A Canadian Election Primer on the Climate Policy Expert Consensus on Policy Design

George Hoberg
April 29, 2011

Our last post called for using the Canadian election campaign to begin a national conversation on climate policy. That may finally have begun on Thursday, but the early discussion has been very discouraging. As the dramatic surge of the NDP has forced Harper to refocus his attacks away from the Liberals and onto the NDP, the NDP’s cap and trade proposal has been part of his critique. Harper has charged that the NDP cap and trade program will lead to soaring gas prices. Layton has responded by denying that the program will increase the price of gas.

Harper and Layton can only say these things by being disingenuous about their own policies. Harper’s proposals are widely recognized to be economically counterproductive, and inadequate to meet his own emission targets. Layton’s proposals will in fact lead to moderate increases in gas prices, and if they don’t, they won’t be effective.

This exchange reveals the central dilemma of the politics of climate action: We rely on elected politicians to make policy that by necessity increases the costs of some activities and goods. But politicians are loath to be seen to increase costs. The only durable way to escape this dilemma is to have voters accept the necessity of increased costs. Ignoring the climate problem is irresponsible, and an honest discussion of Canada’s choices is long overdue.

I believe there is a broad consensus among climate policy experts on four major points. Politicians who ignore these realities are not being sincere about their commitment to taking meaningful action on climate change. Voters who ignore these realities are not being realistic about what it will take to avoid dangerous climate change.

1. Substantial reductions are needed in greenhouse gases to improve the probability of ensuring a safe climate for future generations. There may be disagreement about the magnitude and appropriate timing of these reductions, but there is widespread consensus that a wholesale change in our energy system is required, and the sooner we start the more effective and efficient we’ll be.

2. There will be costs to these reductions. Any politician who hides from this fact is either insincere about their commitment to meaningful action, or is not being honest. We need a national dialogue to focus on how to design policy to get the most bang for our buck and fairly distribute the burden. These issues are addressed by the next two points.

3. There are a variety of ways to achieve necessary emission reductions that come with different consequences. The economists’ favourite solution is an economy-wide carbon tax. It is widely considered to be the most cost-effective instrument in terms of delivering a given target level of reductions for the lowest possible cost. The alternative market-based policy instrument, economy-wide cap and trade, is also considered cost-effective. The main difference between these two instruments is that cap and trade gives you a fixed quantity of greenhouse gases and allows the price to fluctuate. Carbon taxes do the opposite: they fix the price but allow the quantity to vary.

A third approach is the one proposed by Harper’s Conservatives: regulation of specific facilities. The consensus within the expert climate policy community is that regulation is the least cost-effective of these approaches. If Harper really believes his plan would cost less than the NDP’s, it is because he would be aiming for much smaller emission reductions. For the same level of emission reductions, the NDP cap and trade approach would be considerably less expensive. For the same economic investment, the NDP approach could accomplish greater emission reductions.

We need a national dialogue on which approach is most appropriate for Canada. I suspect when we do so, the outcome may be something of a surprise. Many climate policy experts, including economists, have advocated cap and trade not because they think it is a superior instrument to a carbon tax, but because they believe it will be more politically acceptable. But cap and trade is much more complex to administer, and as we learn more about the political response to cap and trade, the argument for its political advantages over carbon taxes becomes less compelling. In particular, the price certainty of a carbon tax is far preferable to large emitting industries. Once they sense the political inevitability of carbon pricing, they will insist it be through their preferred instrument. When faced with big business advocating a carbon tax, the supporters of cap and trade may happily climb on board.

My sense is that most climate policy experts would be supportive of either a carbon tax or cap and trade, as long as they are effectively designed to cover all significant sources of emissions. It is much more important to get on with greenhouse gas reductions than it is to quibble over the relative superiority of these two instruments. There is strong consensus that these two market-based instruments are far preferable to the source-specific regulatory approach favoured by the Conservatives.

4. Finally, there are ways to design these instruments to address transition and distributional issues. We can’t eliminate the fact that the transition to a low-carbon economy will be costly. But we can, through smart policy design, mitigate many of the concerns about adjusting to these new costs. Most importantly, there is general agreement on the merits of phasing in carbon pricing by starting with small increases and ramping them up over time, giving the economy time to adjust. There are also a range of fiscal instruments that can be used to moderate the income and regional distribution impacts. In Canada, the regional distributional issues are particularly controversial, but there are well-considered mechanisms to address these concerns. We need a national dialogue on the fairest way to share the burden of the imperative of climate action.

Let’s hope our party leaders can acknowledge this general consensus and engage in a more productive dialogue in the remaining days of the campaign. We need to give them the political space to do so by acknowledging that meaningful climate action will come with some costs. And after the election, let’s get busy on the long-overdue national dialogue on climate action.

If you think my summary of these consensus points is inaccurate or incomplete, please comment.

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2 Responses to A Canadian Election Primer on the Climate Policy Expert Consensus on Policy Design

  1. Neil says:

    Two points.

    a. You contradict yourself in point 3 where you imply there is little difference between a fixed or fluctuating carbon price: “There are a variety of ways to achieve necessary emission reductions … carbon taxes … fix the price but allow the quantity to vary.” Carbon taxes may not, therefore, achieve the necessary quantity of emission reductions, if they allow the quantity to vary.

    b. It is not a given that “the price certainty of a carbon tax is far preferable to large emitting industries”. For example, these industries cope with other variable input costs (the oil price for example) by forecasting and hedging. They may assume, for example, $50 a barrel oil and fix that with a swap contract. Carbon is just another commodity that can easily be hedged in the same fashion. The industries that want a fixed price can pay it; those that can take the risk can take it; and you get the lowest-abatement-cost-discovery advantage of the market, as opposed to constant readjustment of a carbon tax by bureaucrats.

    Nevertheless I agree with the thrust of your post that the political simplicity of a tax is very attractive, and the sooner everyone in Canada gets used to counting and avoiding ghg emissions the better.

  2. Alex W says:

    I’m very much with you on the point that it is somewhat heartening to see – very belatedly – some attention being paid to climate change/energy policy issues in the election campaign. More than that, I think we are starting to see (or maybe it’s that echo chamber effect that Twitter really amplifies) some acknowledgement that there are, in fact, some significant differences between how the various parties would do things. Our friend Andrew Leach deserves a lot of credit for carrying the analytical load on this. My only regrets are that this attention comes so late as to make a truly fulsome debate unlikely; and that the tendency is still there to see this as a limited debate about climate or environmental policies, without a clear appreciation or linkage to larger economic and prosperity issues facing the country.

    Turning to your entry, now.

    1. Completely agree with your assessment of the real challenge on “selling” climate policy. I actually have some sympathy for politicians on this issue, insofar as they understand better than anyone the ingrained hypocrisy of Canadians wanting action on climate change, just as long as it doesn’t involve higher costs. In this respect, there is something that needs to be said about ENGOs’ insistence that the real barriers to action are corporate lobbying. First, most corporates are now either in favour or neutral on carbon pricing; and second, if the public support was there to actually accept higher costs, corporate lobbying wouldn’t matter. But that supposed causality, and most ENGOs insistence on making that the issue, let’s us all off the hook.
    2. On the C&T vs. carbon tax issue, a couple of points.
    a. First, it is important to point out that there is a third option (not the regulatory one), which is a hybrid C&T and tax. BC, of course, will be a real-life model of what that actually looks like, but will be able to draw on European experience with that combination. More to the point, though, a hybrid ensures that the issues with coverage and the differing elasticities of various sectors get addressed (for example: a cap-and-trade as most effective to cover large emitters, and a tax to cover transportation).
    b. Second, as one of your online commentators points out, the need for price certainty is for me a bit of a red herring inasmuch as carbon is a commodity or input whose costs can be hedged and managed. Siimilarly, the argument that carbon markets are too volatile has always stuck in my craw. If volatility was a disqualifying feature for a market in anything, none would exist. But somehow, carbon markets are supposed to be rock-steady.
    c. Third (and this is the biggie for me), the inherent weakness of carbon pricing policy is that it is pretty much impossible for governments to really know what the real cost of carbon is, and just how much variation there is across the economy in marginal abatement cost curves. The strength of the C&T and the quantity-based approach is that the trading market provides the price discovery mechanism that allows for that price to be known. The tax, by contrast, has to be set by government will less-than-perfect information. Setting it too low translates into inadequate reductions; and setting it too high means the economy bears a higher cost than it should. C&T allows for that Goldilock-esque “just right”…

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