The Failed Economics of Carbon Taxes

Commentary, Climate, Energy, Poverty, Lee Harding

A leading Canadian economist says the case for carbon taxes is limited and its proponents deliver more rhetoric than reality.

In an interview with this author, Steve Ambler, Economics Professor at the University of Quebec at Montreal gave an excellent economic analysis of one of Canada’s most controversial taxes. He disagrees with a Supreme Court verdict that called the federal scheme merely “carbon pricing.”

“Yes, it’s a tax on the carbon dioxide content of everything that’s produced. It includes the carbon content of inputs into the production process,” Ambler said in an interview with this author.

“Most economists agree that to achieve a given reduction in emissions a carbon tax is the way to go. It taxes an externality and allows private businesses to figure out the most efficient way to reduce emissions.”

It’s true that governments have to get their revenues one way or another, and by some reckonings, the carbon tax might not be the worst.

“An ideal tax system involves taxing things that are demanded inelastically at a higher rate, because it creates less economic distortions,” Ambler explains.

“The demand for energy is probably pretty inelastic, since it’s pretty hard to produce anything without it, which suggests that carbon taxes could actually be efficient from a public economics perspective.”

On the other hand, an inelastic tax means people will pay it grudgingly because they can’t avoid it.

“To the extent that carbon taxes fall more heavily on things that poorer people consume, they’re regressive,” Ambler says.

“An ideal carbon tax would be revenue neutral. Other tax rates would be decreased as the carbon tax is introduced or increased. This means that more distortionary tax rates could actually go down…[but] all other forms of quotas, subsidies, etc., must be eliminated.”

If readers think, “Good luck with that,” their instincts are right. Public choice theory and Canadian experience suggests that won’t happen.

“Once governments get their hands on a new source of revenue, they’re invariably reluctant to loosen their grip on other sources of revenue. So, carbon taxes historically are not revenue neutral and other tax rates haven’t been reduced when they’ve been implemented. The BC carbon tax was reputedly revenue neutral for about a year or so. Then revenue neutrality went out the window.”

Ambler says carbon taxes “make everything more expensive,” something we don’t need in already highly inflationary times. Moreover, federal rebates don’t resolve the distortions carbon taxes cause the economy.

“The idea which the Liberals at one point promised, that a carbon tax would be made revenue neutral by cutting cheques to people, makes no sense. Transfers like carbon tax rebates are, unless they depend on economic decisions, lump sum transfers. This means you’re introducing a new distortionary tax and not reducing more distortionary forms of taxation. So you’re increasing the ‘excess burden’ of the tax system.”

In recent months, the Liberal government has indicated car dealerships will start having electric car sale quotas, an idea already implemented in B.C. Ambler is not a fan.

“Introducing a carbon tax and also imposing that X% of new vehicles sold must be electric makes no sense at all from an efficiency standpoint. Do you think that governments are going to give up announcing special favours to their favourite businesses and projects, many of which allow for cool photo ops? I don’t.”

Like any other tax, one on carbon will hurt Canadian manufacturing.

“If Canada were irrationally to go forward with a plan for net zero, one effect would be to shift production from Canada to other jurisdictions with lower carbon taxes. So going it alone, or even going it with only a subset of the world’s economies on board, makes no sense at all,” Ambler says.

“China and India are perfectly rational to want to develop their economies by using cheap, reliable energy. Border adjustments – slapping tariffs on the carbon content of imported goods – would not compensate completely for this effect.”

The big-picture problem, Amber suggests, is that this tax is ineffective for its purported goal.

“We’re assuming that emissions reduction targets even make sense. But as you know, if Canada were completely wiped off the map tomorrow, the increase in emissions from new Chinese coal plants would compensate for the elimination of Canadian emissions within the space of a few months,” Ambler explained.

“According to the IPCC’s own climate models, if Canada were to go net zero by 2050 it would probably make a difference of about 0.02 degrees Celsius to average world temperatures in 2100.”

Ambler says he is persuaded by Patrick Moore and others that increased carbon emissions has some positive effects also.

“The ‘CO2 greening effect’ is the incontrovertible fact that plants grow better and are more drought-resistant. For plausible estimates of this greening effect, and once again using the IPCC’s own climate models, it’s at least possible that the ‘social cost’ of carbon is negative (i.e. there’s a positive rather than a negative externality). If this is true we should subsidize emissions rather than tax them.”

A reverse carbon tax, anyone?

Lee Harding is a research associate for the Frontier Centre for Public Policy.