A carbon tax will hurt the economy, but that doesn’t mean it isn’t the right policy

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Claude Lavoie was director-general of economic studies and policy analysis at the Department of Finance from 2008 to 2023. He has represented Canada at Organization for Economic Co-operation and Development meetings.

Let’s be honest: A carbon tax will hurt the economy, and Canada reducing its emissions will not do much for climate change. But we should also do our part, and carbon pricing is the option that should appeal the most to conservative-minded people and be the least economically damaging.

Canada, along with many countries, signed the Paris agreement and committed to reduce its greenhouse gas (GHG) emissions by 40 to 45 per cent below 2005 levels by 2030. Carbon pricing was adopted as the main instrument to fulfill this commitment, as economists think it is the most growth-friendly way to reduce emissions.

Under carbon pricing, emitters either buy permits or pay a tax for each ton of GHG emissions. The permit and tax systems each have pros and cons, but both result in fees for purchasing fossil fuels. Carbon fuel purchasers pass this fee to consumers through higher prices for electricity, gasoline, and for the products and services that use them.

As carbon price increases, goods delivered with electric vehicles or produced with renewable energy will become cheaper than goods delivered or produced using fossil fuels. Higher emitting firms will want to use less fossil fuel to keep their prices low and remain competitive. This may mean changes such as using more efficient boilers or better insulation. On the consumer side, savings may mean driving less (or slower) and more fuel-efficient cars.

Carbon pricing should appeal to those who prefer small government, as it’s less administratively complex to operate than regulations or subsidies, and gives Canadians full freedom of choice. Regulations or subsidies (for example, strongly incentivizing firms or consumers to buy a particular piece of equipment or vehicle) wrongly assume that civil servants know better what households and firms should do.

Carbon pricing should please fiscal conservatives, as it generates revenues that can be redistributed or used to finance other policies. In contrast, subsidies give taxpayer money to large emitters and regulations need regulators to enforce them. Regulations also raise prices and hurt the economy more than taxes.

Carbon pricing does negatively affect some workers. For example, those who have no access to public transit have no alternative but to bear the tax.

However, without carbon pricing, people would have less incentive to replace their car with a more energy-efficient one or demand better public transit. Why continue to postpone the inevitable need to adapt? The money from the Canada Carbon Rebate and the gradual increase in the carbon price help alleviate the burden and give people time to adjust.

High carbon prices – or any emission regulation – will certainly hurt the oil and gas sector. Reducing emissions requires using less of those energy sources. Policies to reduce smoking also had negative effects on the tobacco industry. What is needed here are better policies to help workers transition to other industries.

Does carbon pricing work? It seems to, as studies show that emissions grow slower in countries with carbon pricing. But the price may need to reach a higher level to see an absolute decline in emissions. The carbon tax was effective in reducing emissions in Sweden, but it reached $170 per tonne of emissions last year, compared with $65 a tonne in Canada.

Some certainty on the future of the system is also necessary. No firm will make long-term investments in costly energy-efficient technologies if they think carbon pricing will disappear. The current political divide is certainly not helping.

Does carbon pricing increase the cost of living? Not necessarily. The goal is to increase the relative cost of emissions-intensive goods and services. But if the Bank of Canada continues keeping inflation at its 2-per-cent target, increases in the price of emissions-intensive goods and services by more than 2 per cent will be countered by increases in other prices by less than 2 per cent. This would keep the cost-of-living increases at the same rate as it would have been without carbon pricing.

Although not perfect, carbon pricing seems to be a reasonable approach. But there is no denying it imposes costs on the economy. Why bear these costs? After all, until countries such as India, China and the U.S. do more, global warming will occur whatever Canada does.

But which side of history do we want to be on? How could we continue to put pressure on these countries if we abandon our commitment? What trade barriers will our exports face? How will it affect our reputation and ability to join other international agreements?

Anybody advocating to “axe the tax” needs to propose a viable alternative or admit wanting to renege on our international commitments. Canadians deserve a clear and frank debate.