An Open Letter from Economists on Canadian Carbon Pricing

As economists from across Canada, we are concerned about the significant threats from climate change. We encourage governments to use economically sensible policies to reduce emissions at a low cost, address Canadians’ affordability concerns, maintain business competitiveness, and support Canada’s transition to a low-carbon economy. Canada’s carbon-pricing policies do all those things.

There is plenty of discussion about carbon pricing in Canada today. Healthy public debate is good, but it should be based on sound evidence and facts. Let’s examine some of the claims made by critics of carbon pricing and compare them with what the evidence shows. 

Critics’ Claim #1: Carbon pricing won’t reduce GHG emissions.

What the evidence shows:  Not only does carbon pricing reduce emissions, but it does so at a lower cost than other approaches.  

Since federal carbon pricing took effect in 2019, Canada’s GHG emissions have fallen by almost 8 percent, although other policies were also at work. A new report from the Canadian Climate Institute shows that federal and provincial carbon pricing, for industries and consumers, is expected to account for almost half of Canada’s emissions reductions by 2030. 

The reason carbon pricing works is simple: when something costs more (in this case fossil fuels), people use less of it. That is basic economics, and common sense.  

Carbon pricing is the lowest cost approach because it gives each person and business the flexibility to choose the best way to reduce their carbon footprint. Other methods, such as direct regulations, tend to be more intrusive and inflexible, and cost more. 

That is not to say that carbon pricing should be Canada’s only climate policy. Other complementary policies are also needed. But the more we use the lowest-cost policies to achieve our climate goals, the more resources will be available for other important things—like health care, education and other social programs.

Critics’ Claim #2:  Carbon pricing drives up the cost of living and is a major cause of inflation.

What the evidence shows:  Canadian carbon pricing has a negligible impact on overall inflation.

The sharp increase in inflation between 2021 and 2023 was caused by several factors, mainly related to the COVID-19 pandemic (disrupted supply chains, rapid growth in the money supply, and pent-up demand), and the impact of the Russia-Ukraine war on commodity prices. These forces are global, which is why most advanced countries—whether or not they have a carbon price—experienced very similar inflation. According to the Bank of Canada, carbon pricing has caused less than 1/20th of Canada’s inflation in the past two years.

In addition, a central feature of the federal carbon price is that approximately 90 percent of the revenues generated are rebated back to households. Most families receive more money in rebates than they pay in carbon pricing, particularly those with low or medium incomes. Rural residents get an additional rebate. In other words, the policy is designed to ensure it does not raise the cost of living for most Canadians.

Climate change, on the other hand, poses a real threat to Canadians’ economic well-being. For example, it increases the risk and severity of natural disturbances, such as fires, floods, and severe storms. A conservative estimate is that the impacts of climate change will cost our economy at least $35 billion by 2030, and much more in future decades. 

Critics’ Claim #3:  It makes little sense to have both a carbon price and rebates. 

What the evidence shows:  The price-and-rebate approach provides an incentive to reduce carbon emissions (due to the price), while maintaining most households’ overall purchasing power (due to the rebate).

Carbon pricing works by raising the price of carbon-intensive products, so consumers and businesses are incentivized to adopt lower-carbon options, such as smart thermostats, heat pumps, or hybrid/electric vehicles. 

Giving back most of the carbon-pricing revenues in rebates doesn’t undermine this goal; consumers still have the incentive to reduce emissions. The rebates just ensure that most households come out ahead, because they receive an amount back that is slightly above what the average household spends on carbon pricing. Those that reduce emissions the most will come out further ahead; they will pay less in carbon fees but still get the full rebate. 

Critics’ Claim #4: Carbon pricing harms Canadian business competitiveness.

What the evidence shows:  Canada’s carbon-pricing scheme is designed to help businesses reduce emissions at low cost, while competing in the emerging low-carbon global economy.  

For large emitting sectors in most provinces—like oil, steel and cement—there is an “output-based” carbon pricing system. In effect, it means most large industries pay the carbon price only on the last 10-20 percent of their emissions. The lower-emitting firms pay less while higher-emitting firms pay more—creating a strong incentive for all firms to reduce emissions. 

The output-based system is designed to maintain industries’ competitiveness: ensuring that the carbon price does not hamper their ability to stay profitable and generate jobs in Canada while competing internationally. 

In addition, carbon pricing stimulates innovation by encouraging the development and adoption of low-carbon technologies. These incentives help Canadian businesses—in all sectors—stay competitive in the global transition to a low-carbon economy.

Critics’ Claim #5:  Carbon pricing isn’t necessary.

What the evidence shows:  Here the critics are right. Canada could abandon carbon pricing and still hit our climate targets by using other types of regulations and subsidies—but it would be much more costly to do so.

Unfortunately, the most vocal opponents of carbon pricing are not offering alternative policies to reduce emissions and meet our climate goals. And they certainly aren’t offering any alternatives that would reduce emissions at the same low cost as carbon pricing. 

Canada has many economic challenges to address. In a world of scarce resources, it seems imprudent to abandon carbon pricing, only to replace it with more costly methods of reducing emissions—or, worse still, take no measures to reduce emissions.

In short, carbon pricing is the least-cost way to reduce emissions, drive green innovation, and support Canada’s transition to a clean and prosperous economic future.

For more research on carbon pricing in Canada, see https://ecofiscal.ca/reports