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In Search of the Double Dividend: Carbon Revenue Recycling
Revenues derived from government environmental policies to reduce carbon emissions should be used to increase efficiency of the tax system. Such a focus could lead to both environmental and economic benefits, according to a recent
Carbon Revenue Recycling – Opportunities and Challenges examines the benefits of “recycling” carbon revenues into the economy to offset the economic costs incurred by reducing emissions. Revenues can be generated through either a tax on carbon emissions or a cap and trade system. The concept of recycling those revenues involves applying them toward reductions to other forms of taxation.
“Carbon pricing mechanisms, if set properly, can actually lead to a
The paper points out that any tax system creates distortions to underlying economic agents, reducing the economic gains from work, investment and savings and, as a result, impacting the decisions made by individuals and businesses. New measures, such as environmental regulations may exacerbate those distortions through what is known as the tax interaction effect. But if budget revenues from carbon policies are used to reduce inefficient taxes, the efficiency of the overall tax system is improved and unintended impacts are lessened.
Carbon taxes and cap and trade systems are two of five categories of policy instruments available for reducing and controlling carbon emissions, however they are the only two that generate revenue. While the concept of a carbon tax is straightforward enough, a cap and trade system generates revenue by creating transferable property rights for carbon emissions, whereby permits may be sold or auctioned to emitters. A market is then established enabling carbon emitters to trade permits.
The other non-revenue-generating policy instruments available are: regulations to limit carbon emissions, subsidies to polluters to assist them to reduce their emissions, and voluntary guidelines and consumer education. Another advantage to carbon taxes and cap and trade systems is that they are also market-based instruments, meaning that they place a price on carbon emissions and are therefore more likely to lead to voluntary behavioural changes from consumers and businesses. (Subsidies are also categorized as market-based.)
“Given that measures to reduce carbon emissions are often accompanied by economic costs, the opportunity to at least partially offset those costs through revenue recycling would be desirable,” says Lefebvre. “However policy makers usually have other objectives to weigh beyond the efficiency and cost-effectiveness of a particular policy instrument. And while the choice of revenue generating instrument is one part of the equation, the revenue recycling option is even more of a challenge for policy makers because there is not much relevant Canadian research available.”
A body of research work, including a previous CGA-Canada Issue in Focus paper (Is Cutting the GST the Best Approach?), has demonstrated that taxes on personal and corporate income impose higher efficiency costs and higher marginal costs to society than consumption or payroll taxes. Therefore, applying carbon revenues to reductions in personal and corporate income taxes would be the likeliest way to achieve a double dividend.
Or so the preliminary research would suggest. As Lefebvre points out, there is a lack of Canada-specific research into the subject of revenue recycling and no clear conclusions from the existing international body of theoretical and empirical studies.
“It is important for Canada’s policy makers to have Canadian data to guide them in their decisions,” says Lefebvre. “Research shows that when successful policy measures in one country are applied to another, the results may differ. It depends on a range of variables such as the structure of the country’s tax system, the diversity of its economic base, and the cultural factors that may influence the behaviour of consumers and businesses.”
Another challenge that must be overcome if we are to achieve a less distortive tax system is the apparent lack of political will. Despite clear evidence to the contrary, Canadian governments in recent years have introduced tax measures that increase distortions in the economy rather than reduce them. Yet addressing this challenge involves much more than informing the nation’s political leaders. It will also involve educating voters. Longtime disagreement over Canada’s Goods and Services Tax (GST) as well as recent controversy in Ontario and British Columbia over the introduction of a Harmonized Sales Tax (HST), suggest that consumers would prefer to pay hidden taxes rather than taxes they can see, even if the hidden taxes are less efficient and give them less discretionary income. Even British Columbia’s carbon tax and offsetting reductions in income tax rates – an approach based on the revenue recycling model – has proven to be divisive and controversial.
“It certainly does demonstrate the need for public education rather than marketing or political positioning,” says Lefebvre. “Clear, fact-based information needs to be readily available so people can make informed decisions on such important but complicated matters.”
One bright sign is that Canadians still see the environment as a priority, even in the current tough economic conditions. In a Canadian Press
“The current economic climate may make carbon revenue and revenue recycling policies more challenging from a political point of view, but from an economic point of view it doesn’t matter,” says Lefebvre. “Since revenue recycling addresses the distortions in the tax system, efficient tax policies work well in both good economic conditions and bad.”
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