5.1 Macroeconomic impacts are manageable

Our research and modelling shows that even with a unified carbon price signal, all sectors of Canada’s economy and national income will be larger in the future than they are now. On its own, we can expect Canada’s national economy overall to grow in the order of 40% by 2020, and 150% by 2050. With an efficient carbon pricing policy, the overall economy would likely be reduced in size from what it would have been by only about 1% to 3% in 2020 and 3% to 5% in 2050. This translates into a reduction in annual GDP growth of about 0.2% relative to an annual growth of about 1.5% to 2% between now and 2050.

Accordingly, under the proposed unified carbon pricing policy, there will likely be no major impacts on the demand for goods and services in the economy, productivity and labour markets, or real incomes. By 2020, domestic demand for goods and services could drop less than 1%. Changes in total exports and imports may change similarly with total trade volumes decreasing in the order of 1% by 2020. Over time, the composition of the economy will likely shift somewhat as less-energy-intensive sectors such as light manufacturing expand, while contractions in the size of energy-intensive sectors and some energy producers is correspondingly small.

With the sustained investments in low-emitting technologies triggered by the carbon pricing policy, both real wages and the labour supply increase relative to a world absent the carbon pricing policy, but likely only marginally. Because the quantity of goods and services supplied falls with increased labour, overall labour productivity declines, but again only by a small amount. Prices in the economy rise somewhat, reflecting the small scale of the necessary technology investments relative to the size of the total economy.

In our carbon pricing policy we discussed the use of permit revenues from auction to reduce the overall tax burden on businesses and households as a means of mitigating the macroeconomic impacts of carbon pricing. Table 1 provides an overview of how the macroeconomic impacts could be mitigated through improving the efficiency of Canada’s tax system:

• Cuts in corporate taxes stimulate growth and “return” more of the lost GDP and economic output than reducing labour and payroll taxes. Corporate tax cuts implemented with the carbon pricing policy can significantly reduce the GDP impact and can therefore be an option to address competitiveness concerns (discussed below).

• Cuts in labour (including personal income) and payroll taxes do not stimulate as much growth as cuts in corporate taxes, but they assist with mitigating impacts on wages and the size of the labour force. Cuts in labour taxes can therefore improve the adverse impacts on households from the carbon policy.

5.2 Competitiveness Issues Are Limited But Significant For Some

The seemingly small national macroeconomic impacts mask some impacts on segments of the economy that may be more significant. This suggests a “tale of two economies,” highlighting variability in the likely competitiveness impacts of a carbon pricing policy in different sectors. On one end of the spectrum, non-emissions-intensive and non-trade-exposed sectors (such as the service and some light manufacturing industries) will face small competitiveness implications. At the other extreme, emissions-intensive and trade-exposed sectors (such as industrial non-ferrous smelting) will face more substantial competitiveness risks. This indicates a concentrated exposure for a small segment of Canada’s total economy.

This tale of two economies stems from the reality that for 60% of Canada’s economic output, energy costs account for less than 2% of total costs, while only 12% of all economic output is from sectors that have energy costs greater than 5% of total costs. Also, some sectors have large shares of output traded and high import competition. While this indicates some trade exposure due to carbon pricing in Canada and not in other jurisdictions, many of Canada’s top trading partners, representing 86% of Canada’s exports and 72% of its imports, are actively considering implementing carbon pricing policies before 2020. The specifics of the design and in particular the stringency of these policies, however, remain uncertain.

Under our proposed carbon pricing policy, these competitiveness-exposed sectors could continue to grow, albeit at a slower rate than the rest of the economy. Still, relative to today, it seems feasible that with an efficient carbon pricing policy, the large industrial emitters, who account for about 20% of all economic activity, could be 1.8 times larger in 2050.²²We do note, however, that the transition to this outcome could still result in medium-term impacts that are significant for some. Some highly traded sectors such as iron and steel, cement, aluminum, and pulp and paper would likely experience larger impacts, with slow to negative growth rates between now and 2020.

Our main conclusions on competitiveness are as follows:

• Overall, net impacts of competitiveness issues on the Canadian economy as a result of carbon pricing policy will likely be small.
  
  
• In the short-to medium-term, domestic climate policies and carbon pricing policies can be expected to be implemented by many of Canada’s trading partners, moderating the direct impact of competitiveness issues arising from carbon pricing policy alone.
  
  
  
• With implementation of a carbon pricing policy for Canada, competitiveness and leakage risks change over time. Risks tend to be largest in the medium-term, as the stringency of the policy is increased, but decrease after international linkages harmonize prices with major trading partners.
  
  
  
• Some sectors of the economy will be more positively impacted (e.g., electricity generation, office machinery and equipment) while others will be more negatively impacted compared to no change in climate policy (e.g., the natural gas, refined petroleum, and crude oil sectors).

In the carbon pricing policy, permit allocations are proposed as one measure to address competitiveness, with firms that can demonstrate financial hardship able to gain free allocations instead of purchasing permits though auction. This may not be sufficient by itself, especially prior to 2020 when major trading partners may not have imposed similar carbon costs on their industries. Some other short-term measures may be required, such as using auction revenue to reduce corporate taxes. These options are discussed in more detail below.

5.3 Distributional Impacts For Some Households And Communities Will Create Challenges

A story similar to that of competitiveness can be told about households. Carbon pricing alone may have a disproportionate impact on low-income households and equitable carbon pricing policy should address this issue. Revenue recycling mechanisms can be used to reduce or reverse regressive distributional effects, as discussed in section 5.5.

We assessed the impact of fast and deep carbon pricing on Canadian households in 2020. Data from Statistics Canada shows that income groups differ in their consumption patterns, and that as a result they differ in their production of greenhouse gas emissions. In general, higher-income households are responsible for more greenhouse gas emissions than their lower-income counterparts. The highest-earning 20% of Canadians are responsible for approximately four times more greenhouse gas emissions than the lowest-earning 20%. This means that under a uniformly applied carbon pricing policy, highest earning Canadians would pay four times more. But this group earns six times more income than those at the opposite end of the spectrum, so the amount paid by higher earning Canadians would be smaller as a proportion of all income. This explains why some believe carbon pricing to be regressive.

Given income constraints, lower-income households are also less able to adjust their behaviour and spend on technology or energy efficiency measures in response to a price. Illustrative modelling conducted by the NRTEE estimates that lower-income households could pay nearly twice as much as higher-income households as a proportion of income, even though the price of carbon will cost less to them in absolute terms. For the 20% of Canadians with lowest income, a carbon price of $100 per tonne in 2020 would add approximately $1,000 a year to living costs, or just over 3% of their average disposable income ²³(Figure 17). It is important to note, however, that these costs assume no change in behaviour or use of new technology so they could be less.

Carbon pricing will also affect households differently depending on the type of community—rural or urban. The average rural household will likely pay nearly 20% more, as a proportion of income, than inhabitants of major cities with populations greater than 500,000. Different effects drive the variation in relative financial impact of urban and rural households. First, on average, rural Canadians have lower incomes than urban Canadians. And while carbon pricing will have a disproportionate impact on lower-earning households, such analysis needs to take all discretionary income into account. Costs of living tend to be lower in some rural areas with higher levels of home ownership and lower property taxes, for example. Second, rural lifestyles may be more emissions-intensive in some cases, with limited access to public transit and in many cases greater distances to travel to access services. The data does not support a conclusion about which of these effects (differences between income and differences in lifestyle) is more significant.

Northern and remote communities face a particular challenge from carbon pricing. Prices of goods and services in many remote communities are already heavily influenced by the costs of energy, and carbon pricing will add to these transportation costs. Using the Northwest Territories as an example, it is noted that electricity prices for households there are typically at least three times higher than those in Vancouver or Winnipeg. Figure 18 shows the different impacts relative to income for rural and urban communities.

Clearly, important impacts can be expected on some households with the carbon pricing policy implemented. Our assessment indicates that as carbon prices rise, these impacts will become more acute unless mitigating action is taken. This indicates an ongoing and sustained need for income support measures delivered directly or through the tax system for some adversely impacted households, rather than outright exclusions from carbon pricing impacts that would make Canadian policy more inefficient and costly.

 

5.4 Technology Deployment Is Crucial To Success

Our research and analysis demonstrates clearly the positive impact carbon pricing has on fostering technology development and deployment. This is crucial for generating the investment needed to develop and deploy new low-carbon technologies particularly in the energy sector. With carbon prices rising to $100 per tonne of CO₂e by 2020, and upward of $200 per tonne CO₂e by 2050, we can expect a significant incentive to deploy low emitting technologies. Our research suggests that with carbon prices at this level, behavioural change and technology choice will be influenced to levels that can decouple energy use from emissions, while sustaining national income and a vibrant economy. Under our unified carbon pricing policy, Canada’s emissions intensity (or emissions per dollar of GDP) will decline in the order of 35% by 2020, and 75% by 2050 relative to what would happen absent the carbon pricing policy. At the same time, we could maintain or increase energy use relative to a future without the carbon pricing policy in place, increasing the amount of low-emitting energy used to produce goods and services in the economy (Figure 19).

The scale of the transformation and the underlying technology deployment to achieve this decoupling should not be underestimated. The necessary investment throughout the economy may need to increase by $2.2 billion per year in the medium-term and $2 billion per year thereafter.²⁴This could mean that capital expenditures on low-emitting technology would be 5% higher annually than they otherwise would have been between now and 2030, and 7% higher annually in the longer-term. Much of these expenditures must occur in the electricity generation and biofuels manufacturing sectors with significant outlays in industrial sectors for CCS. While most sectors can expect an increase in investments, decreased investment in the transportation sector is also likely due to a shift toward smaller, less expensive vehicles as well as movement toward greater use of public transportation.

A few notable technology trends are worth mentioning (and are highlighted in Figure 20):

• The electrification of the economy. The economy will not only reduce its dependence on fossil-generated electricity, it will also significantly grow the quantity of non-fossil-generated electricity produced. In our drive to decarbonize, we will use electricity more widely in our industrial processes, in transport, and in our buildings. Our modelling analysis suggests that the electricity sectors will grow under the carbon pricing policy by 25% above forecast levels by 2020 and 50% by 2050. All of this will need to come from a comprehensive portfolio of low- or zero-emitting generating technologies, notably CCS, hydroelectric power, nuclear energy, and renewables. A movement to low- or zero-emitting generation is therefore an important cornerstone of the electricity sector transformation. To ensure that electrification is sustainable, however, it will be necessary to reflect the full economic, environmental, and social costs of generation and transmission. Figure 20 reflects this trend with significant investments required in new low-emitting generation. This electrification will lower the investment costs for many sectors as fossil fuel energy equipment tends to be more expensive than electric. However, these gains are offset by rising electricity costs relative to the fossil fuel alternatives.
  
  
  
• Output changes alter investment patterns. With changing demand for low-emitting carbon products, some sectors such as industrial minerals and petroleum refining will see a drop in investment as the sector contracts. Other sectors, such as biofuels and electricity generation, will see large increases in investment as demand for their products increases with the carbon pricing policy.
  
  
• Investments in CCS and fuel switching. Carbon capture and storage will be widely deployed in large industrial sources with the implementation of the carbon pricing policy. This will be particularly concentrated in the west and to a lesser extent in Ontario, and in the oil and gas and electricity sectors and some industrial applications. With this deployment comes the need for more energy to capture and transport carbon for storage. This increased energy use explains the increasing energy trend in Figure 19.

But electrifying the economy with low-emitting technologies will not be enough. Significant technology rollouts must occur in virtually every corner of the economy and society. Figures 21 and 22 suggest that no single technology will provide the required reductions, but instead a suite of almost all available emission-reducing technologies must penetrate the market. The carbon pricing policy will also accelerate current low-emission trends in a number of key sectors including buildings, pulp and paper, transportation, aluminum manufacturing, and goods and services. Market penetration of current hybrid electric vehicles, for example, is a transition to increased penetration of plug-in hybrid and zero-emission electric vehicles. Similarly, current biofuels used for transportation will eventually need to be phased out as cellulosic ethanol is accelerated with investment certainty through carbon pricing.

Despite these forecasts, we recognize that technological change is inherently uncertain. We do not conclusively know what emissions reductions will ultimately be needed or what the corresponding prices will be. There is also uncertainty as to the costs of large-scale deployment of currently existing technologies, much less when breakthrough technologies might arrive, or to what degree the costs and/or quality of existing technologies will be improved. These kinds of uncertainties can create a tension among policy recommendations. On the one hand, government policies should be as neutral as possible to allow a broad range of technologies to emerge and compete, and to avoid the problem of governments attempting to pick winners. On the other hand, we cannot remain passive, given that we are largely aware of the major technological options that will be available over the next decades and know that some technologies have specific barriers and specific potentials that might require targeted assistance.

Our analysis also illustrates a carbon price alone is likely insufficient to drive the required technological change. Barriers to the deployment of technology represent a key issue that that is central to design and implementation. Addressing barriers to deployment can improve both the effectiveness and economic efficiency of policy by helping the market to function as it should. Not all barriers, however, are market failures, and using complementary policies to address additional barriers may in fact reduce the cost-effectiveness of a carbon pricing policy. Further, being technology prescriptive, or trying to “choose winners” through policy increases the costs of carbon pricing policy.

5.5 Smoothing the Transition with Auction Revenue

All the impact issues we have identified can be mitigated to varying degrees by the expenditure of auction-generated revenues. It can smooth the transition. Our analysis suggests that a full carbon permit auctioning system could generate revenue of approximately $18 billion in 2020, and $3 billion in 2050 (in today’s dollars) based on our carbon price path of $100 in 2020 and $200 in 2050. Using a forecast of government revenue in 2020, the $18 billion would be equivalent to about 16% of total federal government receipts or all corporate income taxes.²⁵This is a very large amount and points to a need for a thoughtful policy approach in order to both maintain support for the policy once implemented (especially given perceptions of regional wealth transfer) and ensure that the revenue is used wisely and effectively to meet our sustainability goal of deep emission reductions in the most cost-effective way possible.

An important consideration is that there will be different needs for revenue during different phases of the transition. With low carbon prices in the initial fragmented period, there will be a need to further stimulate the deployment of low-emitting technology to better align with the longer-term objectives. Similarly technology research and development takes time to become an innovation, and so early financial support is critical. Over time, the carbon price signal remains the most potent driver of technological innovation. In time as carbon prices rise and negative impacts become more acute on businesses and households, using revenue to reduce the economic impact of the carbon price on each will be required.

Auction revenue could be used in each of the three transition periods as follows:

• The Fragmented Period. We see the need to initially use revenue to invest in low-carbon technology research, development and demonstration such as CCS. This is particularly the case in this fragmented period, where the carbon price is gradually increasing, and there is a gap between where the carbon price is and where it needs to be. This spending would help set the economy on the right path for expanding cleaner alternatives, and achieving the cost reductions needed for future deep targets.
  
  
  
• The Transition Period. In this period there will still be a need to invest in technology research, development, and demonstration. But with carbon prices aligning to deliver significant emissions reductions in 2020, and with broad-based carbon pricing and complementary regulations and technology policies taking root, the emphasis on direct financing of deployment will likely lessen. As auctioning is fully phased in during the transition period and carbon costs rise quickly, revenues will increase rapidly, but so too will the economic impacts. This means that a focus on compensating those most negatively impacted will need to occur.
  
  
  
• The Unified Period. In keeping with a need to focus on economic efficiency, the bulk of the revenue should be used to improve the efficiency of the economy as a whole and set the stage for sustainable growth alongside decarbonization. Our research indicates that if carbon pricing revenue can be used to offset personal income and corporate taxes, the overall economic impacts of the carbon pricing policy can be significantly reduced. This both maintains the strength of the carbon price, with the cap on emissions or the charge rate driving reductions, and reduces taxes to mitigate income impacts from higher energy prices. Our assessment indicates that a number of beneficial outcomes result from offsetting taxes, but most importantly allows the economy to continue on a path closer to that if carbon pricing were not followed. Indeed, reducing labour or income taxes can reduce by half, the impact on the economy.

In all periods, a portion of the revenues should be directed to offset harmful impacts to those subsets of the Canadian economy and its society that are likely to be disproportionately affected. At the same time, it is also the NRTEE’s view that the focus of auction revenue must first and foremost be aimed at meeting environmental targets, and by investing in low-carbon technologies that put our economy on a clear path to sustainable development, and not at regional wealth distribution or broad-based societal engineering. Effective governance mechanisms and processes will be necessary to ensure this goal is met.

« Previous -- Next »