There is a case to be made for complementing carbon pricing with other policies, provided they are low cost, carefully designed and properly analysed.
Four provinces making up around 85 percent of Canada’s economic activity, and roughly the same share of the country’s GHG emissions, now have broad-based carbon prices. Those without such prices are thinking hard about whether to design their own or let the federal government step in to do the work. All governments are also thinking about what other policies, in addition to carbon prices, would work best to achieve their emissions reduction objectives.
Even among strong supporters of carbon pricing, the “What else?” question invites a passionate debate. On one side are those who recognize the value of harnessing the power of markets, and who think we should rely exclusively on the carbon price to reduce GHG emissions in the lowest-cost manner. For them, there is no need for any additional climate policies: just raise the carbon price and watch the market work its magic.
On the other side of the debate are those with less confidence in markets and prices and who believe more strongly in the wisdom and success of government regulations. They like carbon pricing but are sure that even high carbon prices can’t get the job done, and so a large collection of other policies will be necessary. For some of these folks, any policy that can reduce GHG emissions will pass the test.
At the Ecofiscal Commission, which I chair, we economists see some truth in both sides. We habitually sing the praises of markets and prices, and we naturally have a lot of confidence in the ability of carbon prices to reduce GHG emissions. We also recognize that intrusive government regulations are often very costly, especially when they can’t keep up with the rapid development of new technologies.
On the other hand, we recognize that even a well-designed carbon price may not always work as well as it does in a textbook setting. Once we consider how GHG emissions are sometimes difficult to observe and measure, and also how specific kinds of market imperfections may weaken the market signal of the carbon price, we start to see the case for complementing the carbon price with some carefully designed non-pricing policies.
What can’t a carbon price do?
When we first asked ourselves what kinds of climate policies can actually do something a carbon price can’t do, we realized that we didn’t have a ready answer. So we decided to figure it out, develop a coherent analytical framework and write it down in a way that makes sense, even to people who may not think that much about markets and prices.
The result of this work is our latest report, Supporting Carbon Pricing. It is designed to help governments identify the policies that genuinely complement and enhance their carbon price. Equally important, the report can help them identify those policies that may weaken or undermine their carbon price, or may reduce GHG emissions only at a very high cost.
We considered the situations in which the carbon price might need some help from other policies. Then we came up with three general types of policies to respond to these contexts.
Filling gaps, boosting signals and expanding benefits
The first kind of policy is called a “gap filler.” The rationale for gap-filling policies is that even economy-wide carbon prices generally don’t apply to all GHG emissions within a province. Some emissions, such as methane leaks from oil and pipeline equipment, may be challenging to measure and to price. In agriculture, many emissions are similarly difficult to measure and price. In both cases, other regulatory policies can fill the gaps left by the carbon price. But to make the grade, they must be well-designed and must operate at low cost.
The second kind of policy we call a “signal booster.” The underlying logic of using a carbon price is that it sends a clear market signal and financial incentive to consumers and businesses to alter their behaviour in a way that reduces their GHG emissions. But economists have long known that markets do not always operate perfectly; some “market failures” can weaken the private sector’s response to the price signal. Such failures are the rationale for carefully chosen policies to boost the price signal and thereby enhance the effectiveness of the carbon price.
For example, if a carbon price raises the price of electricity, as it will in some provinces, people will be led over time to switch to more energy-efficient appliances. But without the knowledge of which appliances are most efficient and the long-run cost savings they provide, people are less likely to make this switch. A policy requiring appliance producers or retailers to provide reliable information to inform consumers about energy efficiency options and benefits might be a good idea because it better enables the choices that the carbon price is designed to encourage. However, such policies need to be cost-effective before they get the green light.
The third type of policy that governments should consider is a “benefit expander”: in addition to reducing GHG emissions, it generates some other kind of economic or social benefit. More and better bike lanes in some cities may improve urban mobility and public health; expanded public transit may reduce traffic congestion and improve air quality; better land-use policies may lead to environmental benefits quite separate from reduced GHG emissions.
In all such cases, the arguments in favour of the policies need to incorporate all of the significant benefits and costs. A benefit-expanding policy might appear to be a high-cost one if only the GHG reductions are considered, but once the “co-benefits” are included in the analysis, the case for the policy may be significantly strengthened. But the onus is on governments to be clear about all of the costs and benefits, to quantify them as precisely as possible and then to convince us all that these policies genuinely measure up.
Building a cost-effective policy package
Once we clarified the rationales for these three non-pricing climate policy types, our work led directly to a recommendation for governments. If a policy they are considering does not respond to one of these rationales, they should scrap it and rely instead on the carbon price to do its work. After all, for most GHG emissions, the carbon price will be the lowest-cost way to achieve the reductions they seek. Want more emissions reductions? Increase the carbon price, rather than relying on more costly alternative policies.
But even if a policy is shown convincingly to respond to a demonstrated need, governments have more work to do. An equally important part of the framework we developed is that policies need to be well-designed in order to be both effective at reducing emissions and cost-effective to ensure that these reductions are achieved at the lowest possible cost. In a world of slow economic growth and plenty of challenges to our economic prosperity, it is imperative that governments seek to achieve their environmental objectives with the lowest-cost policies.
The various elements of a policy’s design — including how simple it is to comply with, its predictability over time and its flexibility across technologies — all come together to determine the quantity of GHG emissions that will be reduced and at what economic cost. For every nonpricing climate policy, governments can estimate these emissions reductions and associated costs, and thereby compute the policy’s “implicit carbon price.”
Since the economy-wide explicit carbon price is the gold standard for effective and low-cost emissions reductions, each policy and its implicit carbon price should be held up to this benchmark, allowing for side-by-side comparison of the cost per tonne of reductions in GHG emissions. Policies that are less costly than the carbon price should be embraced; much more costly policies should be reconsidered very carefully. Avoiding bad policies is just as important as introducing good ones.
The challenge for governments, then, is to assemble a package of climate policies to achieve their emissions reduction objectives at the lowest possible costs. The carbon price should be the star of this policy package, with carefully selected and well-designed complementary policies playing only supporting roles — enhancing rather than undermining the operation of the carbon price.
Supporting Carbon Pricing does not assess a large number of policies from across the country. Its central objective is to present a coherent and practical framework to governments so that they can do the necessary analysis for each of their policies — ones that are already in place as well as ones that are being considered.
To illustrate our framework, however, we applied it to three sample policies, one of each type. Our results not only show the usefulness of the analytical framework but reveal some interesting aspects of the individual policies.
For a gap-filling policy, we examined the federal government’s newly announced regulation to reduce methane emissions in the oil and gas sector. Taking effect between 2020 and 2023, the policy will require greater detection of leaks and repair and upgrading of equipment, thus reducing the incidence and magnitude of methane emissions.
Our review indicates that this policy is estimated to reduce methane emissions at a cost of roughly $13 per tonne, well below Alberta’s current explicit carbon price ($20 per tonne) and far below where explicit carbon prices are likely to be over the next several years. By these benchmarks, this gap-filling regulation is a slam-dunk. Its addition to a broader policy package will increase overall emissions reductions and actually reduce average per-tonne costs.
For a signal-boosting policy, we examined Quebec’s subsidies for the purchase of electric vehicles (EVs). The market for EVs contains many barriers that weaken the signal sent by that province’s carbon price. Concerns over battery life, performance in cold weather and access to a charging network are just three of the reasons why even well-informed consumers may hesitate to buy an EV, even with the prospect of a steadily increasing carbon price.
Our analysis (based on some complex economic modelling of these kinds of market obstacles) indicates that while Quebec’s EV subsidies are effective at reducing GHG emissions, they do so at a very high cost. The EV subsidy policy’s implicit carbon price is estimated to be almost $400 per tonne, many times higher than the current carbon price of roughly $17 per tonne. For any government that cares about achieving policy objectives at low cost, it is difficult to justify this kind of policy. We encourage the Quebec government to consider other policies to support the EV sector, but ones that do so at far lower costs.
Finally, we examined Alberta’s planned phase-out of coal-fired electricity facilities by 2030 as an example of a benefit-expanding policy. These facilities generate air pollution that leads to serious health problems, so shutting down these facilities can produce significant health benefits.
Estimating this policy’s implicit carbon price is complicated because it is challenging to gauge how much reduction in coal-fired electricity production would occur anyway over the next several years in response to the province’s gradually rising carbon price. However, the higher the carbon price, the more the “phase-down” would occur in response, and the less it would be attributable to the regulated phase-out in 2030.
Our analysis suggests that the implicit carbon price of the phase-out policy is between $42 and $99 per tonne of GHG reduced. This cost is well above today’s carbon price of $20, so it is not a low-cost policy. On the other hand, Alberta’s carbon price is scheduled to rise over the next several years, and it may well be far higher than today’s level by 2025 or 2030. If that occurs, the cost of the phase-out may become quite comparable to the carbon-price benchmark.
The bottom line
Our report can be summarized in the following points.
First, we encourage governments across the country to rely on a broad-based carbon price to achieve the lion’s share of their desired emissions reductions. This price should rise gradually over time, eventually to levels far above the ones we see today. From the perspective of our overall economic health, this is by far the best way to reduce GHG emissions.
Second, the more governments rely on a rising carbon price, the less need they will have for additional, nonpricing policies. Since the carbon price is easier to design than other policies and generally operates at lower costs, reliance on carbon pricing can actually make life easier for governments.
Third, even with a rising carbon price, governments may be able to reduce more GHG emissions at lower costs by complementing their carbon price with other policies. That’s only true, however, if they identify and use genuinely complementary policies of one of the three types: gap-filling, signal-boosting and benefit-expanding. If a measure they are considering does not target the reasons that make the case for one of these policy types, they should rely instead on the carbon price.
Fourth, once governments have established a clear rationale for a proposed policy, they should make sure the policy is well-designed. Our framework allows them to think through the policy’s simplicity, predictability and flexibility, as well as other considerations. Good policy design is central if governments want policies that are both effective at reducing emissions and also cost-effective in their operation.
Finally, governments should establish a process for reviewing and assessing their existing policies. Some will operate as intended, but others will fail for any of a number of reasons. Only thorough and objective assessment can reveal a policy’s true performance. If a policy is not working well, it should be improved. If it cannot be improved, it should be scrapped.
A broad-based carbon price is the best way for Canada to reduce emissions and promote economic prosperity at the same time. It establishes a high bar as decision-makers consider the desirability of other, nonpricing policies. Governments will almost certainly introduce some complementary climate policies, but they should be very careful in doing so. We hope our report helps them to perform this important task.
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