Fall 2018 update: Estimated impacts of the federal pollution pricing system

Key findings

Pricing carbon reduces pollution at the lowest overall cost to businesses and consumers. A well-designed price on carbon pollution provides an incentive for climate action and clean innovation while protecting competitiveness. Carbon pollution pricing is efficient and cost effective because it allows businesses and households to decide for themselves how best to reduce pollution.

In April 2018, the Government of Canada released early estimates of the potential impacts of the federal carbon pollution pricing system across Canada. That analysis was based on an illustrative scenario in which the provinces that had carbon pollution pricing systems at the time—British Columbia, Alberta, Ontario, and Quebec—met the federal standard through 2022, and the federal pricing system was implemented in the other nine provinces and territories.

Since then, the Government of Canada has assessed provincial and territorial carbon pollution pricing systems and has announced where the federal carbon pollution-pricing backstop system will apply ^{Footnote 1} . The updated analysis presented here reflects this actual approach. It finds that

• Carbon pollution pricing will make a significant contribution toward meeting Canada’s greenhouse gas reduction target. It will cut carbon pollution by 50 to 60 million tonnes in 2022. This is lower than the April 2018 estimate, mostly because of Ontario’s decision to cancel its cap-and-trade system.
• Applying pollution pricing across Canada is not expected to have any significant impact on national economic growth rates. It is also likely to stimulate innovation and investments in clean technology, which support long-term growth, although these benefits are not captured in the quantitative estimates presented here.
• In Ontario, Saskatchewan, Manitoba, and New Brunswick, the Government of Canada will return all of the direct proceeds from the federal fuel charge directly to individuals, families, and affected sectors. With the Climate Action Incentive, most households in these jurisdictions will receive more money back than they pay in increased direct costs. In jurisdictions that requested the federal system, the Government of Canada will return the direct proceeds to the provincial or territorial government to use as it chooses.

Benefits of pricing carbon pollution

There are significant economic benefits from pricing carbon pollution:

• Carbon pollution pricing stimulates innovation, which helps Canadian businesses compete in the emerging low-carbon economy. Putting a price on pollution creates an incentive to innovate, develop, and adopt clean technologies and processes. Companies and entrepreneurs that develop new ways to produce goods or provide services less carbon intensively will benefit from access to the rapidly growing global market for clean solutions.
• Pricing carbon pollution also encourages consumers and households to improve energy efficiency. This could include installing better insulation or choosing cleaner technologies (like high-efficiency furnaces), investments and behaviour changes that can save money over the long term. As new technologies are deployed, costs will fall, helping make new technologies more widely available and effective over time.

Although significant, these benefits are not fully accounted for in economic models such as those used for the analysis presented below. This means that the estimated economic impacts presented below are likely overstated.

Estimated greenhouse gas emission reductions across Canada

Under the scenario in this analysis, carbon pollution pricing would reduce greenhouse gas pollution by 50 to 60 million tonnes ^{Footnote 2}  in 2022. This amount is equivalent to shutting down about 30 to 35 coal-fired electricity-generating units for a year ^{Footnote 3} .  This includes reductions from

• the existing systems in British Columbia, Alberta, and Quebec, including an assumption that Alberta’s price would increase to align with the federal standard;
• the planned provincial and territorial systems in Nova Scotia, Newfoundland and Labrador, the Northwest Territories, Saskatchewan’s large industry system (or output-based pricing system), and Prince Edward Island’s fuel charge; and
• the application of the federal backstop in Ontario, New Brunswick, Manitoba, Yukon, and Nunavut; the federal output-based pricing system in Prince Edward Island; and the fuel charge and partial output-based pricing system (for electricity and natural-gas transmission pipelines) in Saskatchewan.

This estimate is based on a similar analytical approach as the estimates released by Environment and Climate Change Canada, in spring 2018, which indicated pollution pricing could lead to reductions of 80 to 90 megatonnes by 2022 ^{Footnote 4} . The difference between the current estimate and the spring estimate is largely due to Ontario’s cancellation of its cap-and-trade system, under which facilities in Ontario were able to purchase allowances in California as a means of reducing their emissions as well as in Ontario.

Estimated impacts on GDP

The federal carbon pollution pricing system is not expected to have any significant impact on national economic growth rates. National real GDP is expected to grow by about 1.8 per cent per year, from 2018 to 2022, without pollution pricing in place, and about 1.7 per cent per year, with pollution pricing across Canada. The model used to develop this estimate accounts for changes to provincial and territorial production and consumption patterns, interjurisdictional trade across Canada, and international imports and exports as a result of carbon pollution pricing.

For comparison, this estimated impact from carbon pollution pricing is significantly less than the range of current GDP projections (which vary by more than 0.1 per cent) and is much less than the typical impact of annual fluctuations in world energy prices.

As explained above, this estimate also does not account for any of the economic activity that likely will be stimulated by carbon pollution pricing. As a result, the estimated economic impact of pricing carbon pollution outlined above is likely overstated.

Estimated implications for households

The cost impact of pollution pricing on households in Canada will vary by province and territory, depending on a variety of factors, including regional differences in energy and fuel-consumption patterns, differences in how electricity is generated (although most electricity is generated from non-emitting sources, in Canada, some regions make significant use of coal, diesel, or natural gas for electricity generation). In addition, the impact on a household will also depend on the extent to which it changes energy use and other consumption patterns in response to the price on pollution.

Provinces with existing pollution pricing systems—British Columbia, Alberta, and Quebec—have invested proceeds from pricing pollution in a variety of ways, including in rebates to citizens, tax cuts, and various climate action programs.

Some provinces and territories are still developing their approaches for how they will use the proceeds from pricing carbon pollution. The implications for households in those jurisdictions depend on how the proceeds are invested.

In the four provinces where the Government of Canada is returning proceeds to individuals and families through the Climate Action Incentive, most households will get more back than they pay as a result of pollution pricing.

Source: Finance Canada calculations using inputs from Environment and Climate Change Canada and Statistics Canada.

*Average family size in these four provinces, in 2016, was 2.6 people.

**Estimated average household impacts reflect the impact on household spending costs, accounting for direct impacts (reflecting consumption of fuels to which carbon pollution pricing applies) and indirect impacts (reflecting consumption of goods and services with carbon pollution pricing embedded in them). These impacts are inclusive of carbon pollution pricing embedded in imports that households purchase from other provinces/territories that have the backstop applied. They do not include the costs associated with pricing in jurisdictions implementing their own systems. Estimates assume full-year application of the federal backstop for 2019. Estimates also assume full pass-through from businesses to consumers.

***Estimated average cost impact for Saskatchewan also includes impacts from the province’s output-based pricing system.

^† Subject to parliamentary approval.

*Note: Climate Action Incentive payments for 2020–2022 are illustrative and subject to change.

Annex A – Technical details on modelling

Models

The baseline of the EC-PRO model is calibrated to a revised version of the 2017 Reference Case from Environment and Climate Change Canada’s E3MC model. The revisions to the reference case pertain to the removal of provincial carbon-pricing policies previously embedded in the case. Alberta, British Columbia, Quebec, and Ontario had carbon-pricing (carbon tax, cap-and-trade, or hybrid) policies in the reference case, which are not included in the baseline presented here. Other non-market greenhouse gas policies and various regulations remain in the reference case.

The analysis reported here was informed by modelling using the EC-PRO model, which is Environment and Climate Change Canada’s provincial computable general equilibrium model. Such models are widely used tools for examining the dynamic response across the economy of relative price changes, such as those resulting from a price on greenhouse gases.

Federal backstop design assumptions

Details of the federal system continue to be finalized. Assumptions related to the fuel charge reflect rates and coverage outlined in the Greenhouse Gas Pollution Pricing Act, Department of Finance Announcing Climate Action Incentive Payments and Launch of Fuel Charge Consultations. Assumptions related to the output-based pollution pricing system reflect current design proposals, including the update on output-based standards released in July 2018, as well as an approach for electricity that differentiates by fuel type. The electricity approach is still under consultation; the most recent proposal is to set coal at 800 tonnes of carbon dioxide per gigawatt hour of electricity produced (t of CO₂e/GWh), natural gas at 370 t of CO₂e/GWh, and diesel at 550 t of CO₂e/GWh.