On the other, with revenue neutrality, it says but don’t worry the government will give it all back in tax breaks elsewhere.

It is ironic that some of the same people who disparage the purchase of offsets, not just for valid concerns about their true incremental effect, but on moral grounds that it ‘permits’ people to continue consuming fossil fuels, are strong supporters of the revenue neutral carbon tax. But a revenue neutral tax allows people to continue consuming fossil fuels without making any direct or indirect effort to offset the emissions they generate or otherwise mitigate the costs their GHG emissions will cause.

While we are already experiencing some impacts and costs of climate change, the most extensive and significant costs will be borne by future generations. So if we are going to pay a tax in recognition of the costs we are imposing on future generations, those payments shouldn’t be returned to us in the form of income or sales tax breaks.

Any reasonable notion of equity would demand that carbon tax revenues be directed to measures that benefit those who will be bearing the costs of what we do. They should be dedicated to measures that will help offset the emissions we are generating, prepare for and mitigate the climate change impacts we know we are causing, and support the research that ultimately will be needed to reduce the impacts and costs of what in all likelihood will be increasing concentrations of carbon in the atmosphere far beyond what our targets call for.

There are legitimate concerns about the inefficient use of earmarked funds. But that calls for vigilance in the manner in which funds are invested so that we do the best we can for the future generations. It doesn’t support the redirection of funds to the present generation at the expense of those who will bear the costs of what we do.

Topics: Climate change & energy policy, Taxes