Ecofiscal Policy: Better environmental and economic outcomes

TheFutureEconomy.ca: Please introduce us to Canada’s Ecofiscal Commission.

Christopher Ragan: We are a group of economists united by the belief that there is a need for better environmental and economic policy. We consider environmental degradation a serious problem worthy of a good policy solution, but we also look at Canadian policies and we think most of them are not very good. Most of them do not use the pricing principle and are instead based on “command and control” regulation, which may be effective at reducing pollution but tends to have a very high cost. If we care about both the economy and the environment, then we must make sure our environmental policies have the lowest economic cost possible. These policies tend to be the ones that use market forces and are based on pricing. It is this very simple vision that brought us together.

“We could have far better environmental and economic outcomes if we taxed pollution more and income and profits less.”

We are a self-appointed commission that isn’t funded by governments; we are funded by a combination of family foundations and corporations. We are completely independent of government, political parties and political platforms. Everything we do is directed at researching and analysing, but also at advocating in a very practical way, the greater use of ecofiscal policies; those that price pollution and recycle the revenues back into the economy. Every report we write is focused on pricing pollution and recycling revenues. Whether we are talking about water, traffic congestion or carbon emissions, it is all the same basic principle. But we are trying to apply it to different situations and be very practical about how these policies can and should be designed in the Canadian setting, whether we are talking about municipalities, provinces or the federal government. We have a six-year mandate, which we are now halfway through, so our current plan is that we come to an end in December 2019. We are therefore writing reports and talking to the media, elected officials, unelected officials, policymakers, policy wonks and others. We speak to these groups and others about why these policies should be pursued, how they work and how they can be designed.

TFE.ca: Does ecofiscal policy mean increased government intervention?

No, it does not mean increased government intervention but it does mean different government intervention. What we consider the essence of ecofiscal policy is putting a price – we can call it a tax if we like – on pollution, whether we are talking of residential garbage by the bag or tailpipe emissions or carbon emissions by the tonne. So that suggests increased government intervention because those prices are not in place right now. But the reason why I say it is not increased government intervention is because we can recycle the revenues back into the economy. And one of the best ways to use these revenues is to reduce existing, highly distortionary taxes such as personal income taxes or corporate income taxes. We could have far better environmental and economic outcomes if we taxed pollution more and income and profits less. So it is not about bigger government, it is about smarter government.

“Smart policy harnesses the power of markets, and that is what pollution pricing is all about.”

TFE.ca: How can we achieve both environmental and economic goals in a practical sense, especially considering Canada largely depends on carbon intensive industries?

There are at least two objectives that are relevant for this discussion. The first is that we want a strong and growing economy because that is what gives us the prosperity we value. The second is that we also want a clean and healthy environment because it provides crucial services in the short run and it is also very much connected to our economic prosperity in the long run. So to me, the question is how do we have both a prosperous economy and a healthy environment? My answer and the Ecofiscal Commission’s answer to that is that we have to do it with smart policy. To me, smart policy harnesses the power of markets, and that is what pollution pricing is all about. So again, putting a price or a tax on various kinds of pollution would allow us to reduce taxes on income and profits and that will give us both better environmental outcomes and better economic outcomes. So the economy and the environment can go hand-in-hand if we approach it with smart policy, but if we don’t, then they can actually be opposed to one another.

“I am fully in favour of Canada continuing to produce oil as long as the world wants to buy it […] and I think that is 100% consistent with also being in favour of nationwide carbon pricing – which sends a market signal to consumers and businesses to change the way they do things.”

TFE.ca: What does that mean for Canada’s oil and gas industry in terms of its growth potential?

Let us consider this on a global scale. The world uses roughly 95 million barrels of oil every day – produced, shipped and consumed. That number is going to rise before it starts falling. If we look at the credible projections, the world will still be using millions of barrels of oil per day 10 years, 20 years and even 50 years from now. I think oil consumption will be on a declining path and that in 2050 we will be using less oil than we are now but we will still be using some oil. As long as the world is going to continue to use oil and other fossil fuels, then I think it is entirely reasonable that Alberta, Saskatchewan and Newfoundland try to supply some of their oil to the world. The problem here is that Canadian oil, for the most part, and especially the oil sands, is relatively high cost oil. So if Canada wants to secure its place in the world’s supply of oil, then it needs to make sure that its oil is competitive with oil elsewhere in the world. It can do that by driving down its cost, by being more innovative and by reducing its emissions because in a world where carbon is being priced inexorably more and more every year, then there is going to be a payoff from reducing our carbon intensity. I do not think that is easy by the way, but I think it is absolutely possible. So I am fully in favour of Canada continuing to produce oil as long as the world wants to buy it; I am also in favour of building pipelines so that we can get that oil to market; and I think that is 100% consistent with also being in favour of nationwide carbon pricing – which sends a market signal to consumers and businesses to change the way they do things. So we can have an oil industry but we can also be mindful of how we produce and consume the product. Most of the oil that we produce in this country is being exported, so we can have an oil export industry but we can still have a carbon price that changes the way we consume and produce domestically.

TFE.ca: Are there other sectors in Canada for which you would draw a similar conclusion?

This would apply to almost any carbon intensive industry, such as the cement industry, the steel industry, the aluminum industry or the fertilizer industry. All of those industries are very carbon intensive and they are participating in a globally competitive environment. I would say that as long as there is a global demand for those products, and there will be for quite some time, then Canadian firms will be rightly interested in supplying that global demand. But we can do that at the same time that we are mindful of the way we both consume and produce these products domestically.

“As long as there is a global demand for [carbon intensive] products, and there will be for quite some time, then Canadian firms will be rightly interested in supplying that global demand.”

This raises a very important issue about Canada pricing carbon while our trade competitors are not; we are ahead of some countries and behind other countries on this, but if we are going to be ahead of countries how do we deal with the competitiveness question? It is a huge issue that cannot be swept under the carpet, but there are effective ways to both price carbon and deal with the competitiveness of our emission-intensive sectors and I would say Alberta, Ontario and Québec are basically already achieving this.

TFE.ca: What impact do you expect climate-driven policy to have on Canadian competitiveness, especially in a post-Paris and Trump administration era?

What we really mean by “competitiveness” is the ability of our sectors and firms to compete with those from other jurisdictions. So we are not really talking about the large part of the service sector that is directed at the domestic market. We are really talking mostly about firms that produce goods and sell them into international markets while competing against rivals from other jurisdictions. In this category are sectors such as steel, aluminum, oil, cement, base metals, fertilizer and others. We call these kinds of industries ‘Emissions-Intensive Trade-Exposed’ (EITE). If we are going to implement a carbon price across this country – and we are in the process of doing just that – then it will have a direct impact on costs for firms in those sectors. By definition, they are emissions-intensive so there will be a relatively large impact on their cost and if their foreign rivals are not facing the same carbon price, then that is a serious challenge.

“There are effective ways to both price carbon and deal with the competitiveness of our emissions-intensive sectors.”

The secret to this is not to avoid carbon pricing but to put a carbon price in place to send that powerful market signal for people to change the way they do things and to reduce their emissions. At the same time, we can address the competitiveness impact directly. Alberta is designing something called ‘output-based allocations’ and the federal government is also planning something similar in case some provinces don’t implement their own carbon price. It is basically an output-based subsidy to be provided to these emissions-intensive firms. So there are really two things in place: there is a carbon price that produces the incentive to reduce the emissions but there is also an output-based subsidy that gives companies a financial incentive to maintain production rather than to shrink and to lose market share to our foreign rivals. That combination of a carbon price with some form of output-based subsidy is what Alberta is currently planning, it is what the federal government is planning if its carbon price should come into effect, and it is what Ontario and Quebec are currently doing by giving free permits within their cap and trade systems to the emissions-intensive sectors. This is a way that we can basically have our cake and eat it, too. We can have an economy-wide carbon price that does all the things we would expect it to do, but we can also deal directly with the competitiveness issue. So when people say Canadians cannot price carbon if the United States is not going to do it, I think they are quite wrong. What we have to do is be careful about the way we design those policies and I would say that Alberta, Ontario and Quebec are currently designing their policies precisely in a way that deals with that issue.

TFE.ca: Are there countries or other jurisdictions that have successfully implemented ecofiscal policies? How does Canada compare?

Yes. If you look at the Ecofiscal Commission’s first report called Smart, Practical, Possible, we gathered examples of various kinds from around the world. We can look at London and Stockholm that have used ecofiscal logic to price traffic congestion with tolls on their busy roads during busy times. In our view, that is a direct kind of ecofiscal policy. We can look at Malaysia that has priced water; in fact our next report is about pricing water and about why that is exactly ecofiscal logic which prices a scarce resource in a way that the market is not currently doing, and then recycling those revenues back into the economy. There is now carbon pricing in British Columbia, Denmark, and throughout the European Union with the European trading system; and there are even large pilot projects in China. There are jurisdictions that are pricing residential garbage by the bag. So there are many isolated examples from around the world with different types of applications.

“The secret [is] to put a carbon price in place to send that powerful market signal for people to change the way they do things and to reduce their emissions.”

I would say that overall, Canada is a little bit behind some of these countries by the following metric: if we look at the share of revenue that Canadian governments collect through some form of a pollution tax, it is lower than in some Western European countries. But I would also say that all of the countries are way behind where they could be. There is a powerful case for an overall tax shift whereby we considerably raise the share of revenues we collect from pollution pricing and simultaneously considerably reduce the share of revenues that we get from taxing personal and corporate income. When economists talk about distortionary taxation, there is probably no more distortionary tax than corporate income taxes, and those tend to be very bad for economic growth. So if we can move away from those distortionary and growth-retarding taxes, and move toward taxing pollution, that is what I believe lies at the heart of both better environmental and better economical outcomes.