Four cap-and-trade myths, debunked

Four cap-and-trade myths, debunked

Beginning January 1st, 2017, Ontario will implement a cap-and-trade (C&T) system to help achieve its emissions reduction targets. Various stakeholders have presented their concerns regarding the incoming program. In advance of our upcoming Working Paper, Toward a low-carbon economy: The costs and benefits of cap-and-trade, we wish to debunk four popular myths about Ontario’s C&T system. 

MYTH #1: Cap-and-trade will kill the economy

Many fear that C&T will increase the cost of doing business in the province. However, the economic impacts of climate policies, such as C&T, will vary by region, design, and stringency of the cap. For example, a recent study by the EcoFiscal Commission found that less than two percent of Ontario’s economy is at-risk of competitiveness pressures as a result of carbon pricing. 

FACT: Cap-and-trade will have a small effect on the economy

If the system is designed optimally, we find that C&T will only have a minor effect on Ontario’s GDP growth rate. As a result, the average annual growth rate is predicted to fall from 2.08 to 2.05 percent (between 2015 and 2030).

MYTH #2: Cap-and-trade is a tax on everything

Some argue that C&T is ‘a tax on everything’ that hurts consumers, like a sales tax. This is understandable since most goods and services consumed contain carbon, if not in the product itself, carbon is emitted when goods are transported.

FACT: Cap-and-trade is a tax on some things (not everything)

C&T is more like an excise tax, specifically a sin tax, which is levied on goods and services deemed to be harmful to society (such as alcohol or tobacco, and in this case carbon). It is intended to shift consumer behaviour to less-carbon intensive forms of consumption. Rather than raising prices uniformly across all consumer goods and services, C&T changes relative prices. This is because carbon pricing increases costs proportionally to their carbon content—things produced using little to no carbon will not rise in price, whereas those containing heavy amounts of carbon will increase in price. For example, it will be more expensive to fill your gas tank, but the price of your movie ticket, dentist, hotel, accountant, or your monthly rent, are not going to change any noticeable amount.

MYTH #3: Firms that receive free allowances don’t have an incentive to reduce emissions

Many disagree with the Ontario government’s decision to issue free allowances to industries at risk of competitiveness pressures. The fear is that this promotes corporate welfare, reduces transparency, and submits to lobbyists’ demands. All these concerns are valid, and it is imperative that Ontario be transparent and fair when issuing free allowances.

A related concern is that firms receiving free allowances will not have an incentive to reduce emissions. This is severely misplaced.

FACT: Every firm, whether issued free allowances or not, has an incentive to abate

Regardless of whether firms are issued free allowances or not, there is an opportunity cost associated with pollution—namely the foregone profits from selling unused allowances. Since allowances can be sold to other firms, there will always be an incentive to abate if the cost of doing so is below the cost of the allowance.

Free allowances are actually highly effective at keeping emissions-intensive industries from shifting production to regions with weaker or non-existent climate policies. In other words, free allowances can improve the environmental integrity by adequately addressing leakage and reducing the greatest amount of global emissions.

MYTH #4: The government can do whatever it wants with cap-and-trade revenues

Members of the Ontario legislature have expressed concerns that proceeds raised through C&T auctions will not be used to fight climate change. Instead, they say, proceeds are a revenue grab and will be used to balance the books.

Bill 172, the Climate Change Mitigation and Low-carbon Economy Act (2016), states that all proceeds from Ontario’s C&T system must be used for initiatives likely to reduce carbon emissions. Although the Bill does include some vague language, the government technically cannot do ‘whatever it wants’ with the revenues.

FACT: Cap-and-trade will provide the government with a new revenue stream

The critics’ concerns are legitimate. C&T revenues can be used for projects that would have been funded through general revenues, such as public transit investments. Consequently, the program allows the Ontario government to free up general revenues for other purposes, such as paying down provincial debt. Since public funds can be ‘shifted’, C&T improves the government’s ability to balance the books.

Photo Credit: Petmal, Getty Images

Category: Environment, Public Policy