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Carbon taxes have taken centre stage in discussing Canadian environmental policy. The National Round Table on the Environment and the Economy recommended Canada adopt a carbon tax as the preferred policy instrument for addressing climate change, and British Columbia became the first province to adopt a comprehensive carbon tax in its provincial budget. Both vaunt the anticipated reduction in greenhouse gas emissions that will result.

But a successful emissions reduction policy must ensure that the domestic economic costs associated with reducing our own greenhouse gas emissions are ultimately validated by reductions in global emissions. Critics of unilateral action point out, rightly, that since Canada produces just 2 per cent of global emissions, even draconian reductions are largely irrelevant to global trends. The same argument holds true, to a lesser degree, for the industrialized world. Put bluntly, success on the climate change front is not possible unless emerging economic superpowers not bound by international climate-change agreements are co-opted into emissions reductions.

Furthermore, we must not subject Canadian firms to unfair competition in domestic and external markets from firms in non-participating countries.

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The proposals on the table in Canada and elsewhere fall short of these goals. Not only do they have no effect on emissions elsewhere, but they fail to come to grips with what is known as "free riding."

There are two sorts of free-rider problems. The first is that firms in non-complying countries will have an advantage when exporting to world markets. The second is that firms in complying countries will have incentives to outsource from, or offshore to, non-complying countries, and then re-export back to their home countries, thereby avoiding the domestic environmental regime.

The answer to this challenge is to augment a domestic carbon tax with an equivalent "carbon tariff" that would be imposed on the emissions resulting from the production and transport of imports. (One could also think of it as a "carbon-added tax" that, like the GST, would be imposed on imports and rebated on exports). Such a tariff would directly address the free-rider problem because exporters in countries with lax standards could no longer escape the "price" that the tariff-imposing country would set on emissions.

As well, domestic firms bearing the costs of the carbon tax would no longer be at a competitive disadvantage with regard to environmental compliance both in domestic and - assuming remission of the carbon tax on exports - international markets.

Of course, the larger the number of participating countries, the greater the impact of this tariff. Applied across North America and the European Union, it would make a major contribution to meeting the climate-change challenge - both by directly reducing emissions in North America and the EU, but just as importantly giving developing countries a strong incentive to do so as well. If enacted by Canada, a carbon tariff could exert a not inconsequential impact on the U.S., which exports $250-billion in goods to Canada a year.

Implementing a carbon tariff clearly presents challenges, but they are not insurmountable. What will be needed is a set of "carbon auditors," whose job it is to measure average carbon emissions by broad product group. The Canadian Institute of Chartered Accountants has been measuring carbon footprints for more than a decade, and there is considerable expertise in this area in most developed countries and even some developing countries. Initially, these auditors would assign average carbon levels by country for each of the product groups. As the system matures, more refined product-by-product or firm data could be used.

There is surprising support in the policy community for a domestic carbon tax. But the question that its advocates dodge is the most fundamental one: How can we impose a domestic carbon tax to help ensure reductions in global GHG emissions, but remain competitive in world markets?

A carbon tax, by itself, can't do this. A complementary carbon tariff, however, would provide strong economic incentives for high-polluting, export-intensive emerging economies to reduce their emissions, whether they sign international climate-change agreements or not, and thus give Canadians more confidence that our greenhouse gas reduction efforts will actually make a difference.

Adapted from a March, 2008,

article in Policy Options.

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