Benjamin Dachis is associate director of research at the C.D. Howe Institute.
The Ontario government has announced the details of its "climate-change action plan." Under the five-year plan, up to $8.3-billion would be spent on subsidies for renewable energy and low-emissions technology support. In doing so, the government has taken a U-turn from a wise cap-and-trade policy toward costly subsidy programs.
The government was on the right track previously by relying on a cap-and-trade program to price emissions. This is a cost-efficient way of reducing emissions because it reaches the desired goal by letting market participants figure out the best way to do so.
The government plans to finance the new subsidies with revenues from an auction for permits that greenhouse-gas-emitting companies must buy.
The new subsidy program reflects a lack of trust by the government in its cap-and-trade policy. That lack of trust might become an expensive self-fulfilling prophecy. Subsidizing low-emissions energy use will reduce the demand for emissions permits, which will reduce the price of permits. A lower price for permits will make the cap-and-trade system less effective at reducing emissions because the price will not motivate as many polluters to reduce emissions.
A lower price for permits also means less revenue than expected to pay for the new subsidies. The government would then need to finance the subsidies from general revenues. That means either higher taxes or a bigger deficit if the government keeps the subsidies. In other words, a more costly system to reduce emissions will crowd out the less costly system.
To illustrate, some of the programs announced this week have eye-watering costs per tonne of emissions reduced. For example, subsidies to retrofit apartments will cost as much as $900-million. They will cost taxpayers $425 per tonne of GHG emissions reduced. What kind of economic analysis did the government do to conclude that was a cost-effective means of reducing emissions? The cost of reducing emissions is lower elsewhere: $30 a tonne in British Columbia's case.
Other announced programs will not have a direct cost to taxpayers, but will be costly to drivers, homeowners and businesses. The government is planning to boost the amount of renewable content in gasoline and natural gas. Renewable-fuel mandates push the cost onto consumers and are an economically expensive way to reduce emissions.
What should the government do instead? Some subsidies for low-emissions technology can make sense. But not the type Ontario is planning.
The beauty of a cap-and-trade program is that the government does not need to decide which technologies hold the most promise for reducing emissions. The Ontario subsidy plan makes that decision instead of leaving it to the market.
The government should focus instead on subsidizing early-stage research and development. It should encourage people and business to innovate when they would not have done so even with a cap-and-trade system. That would build the foundation for others to see further into a low-emissions future. Carbon pricing would do the rest, providing incentives for consumers and business to introduce cleaner technologies for the mass market – when they are ready.
Government policies should be targeted to the precise problems they intend to solve, and that only governments can solve. A cap-and-trade program can directly target emissions. Subsidies for research and development solve a key problem: It's hard to make quick money from research with applications in the distant future. The subsidies the government will apply across the economy will only make Ontario's goals of reducing emissions costlier to meet, compared with a more robust reliance on cap-and-trade.
The government needs to think harder about how it should build a low-emissions economy. It should put its cap-and-trade program first, and scale back the ineffective subsidies.