National Post (National Edition)
Making a carbon tax work
Debate misses the important question
Thirty years ago, when Canada entered into negotiations on a free-trade deal with the United States, opponents of the deal knew, absolutely knew, that our economy could not possibly survive it.
Industries in Canada, they were sure, faced much higher costs than their American competitors, to pay for our vaunted social programs. Without the protective buffer that tariffs provided, they would be decimated — or we should have to jettison the policies that made up our distinctive Canadian way of life, to level the playing field.
It didn’t happen. The immediate effects of the trade agreement are hard to disentangle from the simultaneous campaigns against inflation and the deficit then underway, but the Canadian economy soon after embarked on two decades of uninterrupted growth, boosting median family incomes by a third after inflation.
Yet here we are, 30 years later, and another group of pessimists is just as certain Canada’s economy cannot survive another federal policy initiative: the carbon tax. Taxing carbon, it is claimed, in the absence of similar action in the U.S., will make it impossible for our industries to compete. Either we must harmonize our policy with theirs — i.e., do nothing — or suffer the usual biblical calamity.
Never mind that the same people would be opposed to a carbon tax even if the Americans already had one. Never mind, too, that the costs of the regulatory and subsidy schemes offered as substitutes are many times higher than even the most ambitious carbon tax proposals (see: coal phase-outs, below). Let’s just take the argument on its face. Can a country impose a carbon tax on its own, trade freely and stay competitive?
Or does one of the three have to go?
Continued from A1
Let’s go back to that earlier generation of pessimists. Why were they wrong? Because the impact of a change in policy cannot be assessed by simply comparing costs at a fixed point in time. That’s true for many reasons — when you change one thing, much else changes — but the biggest is the exchange rate: indeed, there is no way to compare costs between countries without it.
Exchange rates may jump about in the short run, of course, for all sorts of reasons. Still, other things being equal, if a country experiences a generalized increase in costs — a carbon tax, a.k.a. “the tax on everything,” would fit that definition — demand for its exports will drop, and with it demand for its currency, leading it to decline in value. Thus a good priced in Canadian dollars will cost less in American dollars — offsetting some or all of the original cost increase.
Yes, at any given exchange rate some industries will be able to compete, while others will not. That’s not a bug, it’s a feature: where it costs more to produce a thing in Canada, we would do better to buy it from others, offering in exchange the things at which we excel. But it is impossible that a whole economy should find itself unable to compete for long: if it were, the exchange rate would depreciate until it could.
People who get this as it applies to ordinary costs like labour or materials nevertheless often resist applying the same logic where the difference in costs is the result of some government action. Thus, a foreign government’s willingness to subsidize its exports is often treated as if the resulting cost differences did not “count,” leading to demands for countervailing duties, subsidies and the like.
Ordinarily this argument doesn’t stand up. The willingness of another country to subsidize its exports is as real as any other cost consideration. But can the same be said with regard to the costs of carbon? Are they costs like any other? That is, after all, the point of a carbon tax: to build into prices costs that had until now been left out.
But the costs that carbon taxes are meant to “internalize” — the contribution of carbon emissions to global warming — aren’t like other costs in the sense that they are not so much costs to Canada as to the planet. So even if we were selflessly inclined to impose a carbon tax on ourselves, whatever good we were doing might simply be undone by the shift of carbon-intensive production to the U.S. in response.
If so, that might be an argument for sparing particularly trade-exposed emitters from the full impact of the tax. It does not make the case for not taxing carbon at all.
Carbon taxes are not the only cost facing these firms. A lower dollar would be a deterrent to capital flight, but so would the savings from eliminating costlier carbon regulations — and from the income tax cuts that carbon taxes could finance. So it matters to this discussion which kind of carbonpricing model we are taking about: whether it is layered on top of existing taxes and regulations, as in the Liberal plan (as the just-announced directive ordering the phase-out of coal makes clear: wasn’t that the point of pricing carbon, to give people an incentive to switch from things like coal?) or is a replacement for them, as some conservatives have proposed.
If we are going to do this without the U.S., it is all the more essential that we do so at the lowest possible cost. The debate needs to shift: from whether carbon taxes should be part of the mix, to whether any other policy should be.