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A federal carbon price demonstrates policy progress, perils

Paul Boothe is a fellow of the Institute for Competitiveness and Prosperity at the University of Toronto and a member of the Ecofiscal Commission. Mel Cappe is a professor in the School of Public Policy and Governance at the University of Toronto and a member of the Ecofiscal Commission. Christopher Ragan is an economics professor at McGill University and is chair of the Ecofiscal Commission.

For the past three years, the Ecofiscal Commission has been analyzing and proposing policies for Canada to address climate change. We take stock of recent policy announcements by considering the following six essential elements of an economically efficient climate policy.

1. A carbon price in all parts of the country. Economists overwhelmingly agree that a broad-based carbon price reduces greenhouse-gas emissions at a lower economic cost than "command-and-control" regulations.

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2. A similar carbon price across the country. Similarity in carbon prices ensures that high-cost reductions will not occur in one region while low-cost ones are unexploited elsewhere. A common carbon price also removes competitive disadvantages of businesses in higher-price jurisdictions.

3. A carbon price that gradually rises over time. To achieve our current emissions target for 2030, we will eventually need a carbon price of $125 per tonne or higher. To achieve even deeper reductions by 2050, the price will probably need to rise even further.

4. Well-designed complementary policies. Some parts of the economy do not lend themselves easily to carbon pricing. Well-designed regulations can complement carbon pricing and drive additional emissions reductions in a cost-effective manner.

5. Federal and provincial governments need to work together. Successful policy-making in Canada usually requires all levels of government to work together constructively. This is especially true for issues with shared jurisdictions, such as the environment.

6. Carbon-pricing revenue should remain where it is generated. To keep the focus on the essentials of carbon pricing as an effective climate policy, and not on other issues such as the overall scale of government or the interprovincial redistribution of resources, the associated revenues should stay in the province where they are generated.

Given these criteria, how does Canada's current policy landscape shape up?

The recent announcement by Prime Minister Justin Trudeau ensures that there will soon be a carbon price in every part of the country. The federal plan is to have a minimum price of $10 per tonne in 2018 that will rise to $50 by 2022. The announcement thus achieves point No. 1 above, and on point No. 3, the carbon price is clearly headed in the required direction.

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The announcement also indicates a preference for provincial action. Only if a province fails to implement a carbon price by 2018 will the federal government step in to do so. In addition, provinces are given flexibility in how they achieve their own carbon price. In the event of federal action in a province, the associated revenues will remain within that province. The federal plan thus achieves some important elements of point No. 5 and it certainly achieves point No. 6.

Although this looks very promising, the Prime Minister's announcement also leaves a few important issues unaddressed. There is no clear indication that the carbon price will increase to the level required to achieve the federal government's stated target for 2030. Point No. 3 is therefore only partly achieved.

There is also no indication that the plan will prevent large differences between the carbon prices in various jurisdictions. One option is to allow emitters to engage in interprovincial trade of emissions permits and/or pollution offsets. Common access to such markets, which would lead to financial flows between emitters in various regions, would align carbon prices and reduce the overall costs of emissions reductions in every part of the country. As things currently stand, however, point No. 2 is not achieved.

Finally, the federal announcement is silent on the role of complementary policies. If the carbon price rises high enough, no other policies are likely to be necessary, although we recognize an active debate on this point. In any event, no advance on point No. 4 was made with the announced federal plan.

The Canadian climate-policy landscape has progressed remarkably over the past decade. In 2006, no part of the country had a significant carbon price. By earlier this year, British Columbia had eight years of experience with a carbon tax, Quebec had a two-year-old cap-and-trade system, and Alberta and Ontario were each designing their own carbon-pricing systems. In addition, Manitoba had recently announced its commitment to implementing some form of carbon pricing. Despite this considerable progress, important policy gaps remained.

With Mr. Trudeau's announcement, the policy gaps will be filled, the minimum carbon price will be on an upward trajectory and the provinces and territories will have considerable flexibility in implementation. All carbon-pricing revenues will remain where they are generated. This is enormous progress.

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Yet important work remains to be done, not least in ensuring that the various governments continue working together constructively. The federal government needs to clarify the path of its minimum carbon price beyond 2022 to provide certainty for business investment decisions. All governments need to work toward preventing large gaps in provincial carbon prices, and they also need to think carefully about which policies are needed to complement and enhance the functioning of their carbon prices.

All things considered, the federal announcement on carbon pricing represented a significant policy advancement for Canada. It also revealed just how difficult it is in a federal system to design policy that is economically smart.

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