choicesVol. 15, no. 11, December 2009 ISSN 0711-0677 www.irpp.org

CanadianFederalism

IRPP

Tracy Snoddonand Randall Wigle

Clearing the Air on Federal and

Provincial ClimateChange Policy in

Canada

F ounded in 1972, the Institute for Research onPublic Policy is an independent, national,nonprofit organization.

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Tracy Snoddon is an associate professor ofeconomics in the School of Business andEconomics at Wilfrid Laurier University. Herresearch focuses on public economics andemphasizes issues relating to fiscal federalism,intergovernmental grants and federal-provincialdimensions of climate policy.

Randall Wigle is a professor of economics in theSchool of Business and Economics at WilfridLaurier University. He has applied computablegeneral equilibrium modelling to a broad rangeof questions in international trade, climate policyand Canadian public policy. A common theme inmuch of this work is the interactions amongenvironmental, trade and taxation policies.

This publication was produced under thedirection of Jeremy Leonard, Research Director,IRPP. The manuscript was copy-edited by JaneBroderick, proofreading was by Mary Williams,production was by Chantal Létourneau, artdirection was by Schumacher Design andprinting was by AGL Graphiques.

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To cite this document:

Snoddon, Tracy, and Randall Wigle. 2009.“Clearing the Air on Federal and Provincial ClimateChange Policy in Canada.” IRPP Choices 15 (11).

The opinions expressed in this paper are those of the authors and do not necessarily reflect the views of IRPP or its Board of Directors.

Contents2 Introduction

3 North American Climate Change Policy: The Status Quo

8 Assessing the Costs of Reducing GHG Emissions

16 Where Do We Go from Here? How Do We GetThere?

20 Conclusions

22 Notes

23 References

25 Résumé

26 Summary

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Introduction

I n Canada the climate change policy environ-ment is currently fragmented. Both the federalgovernment and the provinces are implementing

or proposing their own initiatives, often with littlethought about how they will interact with those ofother governments. While multiple governmentsoperating in the same policy field is not a uniquesituation in Canada, in the case of climate changethis approach can be costly and environmentallyineffective. At the same time, our policies are influ-enced by those south of the border. Just as the USabandonment of Kyoto under the Bush administra-tion in 2001 made it difficult for Canada to adoptmore stringent emissions reduction policies, recentclimate initiatives supported by the Obama adminis-tration make it increasingly unlikely that Canadawill be able to continue with the status quo.

If we are interested in adopting, or are requiredto adopt, a different approach, policy-makers willneed information on the cost and effectiveness ofdifferent options. There have been a number ofstudies assessing the effects of different climatechange policies for Canada, and these have yieldedsome valuable lessons. However, this body ofresearch misses the mark in three important ways.First, most studies ignore the issue of burden shar-ing across provinces. The uneven distribution ofnatural resources and energy-intensive industriesacross provinces makes the issue of burden sharingparamount. Second, most studies ignore policies atthe provincial level and focus instead on Canada-wide policies implemented by the federal govern-ment. But the fact is that Ottawa and the provincesshare responsibility for the environment and joint-ly occupy the carbon revenue base. Provinces can

Clearing the Air onFederal and ProvincialClimate Change Policyin CanadaTracy Snoddon andRandall Wigle

North American Climate ChangePolicy: The Status Quo

I n this section we provide a brief overview of cli-mate change policies at the federal and provinciallevels, as well as discussions of recent develop-

ments in the United States. We highlight the variety ofpolicies in effect or under consideration at both levelsof government as well as the lack of policy integration.

Federal policiesIn 2007 the federal government announced its Turningthe Corner plan (Government of Canada 2007).1 Theplan promised a 20 percent reduction in emissionsbelow 2006 levels by 2020, mandatory emissions-intensity reduction targets for major industrial emitters,energy and fuel efficiency standards, air pollutionmeasures, and a final regulatory framework by January2010. With 2006 emissions estimated at 721 mega-tonnes CO2 equivalent (hereinafter denoted as Mt CO2e)and 2020 emissions forecast at 897 Mt CO2e, the federalgovernment’s goal requires an annual reduction inemissions of 320 Mt by 2020.2

The proposed mandatory emissions-intensity reduc-tion scheme, referred to as a baseline and credit system,covers the following sectors: electricity generation,pulp and paper, cement, oil and gas, and iron and steel.Baseline emissions intensities were set at 2006 levels,and proposed intensity-reduction targets require cov-ered entities to reduce the rate at which they emitgreenhouse gases (GHG) per unit of output below thesebaseline intensities. These targets are less stringent thanabsolute emissions caps, because it is possible in prac-tice to satisfy emissions-intensity targets, even asaggregate emissions are growing. Intensity targets arethus no guarantee of absolute reductions in greenhousegas emissions (see table 1 for a hypothetical example).

Consider the following illustration. The baselineemissions intensity for the fossil fuel industry for 2006is 3.84 (measured in kilograms of CO2e per constantdollar of sector GDP) (Environment Canada 2008a, 7,table 1). The federal government’s proposal requires an18 percent reduction in intensity from 2006 levels by2010 for covered sectors. Assuming the target is appliedto the sector’s average emissions intensity, firms mustachieve an intensity of 3.15 by 2010. As illustrated bythe hypothetical data presented in table 1, the sectorcan achieve the target while aggregate emissionsincrease. This possibility makes the achievement ofemissions-reduction goals more uncertain.

and do implement their own climate change poli-cies, but little is known about how these interactwith federal initiatives. Finally, since joint occu-pancy and provincial policies are ignored, existingwork offers little insight on how we might realisti-cally move from the current patchwork approachto a more cost-effective greenhouse gas (GHG)reduction policy.

The key objective of this paper is to focus attentionon regional burden sharing, joint occupancy and tran-sitional arrangements as the critical obstacles to beaddressed if we are to move climate change policy for-ward. If we fail to remove these obstacles, the statusquo environment is likely to continue for some time.

We begin with an overview of the current policyenvironment, assessing developments at the federaland provincial levels as well as in the United States.The literature offers several valuable lessons aboutclimate change policy. We review these, focusing onsuch matters as cost-effectiveness, revenue recycling,sectoral effects and issues of competitiveness. We alsodraw attention to important issues that have notreceived much attention, such as the interaction offederal and provincial policies. In the fourth sectionwe propose an alternative climate change approachfor Canada. The final section presents some conclud-ing remarks.

Our proposal argues for the implementation of aCanada-wide carbon tax to reduce emissions. In thisregard, it is not novel. The value-added of our pro-posal is that it attempts to address the frictionsbetween the federal and provincial governments thathave to date stymied effective policy. Our proposedregime would achieve real reductions and could overtime be fully integrated with whatever policy isdecided upon in the United States.

Revenue sharing is at the centre of our proposal,not so much as a mechanism for reducing other taxes(although that remains a possibility) as a kind oflubricant to ease the economic and political cost ofimplementing climate change policies and to over-come federal and provincial resistance. We argue thatthe federal government needs to retain a share of therevenues in order to reduce the political costs ofimposing the tax. Provinces need a share, too; other-wise they will have no incentive to abandon theirown climate change policies in favour of a morecost-effective national system.

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investment in emissions-reducing technology. Thefederal proposal set limits on how much of a firm’starget can be satisfied using fund contributions, butthese were set high for the first five years. For 2010,the federal proposal allowed a firm to satisfy up to 70percent of its target using fund contributions. By2015, fund contributions can account for no morethan 40 percent of the target.

The technology fund option effectively caps theprice of tradable permits at $15/tonne. If the price fora one-tonne emissions credit is $20, a firm can opt tosatisfy its target by making a fund contribution at$15/tonne rather than pay the higher credit price.Since a significant share of a firm’s target can beachieved in this manner, permit trading will be limitedand slow to develop. Moreover, the technology fundinvestments will take time to bear fruit with regard toemissions reduction, so few actual emissions reduc-tions will be achieved in the first few years of opera-tion from these compliance mechanisms.

Finally, firms may use the Kyoto CleanDevelopment Mechanism (CDM). The CDM is intend-ed to allow high-income countries with KyotoProtocol targets to generate credits by funding emis-sions-reducing projects in developing countries. Themotivation for the CDM is that both recipient andfunding countries can benefit from the projects. Therecipient will benefit from energy-saving or emis-sions-reduction projects, and the associated economicactivity, whereas the funder can often reduce emis-sions more cheaply in the recipient country than athome. Emissions reductions in the recipient andfunding countries are identical in terms of theirimpact on climate. The federal proposal allowsCanadian firms to use CDM credits to satisfy up to 10percent of their target.

A number of climate plans preceded the Turningthe Corner plan. Action Plan 2000 was followed in2002 by the Climate Change Plan for Canada, and in2005 Project Green was released (Government ofCanada 1998, 2002a,b, 2005). All proposals includedsome mix of regulatory measures, subsidies, a domes-tic emissions-trading scheme (limited in coverage andof the baseline and credit type) and voluntary meas-ures. Rivers (forthcoming) provides a useful compari-son of the various federal commitments, reductiontargets and actual emissions.

With the election of Barack Obama as president ofthe United States in 2008, climate change is nowsolidly on the US agenda. As a result, the Canadiangovernment is being forced to rethink its approach.

The federal proposal outlines five avenues formeeting the intensity-reduction targets: abatement,emissions trading, contributions to a technologyfund, offsets and the Kyoto Clean DevelopmentMechanism.

Covered entities can undertake in-house abatementactivities. If the rate of emissions per unit of outputfalls below the required intensity target, then the firmreceives credits. Credits can be either sold to firmswith higher-than-target emissions intensities orbanked for future use. Suppose a firm in the fossilfuel sector (see table 1) reduces its emissions intensitybelow the required rate, to 3.12. This firm would thenreceive credits equal to 0.03, the difference between3.15 and 3.12 multiplied by its output for that year.

Emissions trading allows firms with low costs ofabatement to generate credits by reducing theirintensity below the assigned target. Firms with costlyabatement options may find it cheaper to buy creditsthan to pursue in-house abatement activities. Thetrading price for credits would be determined bydemand and supply in the emissions-trading market.

Offsets or contributions to a technology fund arealternative ways of complying with regulations forreducing emissions intensity. Offsets are allowancesgranted to parties for emissions reductions achievedoutside of the covered sectors. An example would be afarmer who changes his or her farming practices toincrease carbon uptake in the soil. Covered emittersmay purchase these offsets and apply them againsttheir own reduction targets. One difficulty of this sys-tem is the determination of whether emissions reduc-tions credited with offsets are in fact incremental. Ifthe emissions reductions are not incremental (that is,they would have occurred anyway), then the offsets donot contribute toward the goal of reduced emissions.

Firms may alternatively satisfy part of their reduc-tion target by contributing to a technology fund at aprice of $15/tonne of CO2e. Funds are intended for

Table 1Hypothetical Example: Federal Government’sBaseline and Credit System, Fossil Fuel Sector,2006 and 2010

Emissions intensityEmissions Sectoral GDP (kilograms of CO2e(megatonnes (billions of 1997 per dollar ofof CO2e) dollars) sectoral GDP)

2006 158 41.1 3.842010 160 50.8 3.15

Source: Authors’ calculations based on Environment Canada (2008a), table 1.

observation from table 2 is that provincial emissionstargets differ in terms of the base year chosen and thetime frame for achieving the target. Deeper targets andsmaller time frames call for more stringent policyinstruments if the required emissions reductions are tobe achieved.

A second observation is that provinces can begrouped according to whether they include some formof carbon pricing in their plan. Emissions-permit-trading schemes and carbon taxes are market-basedapproaches that put a price on emissions.3 Contributionsto a special fund at a set price per tonne of CO2e alsoput a price on emissions.

Currently, carbon taxes are levied in two provinces.Quebec introduced the Green Fund duty in its June2006 climate plan. The tax varies by fuel, ranging from

Recent media reports have outlined possible changesto its strategy, including plans to harmonize reduc-tion targets, harmonize the implementation timetable,delay the introduction of targets and match US vehi-cle emissions standards (see, for example, Galloway2009; Laghi and McCarthy 2009).

Provincial policiesIn Canada the federal government and the provincesnot only share responsibility for the environment butalso share the carbon tax base. So it is perhaps notsurprising to see provinces introducing their own cli-mate initiatives.

Table 2 provides an overview of emissions-reduc-tion targets and selected measures by province, asspecified in various government documents. The first

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Table 2Emissions Reduction Targets and Selected Measures Planned, by Province

Emissions targetlevel By Measures planned

Federal 20% below 2006 or 2020 Baseline and credit system with emissions intensity targets; fuel and energy efficiency≈3% below 1990 standards; Technology Fund contributions at $15/tonne of CO2e

British Columbia 33% below 2007 or 2020 Carbon tax; revenues used to fund income tax cuts; cash incentives for making energy-≈15% below 1990 efficient choices (i.e., home heating and fuel-efficient cars), various efficiency

standards; Innovative Clean Energy Fund; Western Climate Initiative (WCI) member

Alberta 50 Mt 2020 Carbon capture and storage technology; baseline and credit system; emissions intensity14% below 2005 or 2050 targets for large emitters; Climate Change and Emissions Management Fund≈2.5% above 1990 contributions at $15/tonne of CO2e

Saskatchewan 20% below 2006 or 2020 Saskatchewan Technology Fund administers carbon compliance payments from large≈31% above 1990 emitters; Climate Change Foundation promotes research and development of low-

carbon technology, adaptation, education; WCI observer

Manitoba 6% below 1990 2012 Tax on coal emissions, starting at $10/tonne in July 2011; aims to become coal- free by 2012 as the last plant phases out; WCI observer

Ontario 15% below 1990 2020 Phase-out of coal-fired power plants by 2014; rebates for energy audits, tax breaks forenergy efficient products; MoveOntario transit plan; WCI member

Quebec 20% below 1990 2020 Carbon tax; revenues allocated to Green Fund; WCI member; Regional Greenhouse Gas Initiative (RGGI) observer; sales tax rebate on hybrids; vehicle emissions standards for vehicles; energy efficiency measures for public buildings

Nova Scotia1 10% below 1990 2020 Caps on emissions from electricity generation; vehicle incentives for consumers; renewable energy standard; RGGI observer, signatory to Conference of the New England Governors and Eastern Canadian Premiers (NEG-ECP) Climate Action Plan (2001)

New Brunswick1 10% below 1990 2020 Energy efficiency measures; RGGI observer; increase in electricity from renewables (10% by 2016)

Prince Edward Island1 10% below 1990 2020 RGGI observer; energy efficiency and vehicle emissions standards; tax/rebate incentives for consumers

Newfoundland 10% below 1990 2020 RGGI observer; 2015 emissions reduction target for electricity from Holyrood and Labrador1 Generating Station; target for electricity generated by renewable energy

Source: Federal and provincial climate change plan documents for 2007, 2008 and 2009.1 Targets for Prince Edward Island, Nova Scotia, New Brunswick, and Newfoundland and Labrador as agreed upon at the Conference of the New England Governors andEastern Canadian Premiers in 2001.

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alternatives. A preliminary report indicates that areduction of 6.5 Mt was achieved.4 This representsabout 32.5 percent of the reduction target for 2010 of20 Mt outlined by the Government of Alberta (2008).

As for the remainder of the provinces, their plansare heavily focused on energy and fuel efficiencystandards; a variety of narrowly targeted measures,including tax rebates for the purchase of fuel-efficient hybrid vehicles; subsidies for energy-savingor carbon-free technologies; and public awarenessprograms to encourage Canadians to adopt environ-ment-friendly habits in their daily lives.

US developments and pressuresIn March 2009 Henry Waxman and Edward Markey(Democratic congressmen from California andMassachusetts, respectively) introduced the AmericanClean Energy and Security Act into Congress. While thepassage of the Waxman-Markey Bill in its current formis far from assured (it has yet to be passed in theSenate), its proposals on greenhouse gas emissions sug-gest the general direction of US policy for the nextdecade. The Bill proposes an emissions-reduction targetof 20 percent below 2005 levels by 2020 on coveredsectors, which is projected to yield an economy-widereduction of approximately 17 percent. The planincludes a hard cap on emissions in covered sectors, ini-tially comprising the electricity sector, refiners, and theprimary oil and gas sectors, with permit trading allowedamong participants. The coverage of the scheme will beextended as time passes, so that eventually 85 percentof emissions will be covered. The Waxman-Markey Billincludes a number of measures intended to ease the bur-den in energy-intensive and trade-sensitive sectors. Thisincludes output-based allocation of permits, as well asthe possibility of GHG-based border adjustments forgoods produced in countries without “similar” climatechange policies. These measures are intended to addresscompetitiveness concerns.5

Although the Waxman-Markey Bill proposes theeventual auctioning of most permits, in the earlystages little revenue will be generated. A significantshare of permits will be given free to the electricitysector to minimize cost increases for electricity. Otherpermits will be distributed to the heating oil and natu-ral gas sectors and are to be used to reduce the impacton consumers. While the plan is to eventually switchto auctioning for most permits, even if the specifics ofthe Bill do not change there is ample scope for them tochange before the Bill is adopted. Currently, the switchto auctioning is intended to take place after 2030.

a low of about 0.5 cents per litre of propane to$8/tonne of coal. Quebec has earmarked revenues forits Green Fund (a technology fund). British Columbiaimposed a carbon tax of $10/tonne in 2008, which isslated to increase gradually to $30/tonne in 2012.Unlike Quebec, British Columbia has adopted a 100percent tax recycling option, using the carbon rev-enues to fund personal and business income-tax ratecuts. Manitoba recently introduced a plan that wouldimpose a tax on emissions from coal productionstarting in July 2011.

A tradable emissions permit scheme is anotherapproach to the pricing of carbon. The WesternClimate Initiative (WCI) (which consists of BritishColumbia, Manitoba, Ontario and Quebec, along withseven US states) hopes to launch a market-based cap-and-trade system covering some 90 percent of emis-sions in the member provinces and states by 2015(WCI 2009). British Columbia’s Greenhouse GasReduction (Cap and Trade) Act was introduced to pavethe way for integration of a BC cap-and-trade systemwith the cap-and-trade systems of its regional part-ners (like the WCI). In 2008 Quebec and Ontariosigned a deal to launch the Provincial and TerritorialGreenhouse Gas Cap and Trade Agreement. Ontariorecently released a discussion paper to generate com-ment on design and implementation issues (Ministryof the Environment 2009). Finally, several provincesare observers to the Regional Greenhouse GasInitiative (RGGI), a consortium of 10 US mid-Atlanticstates that propose to restrict the emissions of theirelectricity sectors using a cap-and-trade system.

Most of the cap-and-trade proposals, which arestill under development, involve some auctioning ofpermits. A key component of any trading proposal ishow it will be integrated with other trading regimes.The integration question is, however, a subject ofongoing research and debate.

Alberta and Saskatchewan have instead opted fora baseline and credit approach similar to the federalplan. While Saskatchewan’s plan has not yet beenimplemented, Alberta’s baseline and credit systemwas launched in 2007, with 2008 as the first year ofcompliance. Under the plan, large emitters (over100,000 tonnes) were required to reduce emissionsintensity by 12 percent in 2008. Emitters can alsocomply by purchasing Alberta offsets or by makingcontributions to an Alberta fund at a price of$15/tonne. Fund revenues are to be recycled back toindustry to be used in the development of clean tech-nologies or to help firms adopt cleaner production

Evaluation of Current Climate Change Policy inCanadaAccording to Environment Canada (2008a), Canada’saggregate 2006 emissions were 22 percent higher thanits 1990 emissions. Figure 1 shows Canada’s emissionsbroken down by province for 1990 and 2006. It alsoshows a “Kyoto” target for each province. Significantgrowth in emissions in Alberta and Saskatchewan, andto a lesser extent in Ontario and British Columbia, hascontributed to the overall growth in Canada’s aggregateemissions.

The future emissions reduction costs implied in fed-eral government documents are much lower than thoseof outside experts. The government’s Turning theCorner announcement of $1.5 billion for the Clean Airand Climate Change Trust Fund, with an associated 80Mt (16 Mt annually from 2008 to 2012) in reductions,implies a cost per tonne of just under $20(Environment Canada 2008b). A recent report byCanada’s Commissioner of the Environment andSustainable Development criticizes these estimates,stating that the government’s analysis of emissionsreductions attributable to the trust fund is flawed andunverifiable (see Auditor General of Canada 2008, 17).The Commissioner also argues that the government’sproposed regulatory framework, developed as part ofthe Turning the Corner plan, overestimates the expectedemissions reductions and lacks transparency (AuditorGeneral of Canada 2009, 58-66).

The Bill also allows offsets, although it remains tobe seen how restrictive the rules will be for grantingthem. The more offsets are allowed against a fixed cap,the lower will be the emissions reduction achieved incovered sectors. A possible response mechanism forvery high or very low permit prices is also under dis-cussion. Initially it was expected that the CO2e permitprice would not be allowed to fall below approximate-ly $25, but recent simulations of the plan suggest thatthe actual permit price would likely be closer to $15.The Bill proposes a number of subsidies and incentivesaimed at various technologies; however, the details arelikely to change before the Bill is adopted.6

One key element of the Waxman-Markey Bill isits stated intention to subsume initiatives at thestate or regional levels. In other words, the federalcap-and-trade scheme would, in time, replace theschemes independently developed by states —including, notably, regional initiatives like theWestern Climate Initiative. At this stage there seemsto be ample goodwill on all sides in terms of effect-ing this transition, but the mechanics and conflictsof doing so remain daunting, even with the pro-posed 2012–17 time frame.

The Bill includes modest emissions targets startingin 2012. The harmonization of state and regional cap-and-trade schemes into a single system is intended totake place in the period 2012–17. Special transitionmeasures designed to support and ease the transitionto a lower-carbon economy are to be phased out by2020. If this timetable is not followed and the transi-tion period and/or measures are extended, the scopefor uncertainty will increase and the uncertainty willspill over into Canada.

As mentioned, in the early stages the bulk of USpermits would be given away gratis. The same is truein the Canadian federal proposal (with the exception oftechnology fund contributions). In both cases, the bulkof the limited revenues generated (by the limited auc-tioning of permits in the United States, or in Canada’scase by technology fund contributions) are earmarkedfor the easing of the transition to a lower-carboneconomy. Consequently, the scope for mitigating theimpact of carbon policy through personal or corporateincome tax cuts is negligible in the near term.

The proposed US Bill has generated a great deal ofinterest in Canada, mainly because of key differencesin the proposed emissions-trading regimes and in thestringency of the emissions-reduction targets — andthe bilateral trade issues that may result.

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0 50 100 150 200 250 300

Kyoto target (6% below 1990 level)20061990

British Columbia

Alberta

Saskatchewan

Manitoba

Ontario

Quebec

New Brunswick

Nova Scotia

Prince Edward Island

Newfoundlandand Labrador

Emissions (Mt CO2e)

Figure 1Provincial Greenhouse Gas Emissions, 1990 and2006, and Kyoto Equivalent Targets

Source: Environment Canada (2008a).

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mate change policies. Along with these barriers, wereview some of the key lessons from the literature.Finally, we draw attention to some important barriersto the further development of climate policy in Canadafor which the literature offers few lessons. Theseinclude issues arising from the joint occupancy of thecarbon revenue base, the shared responsibility for theenvironment and transitional adjustment issues.

Aggregate welfare costUnder what conditions are the costs of achieving agiven reduction in emissions minimized?

The accumulation of GHG and rising surface tem-peratures can trigger, and increase the frequency of,extreme weather events, all of which have seriousnegative consequences for the economy. In monetaryterms, these consequences are referred to as damages.While damage depends on the total stock of gases,the additional damage from one more tonne of GHGemitted (the marginal damage cost) is the sameregardless of where it is emitted. However, the costsof reducing emissions depend very much on wherereductions occur.

For a cost-effective reduction in emissions, the totalcost of abatement must be minimized. This is achievedif, at the target level of emissions, the marginal cost ofabatement is the same across all emissions sources. Theacademic literature is heavily focused on two market-based instruments that are promising in this regard: acarbon tax and a cap-and-trade permit system. Otherauthors have emphasized the importance of market-based instruments. For instance, the main message ofthe popular 2007 book Hot Air, by Mark Jaccard,Jeffrey Simpson and Nic Rivers, is that effective climatepolicy must include a price on carbon.

These instruments work by imposing a monetarycost on emissions. Suppose a carbon tax of $10/tonneof CO2e is applied to all emissions. If firms do notreduce their emissions, they pay $10/tonne emitted.Firms that are able to reduce emissions at a lowercost than the tax thus have an incentive to do this,and will continue to reduce emissions until the addi-tional cost of doing so equals the $10 tax. At thispoint, there is no further incentive to reduce emis-sions, as the additional cost would exceed the tax.

A cap-and-trade permit system creates a market(and a price) for emissions. Suppose a permit isrequired for each tonne of emissions. As long as thenumber of permits available for the year is lowerthan current emissions, aggregate emissions will fall.This is true regardless of how permits are distributed

In contrast, using federal estimates of emissionsreductions actually achieved and federal expendituresto date, Wigle (2005) finds a cost per tonne of around$200. He argues that this high cost can be attributedto the federal government’s heavy reliance on select-ed technology subsidies and voluntary measuresrather than on carbon pricing. Considering thatCanada’s emissions are roughly 200 Mt above theKyoto target, a quick calculation suggests that thecost of using this approach is in the neighbourhoodof $40 billion in today’s dollar terms. These estimatessuggest that the emissions reductions achieved so farin Canada have been small and very costly.

Since most provincial plans set goals more than 10years into the future and are relatively new, it is tooearly to tell whether existing measures will in factachieve stated emissions-reduction targets. However,there have been several “stock-taking exercises” ofprovincial and federal climate change policies. Recentstudies include Jaccard (2006), Jaccard and Rivers(2007), Demerse and Bramley (2008), Council of theFederation (2007) and Marshall (2008).

Key findings from these studies are that Canadahas so far relied heavily on measures that are not par-ticularly cost-effective or environmentally effective.In particular, there is little evidence to suggest thatvoluntary and education measures are effective waysof lowering emissions. Carbon pricing is frequentlyproposed in this literature, as it provides clear incen-tives for reducing emissions, but it is not yet a promi-nent feature in most federal and provincial plans. Andexisting measures, such as contributions to technolo-gy funds and provincial carbon taxes, set a low priceon emissions. These studies highlight the lack of coor-dination between provincial and federal policies andthe weak leadership of programs introduced at thefederal level. Finally, the literature calls for betterattempts to measure actual emissions reductions, trackprogress and measure success, since plans do not nec-essarily translate into real reductions.

Assessing the Costs of ReducingGHG Emissions

B efore going into the details of our proposal, wediscuss some key barriers that are at the heartof the debate in Canada. These barriers include

the aggregate welfare costs, sectoral costs, regionaleffects and competitiveness issues associated with cli-

range of 1 to 2 percent relative to business as usual (BAU)(see, for example, Ab Iorwerth et al. 2000; Wigle 2001;Dissou, MacLeod, and Souissi 2002).8 This amounts toroughly $500 to $1,000 in terms of current per-personGDP per year. Studies also show that more narrowly tar-geted instruments entail greater welfare costs.

Snoddon and Wigle (2007b) find that the welfare costof achieving a Kyoto target is 0.59 percent if Canada par-ticipates in an international permit market (which coversall emissions), as compared to a cost of 1.91 percent ifCanada achieves all of its target by reducing domesticemissions using a domestic carbon tax (or a cap-and-trade system). For a domestic cap-and-trade system,Wigle (2001) finds that the more narrowly targeted theregime, the more welfare costs rise. When all domesticemissions are covered, the welfare cost of achieving aKyoto target is 1.1 percent relative to BAU. Narrowingthe coverage to include first the more energy-intensiveand then only the most energy-intensive sectors increasesthe welfare cost from 1.3 to 2.0 percent. Finally, if onlythe most energy-intensive sectors are exempt, the welfarecost increases significantly, to 7.5 percent.

Policies implemented by subnational governmentswill generally, if uncoordinated, increase the costs ofreducing emissions. Research confirms that uncoordi-nated actions result in variations in the carbon price

(that is, based on historical emissions, based on cur-rent output or auctioned).

Firms with low abatement cost opportunities havean incentive to undertake these activities. If they suc-ceed in reducing emissions below their initialallowance, they can sell the surplus permits to firmsthat find it cheaper to purchase permits than to under-take in-house abatement activities. Market forcesdetermine the price at which permits are traded.

Assuming all sources of emissions are covered bythe tax or the permit system, emitters face the sameemissions price and the same incentive to abate.This ensures that emissions reductions are achievedin a cost-effective manner. If all sources are notincluded and the carbon price differs by emissionssource, the costs of achieving a given reduction tar-get will increase. For a permit regime, the broaderthe coverage (that is, the larger the fraction of totalemissions covered in the system), the closer the sys-tem comes to the lowest cost solution.

Both instruments have a direct effect on produc-tion costs and on the prices of energy-intensivegoods. These price changes ripple through the econo-my, leading to changes in the prices of other goodsand services, wages and the cost of capital. Since cli-mate change policy has the potential to affect manyprices in many sectors and regions, computable gen-eral equilibrium (CGE) models of the economy areoften used to assess the aggregate cost of emissionsreductions. These simulation models, representing theeconomy as a series of interrelated demand-and-supply relationships for goods and services and fac-tors of production, examine the overall effect of thesepolicy-induced price changes on sectoral and aggre-gate economic activity, aggregate and sectoral emis-sions, and households.

While some analyses focus on GDP effects, oth-ers focus on how policies affect welfare (see box 1for the specifics of welfare analysis and the CGEapproach). Changes in output (and the income gen-erated by them) that result from climate changepolicy are captured by the GDP measure. However,climate change policy may also affect labour supplyand the consumption of leisure (if labour supply isvariable). The welfare measure can differ from theGDP effects because the income effects of thesechanges in leisure are included in the welfare meas-ure. If labour supply is fixed, then GDP and welfaremeasures are identical.7

Research for Canada indicates that significant emis-sions reductions will be costly, with GDP losses in the

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Box 1Welfare Analysis and the CGE Approach

CGE overviewA computable general equilibrium (CGE) model repre-sents the economy in terms of interrelated demand-and-supply relationships for both goods and primaryfactors of production (see Wigle 2001 for a moredetailed but intuitive overview). A business-as-usualscenario is generated using baseline data and forecastsfor GDP and emissions. Climate policy — for example, acarbon tax — is modelled as an increase in the cost ofgoods. The extent to which the cost increases dependson the carbon content of the good. As the price effectsripple through the economy, production of goods isaffected. The change in productive activity in the econ-omy resulting from climate policy is measured as a per-centage change in GDP relative to the baseline, orbusiness-as-usual (BAU), scenario.

Welfare analysisLet us determine a household’s real income in the BAUcase, where real income includes factor income likewages and dividends, government transfers and netforeign income. Welfare changes resulting fromclimate-policy-induced changes in productive activityare calculated as the percentage change in real incomerelative to BAU.

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emissions. By contrast, sales tax reductions havecomparatively little impact on investment.Consequently, the distortionary costs of sales taxestend to be lower than those for corporate incometaxes. If the tax proceeds are used to lower the taxeswith larger distortionary effects — corporate incometaxes in particular — then these distortions arereduced and the overall welfare losses from reducingemissions are smaller.

The choice of whether to auction permits orfreely distribute them affects the aggregate costs,since free distribution generates no revenues withwhich to lower distorting tax rates. Dissou (2006)illustrates this point using a CGE model for Canada.Emissions reductions achieved using a permit sys-tem with full auctioning and revenue recycling toreduce payroll taxes causes aggregate welfare to fallby 1.3 percent relative to BAU. In contrast, whenpermits are freely distributed based on a firm’s cur-rent output or historical emissions, welfare lossesrange from 2.1 to 2.9 percent.

Key lessons: A uniform incentive to abate for allemissions will ensure that emissions reductions areachieved at minimal cost; the greater the variation inthe incentive to abate, the higher the costs. Use of arevenue-generating instrument can potentially lowerthe aggregate welfare costs associated with reducingemissions if revenues are recycled to reduce distort-ing tax rates.

Sectoral effectsEmissions reductions will affect sectors differently,depending on how energy intensive they are. Sectoralimpacts are one of the key issues in the debate onhow emissions-trading regimes should be designed.

Wigle (2001) examines the sectoral impacts (meas-ured by changes in output relative to BAU) of using adomestic or international permit scheme. When theKyoto target is achieved entirely through domesticemissions reductions, fossil-based electricity suffersthe greatest change in production, -21 percent rela-tive to BAU. Other hard-hit sectors are coal, petrole-um and coal products, chemicals, resins and plastics,and natural gas, which undergo production changesin the range of -7 to -10 percent. For most other sec-tors, production changes are more modest, rangingfrom -3 to 3 percent. If international permit trading isallowed, the impacts are muted, falling in the rangeof approximately -3 to 3 percent.

Dissou (2006) shows that the choice of how per-mits are distributed in a domestic trading regime can

(and therefore the incentive to abate). Conrad andSchmidt (1998) look at the costs of achieving a 10percent reduction in emissions in one year for 11European Union countries, comparing an EU-widecarbon tax with a system whereby each country setsits own carbon tax. Tax rates are shown to vary con-siderably in the uncoordinated case, contributing togreater welfare losses. Similarly, the NationalRoundtable on the Environment and the Economy(2009b) reports that the carbon price is likely to besignificantly lower if a Canada-wide carbon-pricingpolicy is adopted than if individual provinces act ontheir own to reduce emissions.

We know that uncoordinated action gives rise tocarbon prices that differ across emissions sources; thecosts of achieving a given reduction target could belowered if the carbon price was uniform. We do notknow just how costly uncoordinated action might beor what cost savings might result from eliminatingdifferences in the incentive to abate across emissionssources. We return to this point below.

Welfare or GDP losses are sensitive to how rev-enues from a carbon tax or auctioned permits areused. Most taxes, such as personal and corporateincome taxes, are distortionary. Efficiency gains dueto a lowering of distorting taxes can partially offsetthe welfare losses associated with the imposition of acarbon tax or a permit regime.

The effects of tax recycling are nicely illustrated ina study by the National Roundtable on theEnvironment and the Economy (2009a). This studyevaluates the effects of achieving two emissions-reduction targets (20 percent below 2006 levels by2020 and 65 percent below 2006 levels by 2050)using a Canada-wide cap-and-trade permit systemwith full auctioning. By 2020, revenue recycling via areduction in sales taxes leads to a small, 0.9 percent,increase in welfare relative to BAU. Recycling viacorporate income and labour/payroll taxes leads tochanges in welfare relative to BAU of -0.8 percentand -0.2 percent, respectively. In the long run (2050),however, welfare losses with sales tax recycling aremuch higher, at 4.4 percent, when compared to wel-fare costs of 2.0 and 3.2 percent with corporate andlabour/payroll tax recycling, respectively.

Differences in the welfare costs associated withalternative tax recycling options relate partly to howtax cuts influence capital investment. Corporateincome tax cuts serve to lower business costs andstimulate capital investment and growth, which helpto counteract the higher costs associated with pricing

ing from -3.9 percent for Prince Edward Island to +1.5percent for Alberta. The carbon tax needed to ensurethat domestic emissions reductions hit the target is$153/tonne of CO2e.

While Prince Edward Island is still the hardest-hitprovince, both Alberta and Saskatchewan actuallyexperience welfare gains. This is largely because car-bon tax revenues are returned to provinces in propor-tion to their initial emissions, illustrating that theburden need not predominantly fall on energy-intensive provinces.9

PEI is an outlier because even though its own emis-sions are small, it is a huge net importer of carbon-intensive products. So other provinces receive thecarbon tax revenues, but the extra cost of these carbon-intensive imports increases the economic burden on PEI.Thus, it has little opportunity to abate and little to gainfrom trading in abatement services.

Alternative tax recycling options would, however,generate different results. If carbon tax revenueswere instead used to lower federal personal incometaxes, it is likely that Ontario (the source of over 40percent of federal income tax revenues) would farebetter than it would if revenues were returned inproportion to initial emissions. In contrast,Saskatchewan and Alberta, which contribute smallershares to federal income tax revenues than to aggre-gate emissions, would not fare as well under thisscenario.

ease the burden of energy-intensive sectors but at asomewhat higher aggregate welfare cost. Three allo-cation schemes are considered: full auctioning of per-mits with tax recycling, free distribution based onfirms’ current output levels and free allocation basedon firms’ historical emissions levels. The aggregatewelfare costs are 1.3, 2.1 and 2.9 percent for full auc-tioning, output-based allocation and historical emis-sions-based allocation, respectively. Output effectsare most uneven, and most severe, for the auctionedpermit scenario. In the coal and gas pipeline sectors,output falls by 26 and 21.5 percent, respectively, inthe auctioned permit scenario. If permits are freelydistributed based on output, output falls by 22 and 18percent in coal and gas pipelines, respectively.

Key lessons: sectoral effects can be very uneven;policies can be modified to address uneven burdensharing; and modifications will involve a trade-off —a more even sharing of the burden across sectors buta higher aggregate welfare cost.

Regional effectsThe regional burden is a significant factor in theimplementation of climate change policies. This isespecially true for Canada because its distribution offossil fuels, energy-intensive sectors and emissions isgeographically concentrated. The welfare burden maybe particularly acute for Alberta and Saskatchewangiven their disproportionate shares of emissions rela-tive to population (see figure 2).

While almost all CGE analyses for Canada focuson the aggregate welfare or GDP effects of climatechange policies and ignore how the burden is sharedacross provinces, a few studies concentrate onregional burdens. Snoddon and Wigle (2007b) consid-er the aggregate and provincial welfare and emissionseffects of achieving Canada’s Kyoto target usingeither a federally implemented carbon tax or interna-tional permits.

The carbon tax experiment results in an aggregatewelfare loss of 1.9 percent, as compared to a loss ofjust 0.6 percent in the case of international permittrading. The burden is fairly evenly distributed acrossprovinces when international permit trading is used,with welfare changes ranging from -0.2 percent forNewfoundland and Labrador to -1.3 percent for PrinceEdward Island. In fact, excluding Prince EdwardIsland (which appears to be an outlier), the largestwelfare loss is 0.7 percent for Ontario.

Provincial welfare changes are significantly moreuneven in the domestic carbon tax experiment, rang-

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Newfoundlandand Labrador

Prince Edward Island

Nova Scotia

New Brunswick

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0 5 10 15 20 25 30 35 40 45

Share of populationShare of emissions

Figure 2Provincial Shares of Canada’s Emissions andPopulation, 2006 (Percent)

Source: Statistics Canada, Cansim II table 051-0001; Environment Canada(2008a).

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partially explains the comparatively small losses inOntario. Although the Bramley, Sadik and Marshallreport (2009) claims to represent federal and provincialclimate change policies, this is really not the case. Itsapproach, like most in the literature, assumes a nation-al-level government to implement the Canada-wide car-bon tax (or auctioned permit system), along with theother complementary policies. The underlying CGEmodel assumes a single national government to imple-ment policies and distribute all carbon-pricing revenues.

Key lessons: provincial burdens can be quiteuneven, even if aggregate costs are low; the distri-bution of carbon revenues can influence regionalburdens in the same way that the unevenness insectoral burdens depends on how initial emissionspermits are allocated; complementary policies alsoplay a role.

Competitiveness concernsAs noted above, carbon-pricing policies increasebusiness costs. Canadian firms, competing in interna-tional markets with businesses that do not face simi-lar cost increases, are at a disadvantage. The moreinternationally competitive the market, the more con-strained the ability of Canadian firms to raise pricesin response to increased costs.

Competitiveness was a serious concern when theUS government abandoned the Kyoto Protocol in2001. Klepper and Peterson (2002) discuss the effectsof US withdrawal on the functioning of an interna-tional permit market, permit prices and the benefitsfrom emissions reductions. Canada, in particular,was concerned about the withdrawal of its majortrading partner. If Canada were to take seriousaction to reduce emissions and the United States didnot, there could be serious implications forCanadian competitiveness and trade vis-à-vis itssouthern neighbour.

Harrison (2007) notes that the costs of divergencewould be felt particularly by Canadian manufactur-ing, foreign direct investment, and the oil and gasexport industry. Bramley, Sadik and Marshall (2009)and the M.K. Jaccard and Associates technical report(2009) show that the distribution of welfare lossesacross provinces and sectors is not particularly sensi-tive to whether the domestic carbon price is higher orthe same in Canada as it is in OECD countries.Provincial GDP is, however, sensitive to the relativedomestic carbon price. Concerns about competitive-ness help to explain why Ottawa has avoided broadcarbon pricing (by adopting narrow coverage in its

In Snoddon and Wigle (2008), the focus is onregional welfare losses when the federal governmentopts for a mix of policies (including limited domesticemissions trading, technology subsidies, and buildingand vehicle standards) rather than for a single car-bon-pricing approach to emissions reductions. Thepolicy-mix experiment gives rise to a shortfall in fed-eral revenues.10 Interestingly, the aggregate andprovincial welfare burdens are influenced by how therevenue shortfall is financed. Provincial welfare loss-es are generally lower, but sometimes more unevenlydistributed, when shortfalls are financed by increasesin income taxes rather than consumption taxes at thefederal level. This result reflects the fact that theincome tax base is more unevenly distributed thanthe consumption tax base.

The Pembina Institute and the David SuzukiFoundation recently released a study (Bramley, Sadikand Marshall 2009) of aggregate and provincial wel-fare, GDP and emissions effects of implementing amix of climate policies to achieve two alternativegoals – 25 percent below 1990, and 20 percent below2006 by 2020. The results are based on a technicalstudy produced by M. K. Jaccard and Associates(2009).

Focusing on the 20 percent below 2006 target, theaggregate welfare loss from the climage change poli-cies is 1.2 percent compared to BAU.11 Welfarechanges for provinces range from a high of -4.2 per-cent in Alberta to a low of +0.3 percent in Manitoba.The main policy features include a Canada-wide cap-and-trade system with full auctioning (equivalent toa carbon tax). In this scenario, carbon-pricing rev-enues are disbursed as follows: about 36 percent tofederal personal income tax reductions, 13 percent tointernational permit purchases, 22.3 percent to elec-tricity and transit subsidies, 10 percent to householdsto compensate for higher energy costs, and about 1percent for federal purchases of agricultural offsets;the remaining 18 percent is used to compensate forreductions in provincial revenues from various taxes.With the more stringent 25 percent below 1990 tar-get, the aggregate welfare cost is 2.4 percent, withprovincial welfare losses ranging from 7.8 percent inAlberta to 0.1 percent in Manitoba.

Because the policy mix is complex, it is difficult todistill from either Bramley, Sadik and Marshall (2009) orM.K. Jaccard and Associates (2009) whether the regionalburden effects are driven by one or two key measures.However, the recycling of more than a third of the car-bon revenues to lower federal personal income taxes

The interaction of federal and provincialclimate change policiesMost analyses of climate change policy in Canada focuson national, single-instrument policies implemented bythe federal government. They implicitly assume thatOttawa can and does control all aspects of climatechange policy and that provincial policies do not exist.Revenues are often recycled to lower federal taxes. If apermit scheme with free distribution of permits is con-sidered, the federal government would determine nowthe permits are distributed. Permits are distributed by thefederal government. This stylized approach may haveseveral desirable features, but it is significantly at oddswith the complex reality of a decentralized federalismlike Canada’s. As a result, these experiments provide lit-tle insight into important issues concerning climate poli-cy in a federation.

The provinces and Ottawa share responsibility for theenvironment, and jointly occupy the carbon tax base.These uniquely federal characteristics have contributed toCanada’s current patchwork approach. The provinces andthe federal government have introduced or proposed theirown climate initiatives, and have done so concurrently.Some provinces have carbon taxes but most do not; someprovinces allow contributions to a fund, some havereleased cap-and-trade proposals, and some have intro-duced or proposed baseline and credit systems. There areseveral reasons for provinces to implement their ownpolicies. A provincial government may act to satisfy vot-ers, to influence the distribution of the burden in theprovince or to stake a claim on carbon-pricing revenues(now and, perhaps more importantly, in the future).

To our knowledge, Snoddon and Wigle (2007a) is theonly work that examines Canadian climate changepolicies at both levels of government. This work high-lights important issues relating to the interaction offederal and provincial climate change policies, particu-larly in terms of their effects on national and provin-cial welfare and emissions. Differences in provincialpolicies can cause ripples that are not contained withinprovincial borders, as factors and goods markets arelinked by interprovincial trade and factor mobility.Another concern is emissions leakage, whereby emis-sions reductions in those provinces that have climatechange policies are partially offset by emissionsincreases in provinces that do not.

In their stylized model, the federal governmentimplements either a regulatory approach or a domesticemissions-trading scheme to reduce emissions while atthe provincial level some but not all provinces mayimplement regulatory initiatives. British Columbia and

proposed emissions-trading regimes, delaying imple-mentation of its baseline and credit proposal, and set-ting a low price for technology fund contributions).

Today the situation is reversed, but the competitive-ness concerns remain. The United States is implement-ing climate change policies and threatening to imposeborder measures on goods imported from countrieswith less stringent policies. Since US climate changepolicies increase business costs, US firms are at a disa-vantage relative to imports from countries with lessstringent policies. Border measures on imports addressthis disadvantage. If Canada is judged as failing topursue reductions with the same stringency as the USits exporters may well be subject to such surcharges.More stringent emissions-reduction policies in Canadacould exempt Canadian exporters from these US bor-der adjustments, but higher compliance costs mayreduce their competitiveness in other markets.

Key lessons: what goes on south of the border is acritical determinant of the form and substance ofCanadian policies; Canada will face increasing pres-sure to move from its current approach to an alterna-tive position with more effective policies for meetingemissions-reduction goals; and while stringent goalsdo not necessarily achieve emissions reductions,stringent policies do.

Political factorsA summary of the political obstacles confronting thefederal government when it comes to climate changepolicy is provided in Harrison (2007). Those most hurtby climate change policy (hard-hit sectors andprovinces) will be relatively well informed and willhave the greatest incentive to exert pressure on thefederal government. Harrison notes that in general thepublic shows a high degree of support (but low levelsof attention) for action on the environment (Harrison2007, 94). As a result, relatively benign policies can beadopted — looks like action but achieves little in theway of emissions reductions. The resulting costs forinterested parties are in effect quite low.

Voters generally dislike taxes. This is especiallytrue for highly visible taxes, like a carbon tax. Whilethere will be significant price increases if a permit-trading scheme equivalent to a carbon tax isimposed, voters may be less resistant to such a policybecause its effects are less immediately transparent.

Key lesson: political optics are important; policiesthat are perceived as all cost and no benefit for thefederal government or the provinces will not beimplemented.

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percent. This is modelled as a 5 percent reduction infuel intensity. Second, the government grants subsi-dies for sequestration and afforestation activities suf-ficient to bring about a 10 Mt contribution to thetarget. The third measure is a renewable standard forelectricity that requires a 6 percent increase in newrenewable electricity generation.

The regulatory measures available to BritishColumbia and Quebec are similar to but more stringentthan those of the federal government. Provincial fuel-efficiency targets require that the average vehicle fueleconomy increase by 10 percent.13 The provincialrenewable standard for electricity requires a 10 percentincrease in new renewable electricity generation. BritishColumbia also uses subsidies for sequestration, assumedto achieve a 5 Mt contribution to emissions reductions.

The simulations examine implementation by thefederal government of either a permit-tradingregime or its regulatory policies. They then considerwhat happens when the selected provinces add their

Quebec are selected as the provinces to implementclimate initiatives, since they were among the first inCanada to move on climate change policy.

Canada is required to achieve an emissions-reduc-tion target roughly equal to the Kyoto target in allexperiments. This allows a comparison of differentapproaches that achieve the same emissions target.12

In the event of a shortfall in domestic emissionsreductions, the federal government buys permits onthe world market at a price of $30 a tonne.

If the federal government opts for a domesticemissions-trading regime, it receives an allocation ofpermits equal to Canada’s target emissions. Thesepermits are allocated to provinces in proportion totheir baseline 2010 emissions and are sold at cost.Permit revenues are returned in a lump-sum fashionto households. Under the regulatory approach, thefederal government introduces three measures. First,the average fuel efficiency for both the householdand the transportation sectors must improve by 5

Table 3Estimated Effects of Climate Change Policies on Provincial Welfare and C02e Emissions (Percent Changefrom Baseline Scenario)

Scenario 1: Scenario 2:federal regulatory actions only federal and provincial regulatory actions only

Welfare CO2e emissions Welfare CO2e emissions(% change) (% change) (% change) (% change)

Newfoundland and Labrador -0.76 -2.93 -0.70 -2.80Prince Edward Island 4.48 4.21 4.39 3.78Nova Scotia 0.49 -3.46 0.45 -3.34New Brunswick 1.35 -0.78 1.43 -0.24Quebec -1.89 -1.82 -2.50 -3.60Ontario -1.76 -1.31 -1.61 -0.80Manitoba -1.40 -5.54 1.33 -3.01Saskatchewan 2.82 -0.03 2.72 0.07Alberta 3.52 -1.60 3.60 -1.54British Columbia -1.53 -1.47 -2.57 -4.76CCaannaaddaa --00..8800 --11..4477 --11..0011 --11..5588

Scenario 3: Scenario 4:federal permit scheme only federal permit scheme and provincial regulatory actions

Welfare CO2e emissions Welfare CO2e emissions(% change) (% change) (% change) (% change)

Newfoundland and Labrador -0.70 -11.36 -0.79 -11.37Prince Edward Island -1.77 -9.39 -1.86 -9.64Nova Scotia -0.54 -29.42 -0.50 -29.25New Brunswick -1.01 -17.42 -1.00 -17.48Quebec -0.78 -11.21 -1.35 -12.36Ontario -0.73 -15.87 -0.65 -15.65Manitoba -0.68 -17.10 -0.60 -16.96Saskatchewan -0.77 -30.52 -0.78 -30.01Alberta -0.41 -31.05 -0.38 -30.71British Columbia -0.65 -14.66 -1.69 -17.73CCaannaaddaa --00..7700 --2222..7766 --00..9922 --2222..8811

Source: Snoddon and Wigle (2007b).

into the incentive to abate, as compared to the situa-tion in provinces that do not act. Alberta andSaskatchewan both experience welfare gains when thefederal government alone undertakes regulatoryactions. These gains are partially explained by thesequestration and afforestation subsidies (over $650million) paid mainly to these provinces to ensure thatregulatory targets are achieved.

The analysis confirms the conclusion that market-oriented instruments (exemplified by the permit-tradingscheme in scenario 3, table 3) are more cost-effectivethan regulatory measures and subsidies designed toincrease fuel efficiency and encourage green technolo-gies, discussed earlier in the paper.

More importantly, these results strongly support theview that, from a cost-effectiveness perspective, amarket-based Canada-wide climate policy is preferableto the uncoordinated patchwork of federal and provin-cial initiatives that exists today. The interaction of fed-eral and provincial policies alters the provincialdistribution of GHG emissions and increases the cost toCanadians of achieving whatever emissions-reductiontarget is eventually agreed to.

Key lessons: aggregate costs will be higher when poli-cies are uncoordinated; nonuniform provincial policiesmay also affect distribution of the burden acrossprovinces; and emissions leakage can be a problem.

Transitional issuesThe literature provides useful information on alterna-tive policy scenarios. However, the status quo environ-ment on climate change policy is a long way from thesingle-instrument, national approach discussed exten-sively in the literature.

There has been little discussion of how the provincesmight be convinced to vacate the carbon-pricing policyfield and what they might demand in return. While thefederal government could introduce its own emissions-trading system or carbon tax, it does not have the con-stitutional power to force the provinces to abandontheir own policies. Developments in the United Statesmay force Ottawa to act, but the issues internal to thefederation will still need to be addressed. There is alsothe question of whether to act now or wait until USpolicies are firmly in place. Federal actions alone willnot ensure that emissions reductions are cost-effective.

Key lesson: existing research provides little insighton how to get from the status quo to something else.

regulatory measures. The results, expressed as thepercentage difference from BAU levels, are summa-rized in table 3.

There are three main observations. First, domesticemissions reductions are greatest when the federal gov-ernment uses permits. The regulatory measures, whichdo not harness the power of market incentives, reduceGHG emissions by only 2 percent, and at a higher costin terms of reduced welfare. Since the selected policiesare not sufficiently stringent to bring about therequired reductions in emissions within Canada, inter-national permit purchases close the gap and help keepaggregate costs low.

The second observation is that adding provincialactions to those of the federal government tends toincrease the aggregate welfare cost while contributingmarginally to domestic emissions reductions. Forinstance, adding provincial regulatory policies to thedomestic emissions-trading regime increases aggre-gate welfare losses by 31 percent but generates lessthan 1 percent in additional domestic emissionsreductions. When provincial actions are added to fed-eral actions, emissions reductions (and welfare losses)are greater in British Columbia and Quebec. But formany of the other provinces, both welfare losses andemissions reductions are lower when provincialactions are added to federal actions. This resultreflects the problem of emissions leakage.

To understand emissions leakage, consider the reg-ulatory scenarios. Federal regulations on their ownare relatively ineffective. To the extent that thesemeasures do work, they tend to reduce the user priceof fuels, thereby raising emissions of emitters that arenot directly covered by the regulations. Leakage alsooccurs with provincial regulations. These regulationsdepress energy demand in the regulating province(over and above the effects of federal regulations, asprovincial regulations are more stringent). This maycause energy prices in the rest of Canada to fall andemissions to rise. The problem of leakage can serious-ly reduce the effectiveness of policies implemented bylower levels of government.

The third observation is that provincial welfare loss-es are more uneven when the federal government usesthe regulatory approach. More importantly, addingprovincial regulatory measures to federal action tendsto worsen the regional welfare distribution.

We also note that the addition of more stringentprovincial action raises the aggregate welfare cost.Leakage is partially responsible for this result.Provincial regulations serve to drive a bigger wedge

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tioning.16 The tax could also be structured to adjust asnegotiations proceed for a harmonized carbon-pricingpolicy for Canada and the United States.

A proposal for a federal carbon tax is not new.However, our approach introduces two novel and keyfeatures — federal-provincial revenue sharing anddecentralized revenue recycling — as mechanisms tohelp move climate policy forward.

EvaluationIn the short term, our proposal has two advantages.First, a federal carbon tax can be introduced almostimmediately (and, if necessary, without agreement bythe provinces). The complexities of emissions-reduc-tion certification and verification, which could delayaction, can be avoided. Although the approach differsfrom the developing US cap-and-trade regime, a fed-eral carbon tax would allow Canada to signal to theUnited States the stringency of its own emissions-reduction plans and avoid US border adjustments.

A second advantage is that a carbon tax generatesrevenues. A revenue pool creates a form of liquidityto address burden-sharing concerns immediately. Forinstance, the competitiveness impacts of a carbon taxon industries like cement and glass are a serious con-cern. One way to address this concern would be toearmark a declining share of carbon revenues for sec-tor-specific research and development and energy-efficiency investments, with the share of carbonrevenues available for recycling (and for reducingdistorting taxes) increasing over time.

Formal revenue-sharing between Ottawa and theprovinces is necessary to address the joint-occupancyproblem. It provides the provinces with an incentiveto vacate the carbon tax field (and to withdraw fromregional/provincial cap-and-trade regimes) inexchange for a share of the revenues. Decentralizedrevenue recycling means provinces can use these rev-enues to pursue their own objectives.

Our proposal adheres to two important principleswith respect to the design of a cost-effective andenvironmentally effective policy regime: broad cover-age and incentives. A Canada-wide carbon tax can beimplemented with broad coverage, ensuring that realemissions reductions are possible whatever target isadopted. The cost-effectiveness of these reductionsdepends on how quickly Ottawa and the provincesreach an agreement on revenue sharing and on dis-mantling existing provincial carbon-pricing policies.When provincial policies are dismantled, the incen-tive to abate will be equal across emissions sources.

Where Do We Go from Here? HowDo We Get There?

T he status quo approach to addressing climatechange in Canada is costly and ineffective. If weare required to find a better approach, how do we

get from here to there and when do we make our move?While a unified carbon-pricing policy for North

America may be desirable from a cost-effectivenessstandpoint, the reality is that, despite recent initia-tives in the United States, such a policy will takesome time to formulate.

Yet there will be pressure for Canada to move onclimate change policy. We argue that three criticalobstacles need to be addressed if our current approachis to be successfully replaced with a more cost-effec-tive and environmentally effective one. These obsta-cles are regional burden sharing, joint occupancy, andtransitioning from the status quo to a new approach.Our proposal focuses on these obstacles.

The proposal’s key features are:• Immediate imposition of a federal carbon tax to keep

the aggregate costs of emissions reductions low.• Formal revenue sharing between the federal gov-

ernment and the provinces, recognizing that withexisting policies the provinces have staked a claimon any possible carbon revenues.

• Decentralized revenue recycling to allow provincesto address their concerns.

• An approach that signals to the United States thestringency of Canada’s emissions policies and thatthey can eventually be integrated into a NorthAmerican regime.Under our proposal, the federal government intro-

duces a broad-based federal carbon tax along thelines of that proposed in Mintz and Olewiler (2008)but with a lower rate of about $10/tonne CO2e in2010. This rate is somewhat lower than BritishColumbia’s current carbon tax of $15 but higher thanQuebec’s Green Fund duty. The federal carbon taxwould rise steadily over time, hitting $20 in 2020 andabout $35 in 2030.14 The basic idea is to keep the car-bon tax slightly higher than the permit price in theUnited States.

Recent estimates suggest that even a modest taxcould generate significant revenues. For instance, a taxof $20/tonne CO2e could generate about $10 billion.15

As abatement targets become tighter in the longer term,revenues would be greater as the carbon tax rises or aswe transition to a cap-and-trade system with full auc-

provinces, decentralized revenue recycling makes rev-enue sharing more attractive. In the longer term, recy-cling revenues to reduce distortionary taxes may

The proposal addresses two important transitions.Canada needs to transition from its current fragmentedapproach to a uniform country-wide approach. And atsome point in the future it will need to transition to aNorth American (or US) climate change regime.

Substantial federal carbon revenues will help tobring the provinces to the bargaining table to negoti-ate shares. Without a share, provinces have littleincentive to give up their existing policies. Thisinhibits the transition to a Canada-wide approach. Itis unlikely that any proposal would be adopted in theabsence of some such arrangement.

Revenue-sharing specifics include how to split therevenues between the federal government and theprovinces, how to allocate the provincial share toprovinces and how to adjust shares over time. Thefederal government needs to retain a share for itsown purposes (revenue recycling, redistribution orsubsidization). While there are clear efficiency advan-tages to the recycling of revenues to tax cuts — inparticular, business income tax cuts — retaining ashare may help Ottawa defray the political costs asso-ciated with imposing the tax.

How the provincial share is allocated will be con-troversial. Carbon revenues could be disbursed on aderivation or per capita basis (see box 2 for an illus-tration of revenue sharing under alternative allocationrules). Alberta and Saskatchewan would receivegreater shares using a derivation rule, where carbontax revenues are returned in proportion to the amountof tax collected from the province. Larger provincessuch as Ontario and Quebec would be better off withan equal per capita rule. The regional welfare burdenin energy-intensive provinces like Alberta could besignificantly decreased or increased depending onhow carbon revenues are shared with provinces.17

Finally, the revenue-sharing agreement couldinclude provisions for phasing out the carbon taxshould an integrated North American climate changepolicy be adopted. If a North American cap-and-traderegime is adopted with full auctioning, the carbon taxrevenue-sharing agreement could be replaced with anagreement on sharing auction revenues, although inprinciple an arrangement can apply to revenues fromeither a carbon tax or auctioned permits.

With revenue sharing, Ottawa and the provinceswill have carbon revenues to allocate. In the shortrun, revenue recycling to reduce distorting taxes isone option, but some provinces and the federal gov-ernment may choose to use these revenues to offsetburdens in particular sectors and industries. For

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Box 2Revenue Sharing

To get an idea of federal carbon tax collections byprovince, we consider the Mintz and Olewiler (2008)proposal for a restructured federal fuel excise tax(denoted as MO tax). By the calculations of theseauthors, such a tax applied broadly to consumptionof different fuels could generate about $20 billion inrevenues (assuming a $42/tonne tax on CO2e).

We use data from Natural Resources Canada (n.d.)to calculate provincial shares of fuel consumption bysector and fuel type. We then allocate the MO taxrevenue by sector and fuel using these provincialshares. (MO revenues for the electricity sector areexcluded, as these data are not available by province.)

Figure 3 shows provincial shares of carbonrevenues if these are shared on a derivation basis.It also shows provincial shares if, instead, revenuesare returned on an equal per-capita basis. Forpurposes of comparison, we include provincialshares of federal direct tax collections fromindividuals. These shares give a sense of therevenues that would be “returned” to provincialtaxpayers if carbon tax revenues were recycled byreducing federal direct taxes.

Atlanticprovinces

Quebec

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0 5 10 15 20 25 30 35 40 45 50

Derivation

Equal per capita (2005 population)

Federal direct tax

Figure 3Illustration of Sharing of Federal Carbon RevenuesAllocated on Derivation, Equal Per Capita andFederal Direct Tax Bases (Percent)

Source: Source: Authors’ calculations based on data from Mintz and Olewiler(2008), Natural Resouces Canada (n.d.), and provincial economic accounts,2007 estimates.

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proves more difficult than anticipated, the carbontax can stand in its stead, raising (if negotiationsfail) or lowering (if negotiations are successful)the rate as appropriate.18

While our proposal has much to offer over a con-tinuation of the status quo, some would advocateinstead for a federally implemented cap-and-traderegime. In the static context, the two policies wouldbe very similar (although the compliance costs arehigher in the carbon tax case). There are, however, anumber of considerations (in the short run and dur-ing the transition) that favour our proposal.

A carbon tax generates revenues in the short run.These revenues are essential to the shift from the sta-tus quo to a new approach. Revenues help to ease thetransition to a lower-carbon economy. For theprovinces, revenues provide an incentive to partici-pate. By retaining a revenue share, the federal gov-ernment has a discretionary tool for defraying someof the political costs it will incur.

Suppose instead a US-style cap-and-trade regime isadopted, with most permits being given away ratherthan auctioned over the near term. To finance interim

become more important as targets are tightened andas pressures mount to keep aggregate costs low.

Our proposal also addresses a second transitionissue — namely — the question of how to transi-tion to a North American (or US) climate changeregime. The integration of the Canadian and USeconomies will eventually require the integrationof Canada’s policy regime with a US (or NorthAmerican) regime in some way. That said, there isa good chance that a North American scheme willconverge on a fully (or largely) auctioned cap-and-trade scheme. This could mean transitioningfrom a carbon tax to a cap-and-trade system inthe longer run.

Integration with a North American policyregime does not, however, preclude a continuationof the federal carbon tax integrated with a US capand trade, or even the coexistence of a Canada-wide carbon tax and a Canada-wide cap and trade(box 3 provides some specifics on how the systemcan transition from a carbon tax or tax plus cap toa full cap-and-trade system). Further, if the nego-tiation of a North American cap-and-trade system

Box 3Interaction between a Carbon Tax and aCap-and-Trade System

Whether or not it is seen as a desirable long-termarrangement, a carbon tax can coexist with a cap-and-trade system, and the nature of their interaction andthe transition path from one to the other is fairly clear.

Panel A of figure 4 illustrates a stand-alone cap-and-trade system yielding a permit price of $75. Panel Ashows the demand curve for allowances (referred to byeconomists as the marginal abatement cost [MAC]curve), the cap (500 Mt) and the resulting permit price($75). Emitters have an incentive to reduce emissions aslong as they can do so for less than this price.

Now, suppose that a carbon tax of $25/tonne wereimposed, given the same conditions (the same MACcurve) and assuming that the cap of 500 Mt is still inplace. Panel B of the figure shows the scenario if thebinding policy is still the cap, generating the same car-bon price of $75. While neither the carbon price nor thelevel of emissions has changed, the value of allowanceswill fall by the amount of the tax. This will be true inthis case as long as the tax is less than $75, which isthe carbon price associated with the cap of 500 Mt.

Panel C is identical to panel A, other than in itsinterpretation. In this case the panel shows a stand-alone carbon tax of $75/tonne. Note that this leads tothe same emissions level as seen in panel A. Suppose wehave a cap-and-trade system and a $25 carbon tax, as

illustrated in panel B. Increasing the tax from $25 to$50 to $75 reduces the value of permits from $50 to$25 to $0. This transition is illustrated as a move frompanel B to panel C. If the tax exceeded $75/tonne, theallowances issued under the cap-and-trade schemewould become worthless.

Panel D shows such a case where the carbon tax“dominates” the cap-and-trade system. The original capof 500 Mt is in place, but the carbon tax exceeds thepermit price that would occur at the statutory cap of500 Mt. In this case, the emissions are 300 Mt and theprice of carbon is composed entirely of the tax. Notethat from this starting point, changes in the quantity ofallowances available under the cap-and-trade schemehave no effect. Small changes to the carbon tax will, incontrast, affect emissions.

The main point of this short discussion is to show thata carbon tax can coexist with a cap-and-trade permit sys-tem. The secondary point is to illustrate the interactionbetween the two. To apply this analysis to our proposal, weneed to turn it around.

No binding cap In the initial stages, emissions capsare likely to be relatively lax, leading to low or zeroallowance prices (panel C). In this case, imposing ahigher carbon tax would initially be an effective instru-ment for restraining emissions.

Binding cap As the cap is progressively tightened,the cap becomes the instrument restraining emissions.The tax reduces the market value of the allowances andgenerates revenue (similar to panel B).

with provinces over revenue sharing, the federal gov-ernment will be negotiating the allocation of permitsand the timetable for transitioning to full auctioning.During the transition from free allocation to full auc-tioning, provinces may pressure the federal governmentfor a revenue share.

Another concern is the time and complexity entailedin aligning a federal cap-and-trade system with existingregional initiatives and with the emerging US system. Itis not a straightforward matter to outline the distribu-tion and crediting of permits in an environment of mul-tiple and possibly overlapping cap-and-trade systems.

measures aimed at easing the burden of adjustmentsfor particular groups, existing distortionary tax rateswill increase, as will the aggregate costs of emissionsreductions. The carbon tax proposal avoids theseincreases and allows for the possibility of reduced dis-tortionary taxes at either the federal or the provinciallevel. There is also no guarantee that the public willnot resist increases in these other taxes, although weacknowledge that there may be less resistance thanwould be the case with a carbon tax.

A US-style cap-and-trade approach may meet withless resistance from industry. Instead of bargaining

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Figure 4Schematic Representation of the Interaction between a Carbon Tax and a Cap-and-Trade System

A. Cap and trade only: 500 Mt cap B. Cap and tax: 500 Mt cap, $25/tonne tax

C. Carbon tax only: $75/tonne tax D. Tax and cap: $100/tonne tax, 500 Mt cap

1 MAC = marginal abatement cost.

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policies. About 36 percent of federal carbon taxrevenues are used for federal personal income taxcuts. Various other measures are implemented atthe federal level, such as compensation to house-holds and subsidies to the electricity and transitsectors. About 10 percent of revenues go to inter-national permit purchases (so not all emissionsreductions are achieved domestically).

Key differences in how revenues are used ineach of the experiments may help to explain thedifferent patterns of regional burdens. Differencesin the aggregate burden could reflect a number offactors, including the efficiency gains from recy-cling a portion of revenues to federal income taxcuts in M.K. Jaccard and Associates (2009). Thereare also important differences in the implicit fed-eral-provincial split of revenues and the rule usedto allocate revenues to provinces. Neither paperconsiders the impact of decentralized revenuerecycling. This is clearly an area where moreresearch would be useful.

While the experiments are not fully compatible,they do show that regional burdens are sensitive tohow Ottawa and the provinces share carbon-pricingrevenues. There are many possible revenue-sharingand decentralized-revenue-recycling scenarios. Thewelfare and emissions effects of these options forCanada and the provinces must be fully explored ifclimate change policy is to move forward.

Our proposal can be implemented almost immediatelyand with relative ease and, as shown in box 3, can beused to fill the gap as Canada makes the transition toan integrated North American climate regime.

Perhaps the greatest obstacle to the adoption ofUS-style cap and trade is that it is not at all clearhow or why the provinces would agree to it. In theshort run no revenues will be generated — onlycosts. To operate in a cost-effective manner,provinces would be asked to give up their own car-bon-pricing policies and revenues. It is not obviouswhat they would get in return.

How would our proposal affect aggregate andregional welfare burdens? While there are no studiesthat include formal revenue sharing or that considerdecentralized revenue recycling, we can get a generalsense of the range of possibilities by consideringsome key results from Snoddon and Wigle (2007b)and M.K. Jaccard and Associates (2009). In the lattercase, we focus on the results for the less aggressivetarget. Our observations should be viewed with somecaution as the modelling approaches, the baselineand the underlying parameters differ in severalimportant respects.

Both papers consider regional and aggregate wel-fare effects of climate change policies. These are sum-marized in table 4. In Snoddon and Wigle (2007b) theoverall welfare effects are somewhat greater, as is therange of regional welfare effects. The regional distri-bution of the burden is, however, quite different inthe two scenarios.

The Snoddon and Wigle (2007b) experiment canbe interpreted as a special case in our proposal. Afederal carbon tax is imposed, with 100 percent of therevenues returned to the provinces in proportion toinitial emissions (approximating a derivation-sharingrule). The federal revenue share is zero, there are nofederal adjustment measures to ease the burden, andthe provinces simply give “green cheques” to house-holds (revenues are returned to households in lump-sum form). In this experiment, carbon revenues arenot used to lower distorting tax rates.

The M.K. Jaccard and Associates (2009) experi-ment could also be considered a special case inour proposal. A federal carbon tax (equivalent to afully auctioned permit system) is implemented.The federal government’s revenue share is about82 percent and the provincial share is 18 per-cent.19 The provincial share is distributed to theprovinces in proportion to the reduction inprovinces’ tax revenues induced by federal climate

Table 4Comparison of Regional Burden Sharing (WelfareChanges Expressed as a Percentage of BAU)

M. K. JaccardSnoddon and Wigle and Associates

(2007a) (2009)

Newfoundland andLabrador -1.69Prince Edward Island -3.91 -0.61

Nova Scotia -0.57New Brunswick -1.97Quebec -2.33 -0.7 Ontatio -2.77 -0.9Manitoba -2.56 0.3Saskatchewan 0.57 -2.6Alberta 1.52 -4.2British Columbia -2.41 -0.9Canada -1.91 -1.2

Source: Snoddon and Wigle (2007a, table 7); M.K. Jaccard and Associates(2009, table 55).1 The Atlantic provinces and the northern territories are grouped together in thisscenario.

}

Conclusions

T he recent history of Canadian policy shows thatfailure to put a price on CO2e emissions is verycostly, especially when the scope of nonprice

measures is limited to specific sectors or specific setsof emitters. Few real emissions reductions have beenachieved. Existing and emerging policies overlap andthere is no framework for integrating these differentpolicies and instruments. Recent US climate initia-tives put additional pressure on Canada to reduceemissions.

We propose a federal carbon tax with transitionmeasures. With this proposal, Canada can achievereal emissions reductions almost immediately and ina more cost-effective manner. Canada can also signalthe stringency of its climate change plans to the USgovernment and, in so doing, avoid US border adjust-ments. Unlike a cap-and-trade system, where permitsare distributed freely for a period of time (and henceoffer nothing to the provinces in terms of revenue),our proposal generates revenues that can be used foraddressing the burden-sharing concerns of industry,of individuals and of the provinces. Our proposal rec-ognizes that the carbon tax field is shared by Ottawaand the provinces. Although the federal governmentis in the best position to implement a Canada-widepolicy, provincial governments have already staked aclaim. A move from the current patchwork environ-ment to a Canada-wide approach will thereforerequire a carbon revenue-sharing agreement betweenthe federal government and the provinces, withprovinces free to determine how best to recycle theirrevenue shares.

Finally, our proposal recognizes that in the longerterm Canada will need to integrate into a NorthAmerican carbon-pricing regime. Our carbon tax cancoexist with a US cap-and-trade system and, perhapsmore importantly, can transition into a cap and tradeshould negotiations on a North American climatechange regime prove successful.

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emissions standards (see Environment Canada 2009).As a result, the federal standard sets the new floor. Inour model, the federal government would impose amore stringent fuel efficiency target. Provincial regula-tions (at the same level or below) would becomeredundant.

14 The EPA analysis of the American Clean Energy andSecurity Act of 2009 (EPA 2009) estimates allowancesprices in the range of $13 in 2015 and $27 in 2030.

15 Estimates vary. Under the Mintz and Olewiler (2008)proposal, a federal tax could generate about $20 bil-lion. Under the comprehensive cap-and-trade regimewith full auctioning proposed by the NationalRoundtable on the Environment and the Economy(2009a,b), $18 billion in auction revenues could begenerated. In principle, if all sources of emissions arecovered, a carbon tax and a cap-and-trade systemwould yield equivalent revenues.

16 How carbon tax revenues respond to changes in thetax rate or base depends on the elasticity of the taxbase. Many researchers believe that the carbon taxbase will be inelastic over the short to medium runwith revenues rising in response to increased taxes.

17 Snoddon and Wigle (2007b) return revenues toprovinces in proportion to provincial shares of initialemissions. Provincial shares of initial emissions woulddiffer from the derivation shares as illustrated in figure3, for two reasons. First, the Mintz-Olewiler carbon taxdoes not tax fuel produced for own purposes. Second,the derivation shares, as we have calculated in figure3, do not capture carbon tax revenues from the elec-tricity sector. This is a potentially important omission,since emissions from electricity generation differ sig-nificantly from province to province.

18 Although we abstract here from the issue of offsets, wedo note that a sound and credible offset regime wouldbe an important component of any cap-and-trade sys-tem. Care must be taken to ensure that offsets are notgiven for emissions reductions that would haveoccurred in the absence of climate change policy. Ifthis is not the case, actual emissions reductionsachieved by the offset plus cap-and-trade system willbe significantly lower than expected.

19 The federal revenue share is calculated as the sum ofexpenditures on personal income tax cuts, internation-al permit and agricultural offset purchases, compensa-tion to households, and electricity and transit subsidiesdivided by total carbon revenues.

NotesThe authors gratefully acknowledge the helpful com-ments of two anonymous referees and the researchassistance provided by Griffen Carpenter.

1 Full details of the plan can be found at www.ecoac-tion.gc.ca/turning-virage/index-eng.cfm

2 The 2020 forecast is taken from Natural ResourcesCanada (2006) and the 2006 estimate fromEnvironment Canada (2008a).

3 These are explained in more detail below, in the sub-section “Aggregate Welfare Cost.”

4 According to a recent news release (Government ofAlberta 2009), in-house abatement and associated cred-its accounted for about 58 percent of emissions reduc-tions while offset contributed 42 percent. Large emittersalso made contributions of $82.3 million to the tech-nology fund. At a price of $15/tonne, this translatesinto a 5.5 Mt credit toward achieving compliance withthe required reduction in emissions intensity.

5 Sectoral burdens and permit allocations are discussedin the subsection “Sectoral Effects,” while competitiveissues are outlined in “Competitiveness Concerns.”

6 See the Environmental Protection Agency (EPA) analy-sis (EPA 2009) of the American Clean Energy andSecurity Act of 2009 H.R. 2454 in the 111th Congress,plus the authors’ preliminary calculations.

7 The interest is in welfare and GDP as measures ofbefore-tax income, since in CGE models all tax rev-enues are ultimately “returned” to individuals.

8 Most studies consider emissions reductions in therange of 240 to 270 Mt (or the Kyoto target of 6 per-cent below 1990 levels).

9 The model is calibrated to emissions data from NaturalResources Canada (1999). Revised emissions data sug-gest that emissions in Alberta and to a lesser extent inSaskatchewan are substantially higher than the initialemissions used in the Snoddon and Wigle model. Sincecarbon revenues are distributed to provinces in pro-portion to initial emissions, the qualitative conclusionsfrom the experiments are not likely to change.

10 Shortfalls arise because federal subsidies are needed toensure that the targets for clean electricity generation,CO2e capture and storage, and vehicle fuel efficiencystandards are met. Also, the domestic trading regimehas limited coverage. To model this, we assume thatthe federal government provides an implicit subsidy tocover the cost of permits for exempted firms.

11 This scenario is referred to as G-OAT and assumes thatOCED countries impose policies that are as stringent asCanada’s.

12 The model simulates the economy using 1998 data asthe benchmark. Business-as-usual forecasts are thenconstructed for 2010. Policy experiments are comparedto the BAU case. The model is static and does notexamine the adjustment path. The key strength of thisCGE model is the rich provincial detail and the sepa-rate modelling of 10 provincial economies.

13 The federal government recently committed to match-ing new, tougher US fuel efficiency and automobile

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------------. 2002a. Climate Change Plan for Canada. Ottawa:Minister of Supply and Services.

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------------. 2005. Project Green: Moving Forward on ClimateChange — A Plan for Honouring Our Kyoto Commitment.Ottawa: Minister of Supply and Services.

------------. 2007. Turning the Corner: An Action Plan to ReduceGreenhouse Gases and Air Pollution. Ottawa: Minister ofSupply and Services. Accessed November 15, 2009.http://www.ecoaction.gc.ca/turning-virage/index-eng.cfm

Harrison, K. 2007. “The Path Not Taken: Climate ChangePolicy in Canada and the United States.” GlobalEnvironmental Politics 7:92-117.

Jaccard, M. 2006. “Burning Our Money to Warm the Planet —Canada’s Ineffective Efforts to Reduce Greenhouse GasEmissions.” C.D. Howe Institute Commentary 234.Toronto: C.D. Howe Institute.

Jaccard, M. and N. Rivers. 2007. “Estimating the Effect of theCanadian Government’s 2006-2007 Greenhouse GasPolicies.” C.D. Howe Institute e-brief 46. Toronto: C.D.Howe Institute.

Jaccard, M., J. Simpson, and N. Rivers. 2007. Hot Air.Toronto: Douglas Gibson Books.

Klepper, G., and S. Peterson. 2002. “Trading Hot Air: TheInfluence of Permit Allocation Rules, Market Power andthe US Withdrawal from the Kyoto Protocol.” KielWorking Paper 1133. Kiel, Germany: Kiel Institute for theWorld Economy.

Laghi, B., and S. McCarthy. 2009. “Canada to Match U.S. CarFuel Rules.” Globe and Mail, May 20, A10.

Marshall, D. 2008. Provincial Power Play: Breaking Awayfrom Federal Inaction on Climate Change. Vancouver:David Suzuki Foundation.

Mintz, J., and N. Olewiler. 2008. A Simple Approach forBettering the Environment and the Economy:Restructuring the Federal Fuel Excise Tax. Prepared forthe Sustainable Prosperity Initiative. Ottawa: Institute forthe Environment, University of Ottawa.

M. K. Jaccard and Associates. 2009. Exploration of TwoCanadian Greenhouse Gas Emissions Targets: 25% below1990 and 20% below 2006 Levels by 2020. Calgary andVancouver: Pembina Institute; David Suzuki Foundation.

National Roundtable on the Environment and the Economy(NRTEE). 2009a. Achieving 2050: A Carbon PricingPolicy for Canada. Ottawa: NRTEE.

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Natural Resources Canada. n.d. “National Energy Use Database.”Ottawa: Office of Energy Efficiency, Natural ResourcesCanada. Accessed November 27, 009. http://oee.nrcan.gc.ca/corporate/statistics/neud/dpa/data_e/databases.cfm

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que la façon dont les recettes tirées d’une taxe sur le carboneou d’un système de permis d’émission sont réparties peutavoir un effet majeur sur le coût net pour chaque provincede réduire ses émissions. Par exemple, si les recettes étaienttransférées aux provinces en fonction de leur part initialed’émissions, le fardeau économique net des provinces forte-ment émettrices pourrait en réalité être légèrement inférieurà celui de la plupart des autres provinces.

Les auteurs recommandent donc une ambitieuse poli-tique de réduction des GES plus efficace que le statu quo,et ils proposent un plan de mise en œuvre dont l’élémentcentral est une taxe fédérale sur le carbone. Celle-ci seraitfixée au départ à 10 dollars la tonne d’équivalent CO2 etaugmenterait graduellement à quelque 35 dollars en2030. Cette taxe pourrait être adoptée assez rapidement(contrairement à un système de permis d’émission négo-ciables) et, au besoin, sans l’accord des provinces. Pour lamettre en place avec succès, il faudra toutefois convain-cre les provinces de restreindre radicalement leurs propresinitiatives au profit d’un plan national plus rentable. Pource faire, Ottawa devra négocier avec les provinces desaccords en bonne et due forme sur le partage des recettesgénérées par la taxe sur le carbone plutôt que de s’enservir pour réduire ses propres taxes ou pour financer sesprogrammes. Ces accords auraient pour effet de recon-naître que la protection environnementale est uneresponsabilité fédérale-provinciale et que les provincesdoivent être indemnisées en échange du droit qu’ellesaccordent à Ottawa d’établir les paramètres de la politiquecanadienne sur les changements climatiques. Ce partagedes recettes fera en sorte qu’aucune province ne porteraun fardeau financier excessif en vue d’atteindre les ciblesnationales de réduction des émissions.

Une telle taxe sur le carbone pourrait en outre s’intégr-er aisément à un régime continental sur les changementsclimatiques advenant l’adoption des ambitieuses proposi-tions récemment mises de l’avant aux États-Unis. Mêmesi les Américains semblent favoriser un système de pla-fonnement et d’échange plutôt qu’une taxe sur le car-bone, les auteurs montrent que leur proposition pourraitcoexister avec un tel système. Qui plus est, ils font valoirqu’une taxe sur le carbone pourrait facilement être con-vertie en un système de plafonnement si des négociationssur l’harmonisation des politiques nord-américainess’avéraient fructueuses.

L ’approche des gouvernements canadiens en matièrede changements climatiques est présentement frag-mentée et mal coordonnée. De nombreuses

provinces, déplorant le peu d’empressement d’Ottawa àétablir des cibles nationales de réduction des gaz à effetde serre (GES), ont en effet défini leurs propres politiquesde réduction. Il en a résulté un ensemble de mesures dis-parates qui illustrent la difficulté d’appliquer une poli-tique cohérente quand les deux ordres de gouvernementinterviennent dans le même champ de politique.

Tracy Snoddon et Randall Wigle examinent dans cetteétude les initiatives canadiennes sur les changements cli-matiques du point de vue du « fédéralisme environ-nemental ». Jusqu’ici, la plupart des analyses sur le sujetont éludé le fait qu’Ottawa partage cette responsabilitéavec les provinces. Ceci signifie notamment que les deuxordres de gouvernement auraient accès à toute recette fis-cale pouvant découler de mesures de réduction d’émis-sions. Compte tenu de cette réalité de la fédérationcanadienne et du fait que les GES sont hautement con-centrés dans certaines provinces, notamment en Albertaet en Saskatchewan, il est impératif de mieux comprendrel’interaction des politiques fédérale et provinciales etleurs impacts régionaux afin d’élaborer des moyens d’ac-tion vraiment efficaces.

Contrairement à la panoplie actuelle de programmesfédéraux et provinciaux, les auteurs démontrent qu’ilserait plus fructueux d’instaurer une politique pancanadi-enne fondée sur les mécanismes du marché, avec l’adop-tion par exemple d’une taxe sur le carbone ou d’unsystème de permis d’émission négociables. Leurs simula-tions montrent en effet que les politiques provinciales quis’ajoutent aux initiatives fédérales auront vraisemblable-ment peu d’effets sur l’ensemble des émissions du pays etcomporteront un coût économique substantiel. Parcequ’elles sont plus ou moins sévères, les mesures provin-ciales ne font que modifier la répartition interprovincialedes émissions sans les réduire globalement. Ces mesuresincitent les industries fortement émettrices à se déplacer,quand c’est possible, vers les provinces dont les normesd’émission sont plus souples.

Plusieurs soutiennent que l’adoption d’une politique pan-canadienne sur les changements climatiques relève de lapensée magique, puisque les provinces fortement émettricesrefuseraient catégoriquement d’être soumises aux mêmesexigences que les autres. Les auteurs font toutefois valoir

RésuméClearing the Air on Federal and ProvincialClimate Change Policy in Canada

Tracy Snoddon et Randall Wigle

26

have a dramatic effect on the net economic costs ofreducing emissions across provinces. For example, if therevenues from a carbon tax (or from auction of emissionspermits in a cap and trade system) were returned to theprovinces in accordance with their initial shares of emis-sions, the net economic burden on emissions-intensiveprovinces could actually be modestly lower than that onmost other regions of the country.

The authors propose an ambitious national policy thatis much more cost-effective than the patchwork statusquo, and offer a road map for implementing it. The cen-trepiece of their proposal is a federal carbon tax, initiallyset at $10 per tonne of CO2 equivalent, and rising gradu-ally to about $35 by 2030. Such a tax could be imple-mented relatively quickly (unlike a system of tradableemissions permits) and, if necessary, without agreementfrom the provinces. However, Snoddon and Wigle stressthat its political success hinges on convincing theprovinces to drastically scale back their own climatechange initiatives in favour of a more cost-effectivenational plan. They argue that Ottawa must negotiateformal agreements with the provinces for sharing anyrevenues generated from the proposed tax, rather thansimply using them to reduce federal taxes or fund federalprograms. Such revenue-sharing agreements would rec-ognize that environmental protection is a shared federal-provincial responsibility, and that the provinces must becompensated for allowing Ottawa to set the parameters ofCanadian climate change policy. Revenue sharing wouldalso ensure that no province bears an undue economicburden for meeting national emissions-reduction targets.

Another advantage of a national carbon tax is that itcould easily be integrated into a continental climatechange policy regime in the event that the ambitious pro-posals now being considered in the United States areadopted. Even though the US seems to prefer a cap-and-trade system of emissions permits over a carbon tax,Snoddon and Wigle show that their proposal could coex-ist with such a system and, more importantly, could easi-ly be converted into a cap-and-trade system shouldnegotiations on a harmonized North American policyregime be successful.

C limate change policy in Canada today is frag-mented and largely uncoordinated among govern-ments. Many provinces, frustrated by the

perception that Ottawa has not been proactive enough insetting national targets for greenhouse gas emissionsreductions, have independently embarked on their ownpolicies to reduce emissions. The resulting patchwork ofmeasures illustrates the complexity of achieving coherentpolicy when both levels of government intervene in thesame policy arena.

In this study, Tracy Snoddon and Randall Wigle exam-ine climate change policy in Canada from the perspectiveof “environmental federalism.” Most other analyses on thisissue have sidestepped the fact that Ottawa shares jurisdic-tion with the provinces, which means that both levels ofgovernment have access to any tax revenues that might begenerated by emissions-reduction measures. This “incon-venient truth” of the Canadian federation, combined withthe fact that greenhouse gas emissions are highly concen-trated in specific provinces (notably Alberta andSaskatchewan), makes it all the more critical that weunderstand the interaction of federal and provincial poli-cies, and how their effects vary regionally, in order todevelop effective policy instruments.

The authors demonstrate that a national climatechange policy using a market-based instrument (e.g., acarbon tax or tradable emissions permit system) would bemuch more cost-effective than the patchwork of federaland provincial programs that exists today. Their econom-ic simulations show that provincial climate change poli-cies to supplement national efforts are likely to have littleeffect on Canada’s overall greenhouse gas emissions andwill come at a substantial economic cost. The main rea-son is that differences in the stringency of provincialpolicies simply change the provincial distribution ofemissions rather than actually reducing them overall.Emissions-intensive economic activity is encouraged,where possible, to migrate to provinces with more lenientemissions standards.

Many observers suggest that it is wishful thinking tohope there could be a national climate change policy,because emissions-intensive provinces will vehementlyresist efforts to be subject to the same requirements asother provinces. However, Snoddon and Wigle point outthat the way revenues generated from market-basedemissions-reduction instruments are allocated would

Summary Clearing the Air on Federal and ProvincialClimate Change Policy in Canada

Tracy Snoddon and Randall Wigle