The Standard Way to Justify a Carbon Taxis to Look at Its Effectiveness at Lowering Emissions

Alex Sturges

Econ 398

Prof Guse

Proposal

Introduction

Climate change is a growing challenge that the world faces. The majority of scientists believe that CO2 emissions and greenhouse gases are leading to many health and environmental externalities. CO2 mitigation strategies need to be on the forefront of lawmakers’ minds; however, whether it is or not it is on their mind is another question for a different paper. When looking at possible methods to account for the negative externality of these emissions, many countries have elected to implement a carbon taxon Co2 emissions. Places such as Finland, Sweden, Great Britain, New Zealand and others have passed legislation regarding a tax on carbon emissions. More specifically in Canada, British Columbia introduced a revenue neutral carbon tax by adding in income and business tax cuts, which adds an element to the tax that may make it less harmful for the taxpayers. The government of British Columbia plans to make the tax progressive opposed to regressive, which is the major concern regarding carbon taxes. Opponents of a carbon tax generally point to its regressive nature as reason to not use a carbon tax. A regressive tax is a tax where lower income individuals pay a larger proportion of the tax relative to their income. A progressive tax is a tax where high income individuals pay a larger portion of the tax relative to their income. If the tax is more progressive then it will help lessen the wealth gap between the lower and upper class individuals. The British Columbia carbon tax was instituted in 2008 and in considered the most significant carbon tax in the western hemisphere.

The standard way to justify a carbon taxis to look at its effectiveness at lowering emissions. Instead I want to look at the cost distribution between income classes. The costs must be near equal and manageable for all in order for the tax to be justified. There is a concern that taxes of this nature will affect low income families more than high income families because the low income families need to spend a higher percentage of their income on goods that will be taxed. The low income families are not necessarily consuming more, but they are spending more relative to their total income.In British Columbia the government put several tax cuts in place to counteract this possibility. However,I want to find out if the carbon tax and subsequent tax cuts in British Columbia have led to an equal distribution of the costs.

There is a large discrepancy among emissions per person across income quintiles in British Columbia. The bottom quintile averages 30% less emissions than the average person, whereas a person in the top quintile averages 27% more emissions.[1] Therefore, people in the top quintile produce almost double the emissions as a person in the lowest quintile. For the top earners, there are many easy methods available to reduce their emissions; the proverbial low hanging fruit are plentiful for the picking. However, the lowest income individuals have a harder time reducing their consumption because they are already producing at a relatively low level.

A carbon tax may favor the upper echelons of the income distribution and be regressive for several reasons. Families with a higher income have an easier time upgrading their homes and cars to be more energy efficient because they have more disposable income at their control, making it easier to change behavior. Lower income individuals and families have a higher propensity to rent homes or apartments, making it difficult to reduce heat or invest in upgrades to make the dwelling more energy efficient. Lower income individuals generally have less ways to adapt and change behavior toward more energy efficient ways. Of course there is some discretion in all households, they can turn down the heat during the winter or drive less to reduce their carbon emissions.

Background

Other Provinces in Canada have made attempts to curb their carbon emissions. In 2007, Alberta implemented a cap and trade system for large emitters and Quebec instituted the first carbon tax in North America at $3 per ton of CO2 produced.[2] British Columbia’s carbon emissions are among the lowest of the Provinces in Canada at 15.5 tons per capita in 2005, which is much lower than the country level of 23.1 tons per capita. British Columbia’s carbon emissions are low because 93% of electricity is generated using hydroelectric power, opposed to carbon rich methods like coal.[3] Despite the low levels of emissions, carbon emissions were becoming a concern, growing at a rate of 30% between 1990 and 2005.[4]The carbon tax became the government’s method to mitigate carbon emissions came with the aggressive carbon tax in 2008.

The government in British Columbia announced that the Legislature would introduce a broad-basedcarbon tax in 2008. The tax would affect the purchase and use of fossil fuels in the Province including, gasoline, diesel, natural gas, heating fuel, propane, and coal. The carbon tax also is intended to tax the use of tires when used as fuel, like in the cement making industry.[5] The tax started at $10 per ton of Co2emissions. The tax has increased at a constant rate of $5 per ton of CO2 emissions a year andwill reach its maximum in 2012 at $30 per ton of C2 emissions[6]. A major aspect of the carbon tax is that it is revenue neutral, meaning that all the revenues from the carbon tax will be returned to the taxpayers through various tax cuts.

The government introduced several tax reductions aimed at the lower income groups. The introduction of a new Climate Action Tax Credit for low income individuals and families is designed to help repay a portion of the income lost to the carbon tax. Income tax rates were also affected as a method to make the carbon tax revenue neutral. For the two lowest provincial personal income tax rates received a 2% cut in 2008 and a 5% cut in 2009.[7] These tax cuts are an added measure to make the tax more progressive overall. The general corporate tax rate was reduced 1% to 11% in 2008. Also, the small business corporate tax rate changed from 4.5% to 3.5%. These corporate tax cuts are believed to help businesses develop, create new employment and grow the economy.[8] In addition to these more lasting effects, the government made a one-time climate action payment of $100 to each citizen to facilitate any lifestyle changes that will reduce the use of carbon emitting products, such as insulating one’s house to reduce the amount of fuel needed to heat the house.

There are several notable exceptions to the carbon tax. Any biofuels or renewable energies are not covered by the tax, which will encourage people to make the transition to these types of fuels to avoid the tax. Fuel that is exported out of the province will not be covered by the tax so the exports can remain competitive with market prices. Fuel purchased by commercial airlines and marine services are also exempt from the tax. These two services use an enormous amount of fuel and subsequently produce a large amount of CO2 and other greenhouse gases.[9] However, plane tickets are high enough as it is and the tourist and travel industries would take a large hit if these services were taxed.

Literature

There has been much research on the effectiveness of a carbon tax. In theory a carbon tax would equate the market price with the total social cost of carbon emissions and many papers have shown that this theory does work when implemented. The conclusion of a paper by Schnelder and Goulder, 1997, is that a carbon tax is the most economically efficient policy option available to law makers. In British Columbia, the Carbon Tax is still in its infancy and it is too early to see wide spread effects on carbon levels. It will be several more years before Co2 levels will be significantly effective and the people will notice the benefits like cleaner air.

In order to fully understand a carbon tax, one must look at the effects on the tax payers. Several papers look into the distributional effects of a carbon tax. The common determination is that the tax will be regressive unless at least a portion of the revenue is returned to the tax payers and specifically the lower income tax payers. Several ideas have been proposed and tested theoretically, including income tax cuts, lump sum payments, and corporate tax cuts along with others.

In British Columbia, authors have looked at the carbon tax over the past several years to attempt to measure its effects. When the tax was first introduced, authors attempted to project into the future its affects, and determined that the tax would end up being regressive. However, the majority of the studies I have seen on the carbon tax in British Columbia have had some major flaws that make their results difficult to believe. One author in particular, Marc Lee, from the Canadian Centre for Policy Alternatives, has focused on the tax over the past few years and has several papers specifically about the tax and about greenhouse emissions in British Columbia. Lee’s methods are sometimes dragged down by some poor assumptions, but he provides a solid base for my paper to spring from and improve on his method.

Method

In order to measure the equity effects of the carbon tax, I need to look at how much the different quintiles are spending on goods that are affected by the carbon tax. Previous papers have broken consumption down into two categories. The first category is direct consumption, which includes the purchase of fossil fuels used in the home or for transportation and the second is indirect consumption which have the use of fossil fuels imbedded in the cost. Previous papers have made the assumption that the different income groups have equal indirect consumption, which is not a good assumption. Higher income families have more disposable income to spend on indirect goods. Many luxury goods use a large amount of fossil fuels in production and are consumed mainly by the top earners. I need to find previous research that has measured the amount of spending on different goods. This paper will allow me to properly determine how much each income group spends on individual goods. To go along with the consumption per income group, I need information regarding how the carbon tax affects the prices of goods, especially the indirect goods. Papers that provide estimates of the increase in costs due to a carbon tax would allow me to provide an estimate for the increase in costs of goods in British Columbia. With these two pieces, I can estimate the amount of money that goes to the carbon tax per income group. Once I can provide an estimation of the proportion of income that different income groups spend on the carbon tax and if it is proportional between the quintiles.

Annotative Bibliography

Lee, Marc. "Fair and Effective Carbon Pricing: Lessons from BC." Feb. 2011. Web. 10 Oct. 2011. <

Marc Lee is an economist who has looked extensively into British Columbia’s carbon tax. Lee finds that the carbon tax is not revenue neutral as it was advertised but is actually revenue negative. Also, More than half of the tax revenue is going toward corporate tax cuts. The low income tax credit, designed to prevent low income families from paying proportionally more in taxes, has not kept up with the growing carbon tax.

This paper is helpful because it looks at my question and provides some initial findings that I can build off of. The author looks at the distribution of the tax revenues and finds that the low income families have to pay more, which goes against what the government is saying.

Duff, David G. "Carbon Taxation in British Columbia."Web. 10 Oct. 2011. <

This paper provides background information for the carbon tax in British Columbia. It gives a general overview of the tax and presents a summarization of the development of Canadian climate change policy. The paper also explains the structure of the carbon tax. My paper will benefit from this paper due to the large amount of background information provided. A large part of my introduction can come from this paper.

Lee, Marc, and Toby Sanger. "Is BC's Carbon Tax Fair? An Impact Analysis for Different Income Levels." Oct. 2008. Web. 10 Oct. 2011. <

This paper looks at the distributional effects of the carbon tax. The authors extrapolate into the future and determine that the carbon tax will favor the rich more and more through time. For the lowest income group, the tax becomes a burden on them by 2010, where it is still progressive for the top 20% of residents. This paper provides an outlook into the future of the carbon tax in British Columbia. I will need to look at updated data to see if the authors’ predictions are correct of not, but it is a good model I can look at when creating my own model.

Canada. Ministry of Small Business and Revenue.British Columbia Carbon Tax. Feb. 2008. Web. 10 Oct. 2011. <

This is the actual law passed in 2008.

M. Lee, By Our Own Emissions: The Distribution of GHGs in BC (Vancouver: CCPA–BC, April 2010).

This is a helpful article that provides some background information on the distribution of CO 2 emissions in British Columbia.

[1]Lee, Marc. "Fair and Effective Carbon Pricing: Lessons from BC." Feb. 2011. Web. 10 Oct. 2011. <

[2]Duff, David G. "Carbon Taxation in British Columbia."Web. 10 Oct. 2011. <

[3]Duff, David G. "Carbon Taxation in British Columbia."Web. 10 Oct. 2011. <

[4]M. Lee, By Our Own Emissions: The Distribution of GHGs in BC (Vancouver: CCPA–BC, April 2010).

[5]Duff, David G. "Carbon Taxation in British Columbia."Web. 10 Oct. 2011. <

[6]Lee, Marc. "Fair and Effective Carbon Pricing: Lessons from BC." Feb. 2011. Web. 10 Oct. 2011. <

[7]Canada. Ministry of Small Business and Revenue.British Columbia Carbon Tax. Feb. 2008. Web. 10 Oct. 2011. <

[8]Canada. Ministry of Small Business and Revenue.British Columbia Carbon Tax. Feb. 2008. Web. 10 Oct. 2011. <

[9]Canada. Ministry of Small Business and Revenue.British Columbia Carbon Tax. Feb. 2008. Web. 10 Oct. 2011. <