Carbon Tax Offers Better Option for Reducing Greenhouse Gas Emissions than Imposing Standards

Canadian policy-makers are faced with a slew of options for reducing greenhouse gas emissions. A report published today by The School of Public Policy, written by Jennifer Winter and Trevor Tombe, finds that the most effective approach is to impose a carbon tax on a firm’s energy inputs.

“Policy-makers seeking an approach to lower greenhouse gas emissions, with minimal impact on economic efficiency and productivity, should look no further than the flat tax,” the authors write. The authors refer to the carbon tax as a flat tax because it is neutral across industries and firms. Regardless of where they operate, or what they produce, firms would face the same tax rate on their energy. Firms are incentivized to lower their energy use, and hence emissions, in the most efficient way.

The authors also evaluate the effectiveness of “intensity standards” or limits on emission intensity and their impact on the economy. Essentially, these standards place a ceiling on a firm’s emissions per dollar of output. While these standards can take many forms, they all have something in common: they place different costs on different firms. This distorts firms’ incentives, having the perverse effect of increasing the economic cost of environmental improvements.

The authors find that a carbon tax on energy inputs is more efficient than any form of standard. For example, in comparing a carbon tax to sector-specific standards, the authors calculate that, to achieve the same level of carbon reduction, the carbon costs associated with sector-specific standards are $359 per tonne versus $70 per tonne with a tax.

Winter and Tombe concede that a flat tax on energy is a tough political sell. However, if politicians are unwilling to pursue this route, there is a second-best option that minimizes negative economic effects. This involves a combination of setting intensity standards, allowing firms to pay fines for surpassing these standards, and offering compensatory measures to prevent overburdened firms from shutting down.

This approach “may well be the policy approach they can persuade the public, and industry, to accept,” the authors write.

The report can be found here.