Market Overview

What British Columbia Can Teach the World About Climate Change

During the first two weeks of December 2011, representatives of the member states of the United Nations gathered in Durban, South Africa, to attempt to strike a legally binding deal limiting carbon emissions.

They produced an agreement that requires a comprehensive treaty to replace the Kyoto Protocol to be negotiated by 2015. After the abject failure of the much hyped Copenhagen conference in 2009, this was a somewhat encouraging result.

However, in order for an effective deal to be reached, world leaders will have to be convinced that emission reductions can be achieved without serious economic side effects. A program launched three years ago in British Colombia ("BC") introducing a unique tax structure to carbon emissions could offer hope. By showing that emission restraints can work without excessively slowing growth, it paves the way for solutions to the climate change problem.

Before discussing BC’s program, a quick primer on the economics of emissions reduction: Carbon dioxide emissions are a classic example of a negative externality. Externalities are costs or benefits of an economic transaction – such as global warming caused by carbon emitted during production – that are borne by third parties not involved in the decision of whether to make the transaction. Since the effects of carbon emissions are global, every economic activity that emits carbon causes a global externality.

Emissions are therefore ‘cheap’, in that their true cost is not all borne by the buyer or the seller. The price paid will not reflect the true cost of the transaction, and so more emissions producing transactions will happen than would be ideal for society as a whole.

The goal of current government policy is then to intervene in the market and lower emissions. There are three main proposed ways to solve this issue: emission limits, carbon emission trading markets and carbon taxes.

The first is simply legislating a limit on carbon emissions. The Environmental Protection Agency in the US already sets national emission standards for cars, for example. Regulating carbon emissions has serious drawbacks though. Legislated standards do not take into account market forces, so it is very difficult to determine the optimal level of the good that produces the externality.

Regulations inevitably create ‘deadweight loss’, the loss of utility caused by shifting from the effeicient market outcome to a less efficient one. Unless the regulations are set exactly right, either the deadweight loss will be greater than the externality cost and the economy would be better off unregulated, or the regulation will not be strong enough and the externality will not be completely covered. For something affecting as many industries as carbon regulations, it would be almost impossible to set rules that would not miss their targets and cause excessive economic damage.

Carbon markets, the second option, work by creating ‘emission credits’, sold or handed out by governments, which polluters must buy to cover their emissions. Businesses that pollute are forced to consider the cost of buying credits, and so the externality cost is ‘internalized’, or brought into the transaction. This distorts markets less, because it allows pollution that produces enough value to be worth buying credits for, and forces cuts among activities that are less profitable and therefore not worth the cost.

This was the method chosen by the European Union, which implemented the Emissions Trading Scheme in 2005. Results have been unimpressive. Prices have stayed low as there is a chronic oversupply of credits, according to data from Reuters. This highlights a problem with carbon markets: since the government must set the number of credits available, it runs into the same difficulty in determining the ‘right’ amount of emissions as regulation does. There have also been numerous instances of fraud, including a discovery by London’s Telegraph newspaper that the Hungarian government was selling the same credits multiple times to raise more money.

As a result of poor management and fraud, the European Commission’s report on the first three years of the market found that total emissions actually rose by two percent, despite a serious recession.

Finally, carbon taxes do exactly what their name would suggest and place a tax on emissions of Carbon dioxide. The advantage of carbon taxes is that they are very simple to implement. The government does not have to worry about setting exact emissions targets, and the tax can simply and uniformly be applied to every carbon emitting activity in the economy.

Ian Bruce, an environmental consultant at the David Suzuki Foundation, says that carbon taxes are the most powerful tool available to fight emissions. Instead of creating an artificial market for carbon subject to government manipulation and mistakes, taxes include the costs of emissions directly in already existing markets.

They still impose a deadweight loss on the economy, because they cause actors to make decisions they would not in a free market, but if the tax is well administered it is likely to be smaller than for other options. That is where Canada comes in.

In 2008, British Colombia introduced a carbon tax, beginning at CAN$ 15 per tonne of Carbon dioxide emitted and increasing by CAN$ 5 per year until it peaks this year at CAN$ 30. Taxes were to be paid by consumers of any fossil fuel in the province, including businesses and individuals. In order to decrease the harmful effects of the tax on the economy, the plan was designed to be revenue neutral. The carbon tax was offset by a one percent cut in the corporate tax rate to help business and a two percent cut in the two lowest income tax brackets because the poor spend proportionately more on polluting necessities like fuel and electricity. Other countries have imposed carbon taxes before, notably Sweden in 1991, but BC’s is unique in covering all fuels with a flat rate.

Three years into the program, the results are very promising. The Economist reported in July  2011 that the CAN$ 25 per ton price was more than twice the going rate for credits on Europe’s market. That high price means strong incentives to cut emissions. Research by Stewart Elgie of the University of Ottawa found that per capita fuel consumption in BC has fallen by 4.5 percent relative to the rest of Canada since the introduction of its new carbon tax.

So even accounting for the recession, which hit the rest of Canada as well as BC, the tax has caused a significant decrease in emissions. Elgie’s research also concluded that there was no significant economic slowdown caused by the tax. In an economy like BC’s, with large oil, forestry and agriculture sectors that all emit carbon, that is impressive. It suggests that countries can phase in carbon taxes that will have a real impact without huge economic damage.

Probably the most important and surprising result of BC’s experiment, however, is that it is popular. A Pembina Institute poll in July found that almost 70 percent of British Colombians supported the tax. For a tax, that is outstanding.

If world leaders conclude that a carbon tax can be a political winner, and not the electoral poison it is assumed to be, it could help solve the international deadlock on climate policy. Other governments, at home in Alberta and Quebec and abroad in Australia, have brought in their own taxes. There are still a lot of hurdles between where we are and a comprehensive global solution to climate change. But BC’s example demonstrates that workable solutions do exist, and offers real hope for further progress.

By Thomas Mullie

The original article can be found at www.WesternESA.com

The following article is from one of our external contributors. It does not represent the opinion of Benzinga and has not been edited.

Posted-In: Global Economics Markets

 

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