Guidance for Using Carbon Pollution Pricing Proceeds to Support Canadians and Drive Climate Ambition

Introduction

A price on carbon pollution is an essential part of Canada’s plan to fight climate change and grow the economy. It is one of the most efficient ways to reduce greenhouse gas emissions and stimulate investments in clean innovation. It creates incentives for individuals, households, and businesses to choose cleaner options.

Carbon pollution pricing, if designed thoughtfully, can drive down greenhouse gas emissions while keeping life affordable for families. One way to help families come out ahead is to use some or all of the proceeds to support consumers.

This Guide outlines approaches for designing government programs that use carbon pricing proceeds in a way that maintains the carbon price signal required to reduce greenhouse gas (GHG) emissions while ensuring affordability for households, particularly Indigenous, low-income and other vulnerable populations. It also outlines approaches for supporting affected sectors, including small and medium-sized enterprises and emissions-intensive, trade-exposed industries, to prevent carbon leakage and support decarbonization and the transition to a net-zero economy.

As part of Canada’s climate plan, provinces and territories have the flexibility to maintain or implement a carbon pollution pricing system that works for their circumstances, provided it meets federal benchmark stringency requirements. As has been the case for the past few years, post-2023, any provincial or territorial government that requests the federal system be utilized in their respective jurisdiction will receive pricing proceeds directly, with a condition that those governments do not take actions to weaken, negate or reduce the price signal. As such, provinces and territories have a key role in using proceeds in a way that address these concerns and is appropriate to their unique circumstances.

This document outlines the federal approach and provides guidance as to how proceeds can be used to support Canadians and Canadian business in ways that do not negatively impact the overall effectiveness of pricing.

The Federal Approach to Carbon Pricing and Using Proceeds

To ensure carbon pollution pricing applies in a consistent manner throughout Canada, the federal backstop pricing system will be in place – in whole or in part – in any province or territory that requests it or that does not have a pricing system that aligns with the federal benchmark requirements.

The federal government has published key elements of its updated benchmark for carbon pricing systems in Canada for the 2023-2030 period, and will post a final benchmark before the end of July. Changes in the benchmark aim to improve consistency and ensure that carbon pricing systems continue to drive low-cost emission reductions required to meet Canada’s climate commitments and build a cleaner, more prosperous economy.

The updated benchmark will preclude actions that directly reduce or negate the marginal carbon price signal but otherwise will not impose specific requirements for how provinces and territories use the proceeds from their systems.

Carbon pricing proceeds are one way to address fairness and affordability. Federal, provincial and territorial governments are also making a range of investments to lower emissions and support households, including the Canada Greener Homes Grant, incentives for purchase of zero emissions vehicles, and significant investments in transit and active transportation.^{Footnote 1}

Using Proceeds while Maintaining the Price Signal

The carbon price signal drives emission reductions in carbon pricing systems. By putting a price on pollution, households and businesses have an incentive to choose lower or zero emitting alternatives. However, if the proceeds from carbon pricing are not used carefully, they can undermine or eliminate the carbon price signal, leading to fewer emission reductions and making it harder and more costly to achieve Canada’s greenhouse gas emissions goals and economic ambitions.

While this Guide focuses on carbon pricing proceeds, the same considerations for maintaining the carbon price signal extend to other government spending and programs.

Jurisdictions use proceeds from pricing carbon pollution in different ways to support a range of goals and priorities, including supporting further emissions reductions and the transition to a net-zero economy, reducing income taxes, or debt reduction. These approaches to using carbon pricing proceeds can all be designed in a way that maintains the price signal.^{Footnote 2}  However, since carbon pricing policies on their own have the potential to disproportionately impact low-income and other vulnerable populations, jurisdictions should also consider how proceeds can be used to mitigate those impacts to ensure the overall policy is fair.

Based on its expert assessment of carbon pollution pricing systems in Canada, the Canadian Institute for Climate Choices recommended, “any rebates that are directly tied to fuel purchases or the level of emissions should be replaced with other approaches to recycling carbon pricing proceeds such as direct rebates, income tax reductions, or abatement technology subsidies.”^{Footnote 3}

One type of action that is to be avoided is the provision of instant rebates on fossil energy purchases, for example by reducing specific fuel taxes in order to offset increased carbon prices. This kind of rebate counteracts the incentive to reduce GHG emissions. By contrast, a lump sum payment that is completely separate from an individual’s energy purchases maintains the carbon price signal. Since this latter kind of payment does not adjust based on actual energy use or emissions, the individual has an incentive to reduce energy use and still collect the full payment. This approach is implemented by the federal government through the Climate Action Incentive payment.

Carbon pricing can be effective with proceeds used in a variety of ways, as long as the mechanism does not negate or lower the price incentive. Any use of proceeds should not be linked to a household’s or business’s level of GHG emissions, fossil energy use, or carbon price payments. Nor should proceeds be used to reduce other charges, fees or taxes on emissions or energy use in a way that offsets the carbon price.

Approaches for Using Carbon Pricing Proceeds

Mechanisms for using carbon pricing proceeds include: lump sum payments to individuals, households, businesses, or large emitters; reductions of taxes or charges unrelated to energy use or emissions; and programing to advance climate action or support vulnerable populations. A government could also use carbon pricing proceeds for general revenue.

Policy makers may have more than one goal for the use of carbon proceeds and may combine approaches to contribute towards theses different goals. For example, a portion of proceeds could be allocated to addressing impacts on low-income households with the balance allocated to programming or general revenues.

Canadian experts have assessed a wide range of options for using carbon pricing proceeds, including assessments of their affordability and implications for economic growth. Provinces and Territories should consider this literature^{Footnote 4}  when designing their approach to using carbon pricing proceeds.

Proceeds used for emission reduction programs should ideally target reductions beyond those already incented by carbon pricing. Programming can also address market failures that impede pricing and can be used to support the deployment of supportive infrastructure that receives less of a direct incentive from carbon pricing. This could include, for example, investments to make low-carbon fuels and technologies more widely accessible. These investments should also consider if the assets being funded are aligned with a net-zero future. This will avoid future stranded assets. Other sources of emissions reductions that may not be sufficiently incented by carbon pricing include new or emerging technologies not yet proven at a large scale. Additional support for these new technologies may reduce the risk associated with their adoption.

Transparency on the collection, use, and results achieved by any programming funded by carbon pricing pollution proceeds is also important for good governance and can build public support for the policy.

Issues to Consider, Potential Approaches and Approaches to Avoid