How to maximize value: Options for allocating carbon pricing revenue

Revenue from carbon pricing is increasing in Canada. Jurisdictions with carbon prices will be able to choose from various revenue allocation options, selecting those that present the best value to them. This blog presents some of the main ideas in Sustainable Prosperity’s Issue Summary on the allocation options for carbon pricing revenues, based on a research paper by Marisa Beck and Randall Wigle.

It’s increasingly recognized that price incentives are vital to cost-effectively lowering the greenhouse gas emissions associated with economic activity. Governments implementing carbon pricing as part of their efforts to transition to a low-carbon economy must also decide what type of carbon pricing mechanism to use – and then what to do with the resulting revenues.

In Canada, this is a very timely topic. Early estimates indicate that Ontario’s newly announced cap and trade program could raise around $2 billion in revenue each year. Alberta’s carbon pricing regime has just been extended (increasing somewhat in stringency) for the short-term, with a broader climate change panel underway. A recent fiscal review for Nova Scotia came out in favour of provincial carbon pricing. British Columbia is pondering the next moves on its climate file with an update to its Climate Action Plan. Québec has linked its emissions trading regime with California’s and has now held four (revenue-raising) joint permit auctions.

This raises an interesting question for policy makers: What’s the best way to allocate carbon pricing funds, given the particular context of each jurisdiction?

Sustainable Prosperity releases today this Issue Summary on the various revenue allocation options, based on Marisa Beck and Randall Wigle’s research paper, “Carbon Pricing and Mind the Hissing”. Their paper provides an overview of different options for using government revenues from carbon pricing, with discussion of what criteria might guide this decision.

So, where to allocate the funds??

There are a number of options available. And the choice of option(s) has the potential to influence the pricing policy’s effectiveness, efficiency and public acceptability. Allocation options generally fall into four general categories:

• Reducing existing taxes (personal, corporate and/or others);
• Investing in clean technology;
• Investing in general productivity measures (like debt reduction, climate change mitigation, education and others); and,
• Redistributing the money to help vulnerable sectors/populations.

Interestingly, all of these approaches can be seen in Canada: Quebec invests its carbon revenues in climate change adaptation efforts and infrastructure; Alberta invests in clean technology and emissions reductions; and British Columbia uses carbon revenues to reduce existing taxes (with a particular effort to help groups unfairly impacted). Ontario has yet to announce its plans. For those who like to see their choices mapped out, we’ve developed a bit of a decision tree to show these options.

Really, these are all great options. Some are more appealing to a jurisdiction, depending on itsunique context and priorities. Beck and Wigle outline three key policy objectives that can help inform this choice:

• Economic efficiency;
• Emissions reductions; and,
• Public acceptability.

For those who feel they might need a decision-making tool, we’ve developed a table that shows how – in a simple way – there’s interplay of revenue use options and policy objectives. This is a fairly simplistic – but we think still helpful – presentation of the relationships between options and objectives. The relationships below could differ in different jurisdictions and will depend on the particularities of the pricing policy and revenue allocation design. With those disclaimers out of the way, the table summarizes how each of the four allocation options influences the three policy considerations outlined above. A green upward arrow denotes a positive impact on a given policy consideration, a red downward arrow denotes a negative impact, and a question mark means that the influence is uncertain due to too many interacting effects or regional variability.

For example, the top left green arrow indicates that reducing existing taxes (such as relatively distortionary labour taxes that change the amount and type of economic behavior more than others) can boost economic efficiency.

On the other hand, as shown by the question mark in the right column, second from top, spending revenue on general productivity measures (such as investing in infrastructure or climate change adaptation) could boost or lower public acceptability. Some companies or individuals might like seeing revenues used for one purpose more than another.

Revenue allocation is one of the key design elements of carbon pricing systems. Policy makers in every jurisdiction that implements a carbon price will have an important decision to make. The paper SP has released today and the supporting research paper by Wigle and Beck will help inform that decision.

Ultimately, it’s a question for each jurisdiction – where do you get the maximum value?