The almost-consensual pan-Canadian climate plan has unravelled in just two years. Why is meaningful action on carbon pricing so hard in Canada?

(This article has been translated into French.)

Canadian federal and provincial governments are deeply divided over carbon pricing. The current state of affairs is a far cry from that in 2016, when the prime minister and the premiers of 11 of 13 provinces and territories unveiled the Pan Canadian Framework on Clean Energy and Climate Change, in which the parties committed to work together to achieve Canada’s Paris Agreement target using carbon pricing and other policy tools.

That moment of intergovernmental harmony now seems a distant memory. The federal government has imposed a carbon tax over the objections of provincial governments in Saskatchewan, Manitoba, Ontario, and New Brunswick, and will do the same in Alberta in January 2020. Saskatchewan, Manitoba, and Ontario have gone to court to challenge the constitutionality of the federal carbon tax. Alberta has promised a legal challenge of its own.

To understand the genesis of these tensions, it’s helpful to have some background on carbon pricing as a policy tool and the evolution of federal-provincial relations on climate change.

What is carbon pricing?

There are two main approaches to carbon pricing. Carbon taxes apply a levy on fossil fuels based on how much carbon dioxide they release per unit of energy. The price increase is greater for an emissions-intensive fuel like coal than for a less emissions-intensive one like natural gas. There is no price impact for renewable energy sources that release no carbon.

The second carbon-pricing approach is emissions trading, also known as “cap and trade.” As with traditional regulatory standards, the core feature of cap and trade is the distribution of a restricted number of emissions permits. But cap and trade differs from regulation in that permit holders are allowed to buy and sell permits. A firm that can reduce its emissions at a relatively low cost will make extra reductions and sell its surplus permits at a profit. A firm facing relatively costly on-site reductions can buy extra permits, in effect, paying someone else to make reductions for them. Both firms ─ and their customers ─ would be better off financially with cap and trade than under a system of inflexible emissions standards.

Both approaches to carbon pricing create financial incentives for individuals and businesses to reduce their emissions by conserving energy, switching to cleaner energy sources and, especially in the case of industry, developing lower-carbon technologies. We know from previous experience that both carbon taxes and emissions trading work.

Within each approach to carbon pricing, policies can differ depending on how revenues are spent. Governments can earmark carbon-tax dollars or revenues collected from the sale of permits to fund environmental programs, they can direct them to general coffers, or they can give the money back through tax cuts or dividend cheques. Although the last option might appear to undermine the functioning of a carbon tax, as long as revenues are returned independently of individuals’ or firms’ fossil fuel consumption, that is not a concern. When you get a raise at work, you don’t stop paying attention to prices when you shop. The same is true for carbon-tax rebates.

Both approaches to carbon pricing will yield the same outcome at the same price if they cover the same pollution sources.

There are, however, some noteworthy differences between carbon taxes and cap and trade. The first difference concerns uncertainty. A policy-maker with complete knowledge of the costs of emissions reductions in all sectors of the economy could design either a trading scheme or a carbon tax to deliver the same outcome. In reality, policy-makers don’t have the full picture. If they opt for a carbon tax, they can be sure of the price but not by how much emissions will decline. With cap and trade, policy-makers can be confident of what emissions reductions will be achieved but not of the costs to the economy. In practice, this difference between carbon taxes and a cap-and-trade program is not as important as it might seem, because governments will need to make many policy adjustments, whether to raise the carbon tax or lower the emissions cap, in the decades to come.

The second difference concerns the visibility of costs. A carbon tax makes the costs, especially in the form of higher gasoline prices, highly visible to consumers. In contrast, because cap and trade applies in the first instance to industrial sources of emissions, consumers might not realize that the costs will be passed on to them in the form of higher prices, including for gasoline if transportation-fuel distributors are covered by the cap. Carbon taxes thus tend to be less popular with voters. That said, Doug Ford’s labelling of Ontario’s cap-and-trade scheme as a “carbon tax” illustrates that opponents of any form of carbon pricing or regulation have incentives, whether political or financial, to make associated costs visible to consumers.

Federal-provincial relations and climate change

Diverse fossil-fuel endowments have resulted in significant variation in carbon-emissions profiles among Canadian provinces. Figure 1 shows per capita annual emissions in the provinces. To put the provincial differences in perspective, there are no countries in the world with as large a per capita emissions gap as that between hydro-rich Quebec and fossil-fuel-rich Alberta and Saskatchewan.

Figure 2 compares absolute, rather than per capita, emissions over time. The emissions in most provinces stabilized or declined between 1990 and 2017, with the exception of those in Alberta and Saskatchewan, which increased by 58 percent and 77 percent, respectively, primarily as a result of increasing volume and carbon intensity of their oil exports.

Historically, provincial governments – as owners of Crown resources (an ownership that is often contested by First Nations) – have resisted federal government “intrusion” into their jurisdiction over natural resources. This is both because they want to deliver environmental protection services within their own borders and, arguably more importantly, they want to control economic development of their natural resources. When it comes to climate change, provincial defensiveness is exacerbated by the significant differences in carbon intensity of provincial economies, which implies that some provinces will need to make bigger changes, potentially at greater cost, than others.

Resulting federal-provincial tensions have been resolved within the Canadian Council of Ministers of the Environment, where a norm of consensus has for the most part ensured intergovernmental harmony, but this harmony has often come at a cost of limited ambition. A tendency toward lowest-common-denominator climate policy was evident throughout the 1990s and early 2000s, as Alberta consistently opposed federal regulation of industrial carbon emissions, while Ontario resisted national emissions standards for motor vehicles. The federal government chose not to pick a fight, and Canadian emissions steadily increased.

That landscape has changed significantly in the last decade, however, as the four most populous provinces implemented their own carbon-pricing schemes. Alberta adopted a hybrid system for industrial emitters in 2007, British Columbia implemented a carbon tax in 2008, and Quebec joined California in emissions trading in 2013. Ontario committed to join the Quebec-California scheme in 2018. Provincial leadership created the conditions for the federal Liberals to promise in 2015 that a Liberal government would establish a Canada-wide carbon price, in partnership with the provinces.

The newly elected Trudeau government subsequently gained agreement among all premiers to the “Vancouver Declaration,” which embraced Canada’s Paris Agreement target of reducing emissions to 30 percent below those of 2005 by 2030. However, the declaration only mentioned carbon pricing as an option for provincial governments. But in October 2016 the Prime Minister announced that the federal government would unilaterally establish a carbon price in any province that failed to establish its own.

Two other developments also set the stage for federal-provincial agreement. A month after Trudeau’s announcement, the newly elected Alberta NDP government committed to a broad-based carbon tax rising to $30/tonne. Thereafter, Alberta agreed to the higher carbon price demanded by the federal government, contingent on federal approval of the Trans Mountain pipeline expansion project. The federal government approved the project days before the Pan-Canadian Framework was unveiled.

In signing the framework, all provinces and territories except Saskatchewan and Manitoba (which later signed it) committed to implement either a carbon tax rising to $50/tonne in 2022 or an equivalent emissions-trading scheme. The federal government issued specific conditions provincial governments would have to meet in order to avoid the federal carbon pricing “backstop.” In 2017, the federal government announced that for small-scale polluters, the backstop would be a revenue-neutral carbon tax (technically a “regulatory charge”) with all revenues returned to the province of origin (90 percent to households and 10 percent to small businesses and public institutions). A separate federal pricing scheme that closely resembles Alberta’s was designed for large emitters.

For a time, it appeared that Justin Trudeau had squared the circle of delivering a nationally consistent carbon price in partnership with the provinces. However, this near-consensus unravelled in 2018. A newly elected Conservative government withdrew Ontario from emissions trading that summer. In October 2018, Manitoba announced its refusal to meet federal conditions for carbon pricing. In November, the federal government rejected New Brunswick’s carbon-pricing plan.

In response, in April 2019 the federal government implemented a carbon tax in Saskatchewan, Manitoba, Ontario and New Brunswick, and the first annual dividends were delivered to residents of those provinces via their 2018 income tax returns. Then in May 2019 the newly elected United Conservative government repealed Alberta’s carbon tax. The federal government will implement its carbon tax in that province in January 2020, at which point five provinces, accounting for half the population of Canada, will be covered by a federal carbon tax.

The Canadian carbon-pricing regime faces a number of challenges. Provincial court cases contesting the federal carbon tax will eventually be resolved by the Supreme Court. There is a federal election in October 2019, and the Conservative Party has promised to repeal the federal carbon tax.

The decentralized approach of allowing each province to choose either carbon taxation or cap and trade has made the prospect of Canada reaching its Paris Agreement target even more challenging, because it invited provinces to embrace the approach that is least demanding for their economies. Nova Scotia thus opted for emissions trading, setting a cap equivalent to Canada’s Paris target that will not deliver much of a reduction below an already declining emissions baseline. For its part, Alberta’s NDP government opted for a fixed price which, at $50/tonne, would have a limited impact on emissions from the oil sands.

As Canada seeks to meet its Paris Agreement target, how long will other provinces be willing to make deeper reductions to compensate for continuing emissions growth in Alberta and Saskatchewan? Or will Canada return to the pretense of embracing but failing to meet ambitious climate change goals?

This article is part of the The evolution of carbon pricing in the provinces special feature.

Photo: Prime Minister Justin Trudeau, left, talks after meeting with premiers at a First Ministers meeting at the Canadian Museum of Nature in Ottawa on November 23, 2015. The Canadian Press, by Sean Kilpatrick.

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