5.0 The Design of Carbon Pricing Instruments

An instrument to implement a price on carbon emissions is the central element of a carbon pricing policy to achieve Canada’s emission reduction targets at least cost. Design of a pricing instrument, however, is complex. There are multiple dimensions to carbon pricing policy design, and policy makers must make design choices in several key areas. This includes choosing to balance emission price or reduction quantity, determining how revenue from the policy will be used or permits allocated, or including or excluding mechanisms such as border adjustments.

To achieve cost-effective reductions, a carbon pricing instrument must implement a unified price signal as broadly as possible. Detailed design choices for the pricing instrument can affect how well this unified price signal is applied. Yet the design must also address risks of adverse competitiveness and distributional effects (these possible impacts are discussed in Chapter 8.0). The design problem is challenging, however, because design choices involve trade-offs for how well the policy addresses these different and competing issues.

This chapter assesses how various design decisions affect how carbon pricing policy can 1) provide broad, uniform coverage, and 2) address adverse competitiveness and distributional impacts. To evaluate trade-offs between alternative design choices, five evaluation criteria set out in Section 2.2.1 are used. Not every design choice has implications for every evaluation criteria, so only relevant trade-offs for each section are described.