British Columbia’s Revenue-Neutral Carbon Tax: A Review

By: Brian C. Murray and Nicholas Rivers
Nicholas Institute for Environmental Policy Solutions

In 2008, British Columbia implemented the first comprehensive and substantial carbon tax in North America. By 2012, the tax had reached a level of C$30/t CO2, and covered approximately three-quarters of all greenhouse gas emissions in the province. This paper reviews existing evidence on the effect of the tax on greenhouse emissions, the economy, and income distribution as well as provides new evidence on public perceptions of the tax.

Empirical and simulation models suggest that the tax has reduced emissions in the province by 5–15%. At the same time, models show that the tax has had negligible effects on aggregate economic performance, though certain emissions-intensive sectors have faced challenges. Studies differ on the effects of the policy on income distribution but agree that they are relatively small. Finally, polling data show that the public initially opposed the tax but now generally supports it.

The carbon tax was originally implemented as a “textbook” policy, with wide coverage, few exemptions, and use of revenue for low-income tax credits and broad-based tax cuts. But the recent use of some tax revenues to support particular industries rather than to deliver those broad-based tax cuts may reduce its overall cost-effectiveness.

Conclusion and Policy Implications

British Columbia has given the world perhaps the closest example of an economist’s textbook prescription for the use of a carbon tax to reduce GHG emissions. The tax covers a wide base, started low to ease the transition, and rose to a more substantive level, roughly in line with recent mid-range estimates of the marginal damages per ton or the “social cost of carbon” (Pizer et al. 2014) and the highest broadbased carbon price in practice today (2015).

The intended use of tax revenues is to lower preexisting distortionary income taxes on businesses and households as well as to target transfers to presumptively disadvantaged low-income households. Reporting of the sources and uses of carbon tax funds is subject to a highly transparent process, under which politicians and their constituencies can track how the revenues are used each year. Given these features, the BC carbon tax provides an excellent field test of a widely prescribed policy.

This analysis has assembled and reviewed existing studies of the BC carbon tax’s effect on emissions, economic performance, distributional outcomes across household-income levels, and public acceptance. It also presented an original statistical analysis of household perceptions of the tax in British Columbia or a hypothetical similar tax in other Canadian provinces.

Although the published work in this area is fairly thin in quantity, findings are fairly consistent across studies within a category and are consistent with economic and demographic theory.

Key messages from this assembled body of work follow.

Signals of Success

• The primary objective of the BC carbon tax is to reduce GHG emissions, and essentially all studies show it is doing just that, with reductions 5–15% below the counterfactual reference level. Some studies suggest that the tax has an amplified effect on fuel-consuming (emitting) behavior above that produced by an equivalent change in fuel price. Those studies provide a range of explanations, and also find consistency with results on other taxes and policy interventions that produce outsize responses.
• A secondary goal of the carbon tax is fiscal reform—to enable the use of a tax on “bads” (pollution) to displace a tax on “goods” (labor and capital), with the attendant possibility that a double dividend— pollution reductions and economic growth—might be produced. The evidence, although not decidedly pointing to a strong form of double dividend, tends to show no statistically significant effect at all on net growth for the province. At minimum, this finding suggests any negative economic effects are minimal. Studies do not estimate the economic benefits from avoided climate change, which would also contribute to policy success.

Shortcomings

Although the tax appears to be a success on many fronts, it has some potential shortcomings.

• First, although the empirical literature suggests that the tax has reduced emissions from covered fuels in British Columbia, no one knows if it has led to emissions “leakage”—that is, whether some observed emissions reductions in British Columbia are associated with emissions increases elsewhere. 8 No studies are known to have attempted to quantify the magnitude of this effect.
• Second, although the carbon tax in British Columbia was originally implemented as a “textbook” policy, with wide coverage, no exemptions, and use of revenue for broad-based tax cuts and low-income tax credits, deviations from the policy have occurred in recent years. Exemptions from the tax were granted starting in 2012 to some agricultural sub-sectors and in 2014 to liquid fuel use for the entire agricultural sector. Rather than attempting to increase the (already wide) coverage of the tax, coverage has been slightly narrowed over time.
• In addition, broad-based tax cuts that accompanied the tax in its original implementation have more recently been used to support particular industries (especially the film production industry) through targeted tax credits. These trends likely reduce the cost-effectiveness of the tax overall.
• Finally, although the tax is now supported by more than half of the BC population, it remains a politically difficult policy to implement, because support and opposition are concentrated in particular groups. Opposition to the tax remains high in middle- and low-income, older, male, and rural groups, which are important electoral demographics.

Download the publication here.