1. Distributional incidence
Of a carbon tax in Canada

2. CONTENTS 1. What is global warming and climate change?
2. Environmental policy
3. The design of the carbon tax
4. Economic incidence
5. Distributional incidence on households
6. Determinants of incidence
7. Policy implications
8. Conclusion

3. Global warming & climate change
The earth’s temperature is getting warmer.
Over the last century, it’s risen by 1.5 Fahrenheit, and expected to multiply.
Global warming causes climate change
Climate change is bad for the environment – leads to natural disasters, humanitarian crisis, and ecosystem destruction

4. What causes global warming?
Burning fossil fuels for consumption emits greenhouse gases into atmosphere
Greenhouse gases contribute to the “greenhouse” effect that traps heat within the atmosphere
Carbon dioxide, methane, nitrous oxide, are examples of greenhouse gases

5. Environmental policies to combat global warming
“The Paris Agreement’s aim is to strengthen the global response to the threat of climate change by keeping a global temperature rise this century well below 2 degrees Celsius above pre-industrial levels and to pursue efforts to limit the temperature increase even further to 1.5 degrees Celsius” – UNFCC
“Vancouver Declaration”
Carbon pricing

6. Carbon pricing A price put on carbon
Two leading methods: cap-and-trade and carbon tax
Cap-and-trade system sets a limit on overall industry pollution, government creates and distributes pollution quotas through an auction
Carbon tax is a levy on the emissions generated from burning fossil fuels
B.C, Alberta, and Manitoba have implemented a carbon tax
Ontario and Quebec have implemented a cap-and-trade system

7. Design of a carbon tax
British economist Arthur Pigou theorized the carbon tax
Carbon tax has arisen to address a market failure
Allows the market to internalize the negative externalities that arise from pollution

8. Design of a carbon tax
Dollar amount per tonne of carbon emitted into the atmosphere
Levied on energy sources that contain carbon content (fossil fuels)
Gasoline, diesel, natural gas, coal etc..

9. Design of a carbon tax Revenue neutral
Revenue ‘recycled’ back into the economy to maintain pre-tax levels of income
Rebates and tax reductions
Strictly imposed to change behavior

10. Carbon tax in Canada Federal Government mandate
Provinces must implement some form of market-based carbon pricing
In the absence of a carbon pricing policy, Federal Government will impose a carbon tax
Timeline: $10/tonne by 2018, rising to $50/tonne in 2020.
Carbon tax has potential to yield massive revenues
600m carbon emissions at $30/tonne = $18b revenue per year

11. Tax incidence Statutory vs. economic incidence
Statutory incidence = who legally remits tax revenue to government
Economic incidence = distribution of the burden of the tax
Economic incidence is more important because it tells us how a tax impacts different parties
Depends how responsive either party (producer, consumer) are to changes in prices

12. Tax incidence
Tax can be fully or partially passed onto consumers or absorbed by producers
Elasticity of supply, elasticity of demand
Graph depicts two extreme cases, perfectly elastic demand, and perfectly elastic supply

13. Carbon Tax incidence
Incidence analysis examines how welfare is affected by taxation
A carbon tax can influence welfare in many ways
Three main avenues
1) Direct increase in fossil fuel prices – gas prices
2) Indirect cost increases of other goods and services – electricity prices
3) Wages – Harberger Model
Taxation impact of factor prices
Dependent on relative intensity of factors
Study: Carbon intensive firms are capital intensive “backward shifting tax”
Referencing Harberger’s model, recent studies have been conducted to calculate the impact on factor prices due to a carbon tax. Fullerton and Heutel conducted a study that calculated the impact of a carbon tax on factor prices. They found that firms that produce carbon intensive goods tend to be capital intensive; therefore, a backwards-shifting tax is likely to reduce the return on capital, rather than reduced labour wages. The findings suggested that the return on capital will fall by 1%, and the wage rate is likely to increase by .75% (Fullerton and Heutel, 2010).

14. Distributional incidence on household income
Rate of levy on selected fossil fuels
 Fuel
Unit tax at $30/tonne ($)
Baseline Commodity Price ($)
Equivalent ad valorem tax on commodity (%)
Baseline delivered price (%)
Equivalent ad valorem tax on delivered good (%)
Gasoline
0.074/L
0.65/L
11.4
1.29/L
5.8
Diesel
0.085/L 13
1.22/L 7
Natural Gas
0.068/m3
0.132/m3
51.9
0.39/m3
17.7
Coal
2.70/GJ
2.50/GJ
108
L = litre, m3 = cubic metre, GJ=gigajoule
Delivered price includes tax, storage, transport, and distribution margins.
Source: Nic Rivers “Policy Forum: The Distribution of Costs of a Carbon Tax Among Canadian Households”. Canadian Tax Journal (2012) 60:4,

15. Distributional incidence on household income
The next step is to use the survey of household income to find out how much households spend on energy products
Household are ranked from lowest to highest based on pre-tax income, and then divided in 5 groups
As you can see expenditure increases with income groups, and all groups except the lower spend the most on gasoline fuel
Lowest quintile spends more on electricity then any other energy source
Now you must find the proportion of total expenditure spent on energy products to give insight into how progressive it can be
Statistics Canada Survey of Household Expenditure, Cansim

16. Distributional incidence on household income
We use expenditure as a proxy for income because previous theory has stated it is a better proxy for lifetime income rather than current year income
For example: med student, wealthy retiree, may not have a lot of “income” per say, but a med student will have more income in the future, and the retiree had a lot of income in the past so current year income may not be best use
This graph depicts a regressive pattern, as income quintiles increase, expenditure on energy decreases. This is preliminary proof that carbon tax can be regressive
Statistics Canada Survey of Household Expenditure, Cansim

17. Distributional incidence on household income
Three approaches used to analyze distributional incidence of climate change policies
1) Input output models
2) Econometric simulation of consumer demand,
3) Computable general equilibrium models

18. Input output models
Compute direct and indirect price increases of carbon tax
Results of most studies find carbon tax to be regressive
Low-income households experience larger income losses then high income households
Issues:
These models analyze absolute incidence – assumes government spending is constant
Doesn’t account for behavior changes of producers or consumers
Assumes consumers bear all the tax burden

19. Estimation of consumer demand model
Measure welfare changes in due to a carbon tax using cost of living index
Explicitly recognizes ability of consumers to change behavior in wake of a carbon tax
More accurate change in welfare is captured
Tiezzi, 2005 found that carbon tax is progressive in Italy
West and Williams 2005 found that carbon tax is regressive in Australia
Issues:
Doesn't account for producer change in behaviour (factors of production)
Also compute direct and indirect price increase

20. Computable general equilibrium models
Most accurately captures distributional incidence of carbon tax
Allows for tax burden to be shifted forward to consumers, and backward to producers
Allows for changes in behavior due to carbon tax
Araar et. al find that using a CGE model, a carbon tax is mildly regressive when taking into account revenue recycling
Find that revenue recycling in form of income tax cuts has a greater positive impact on poverty rates than a reduction in consumption taxes

21. Determinants of carbon tax incidence
Socioeconomic determinants of carbon tax
Help understand reasons for unequal incidence of carbon tax
Location, nature of employment, and household structure plays a role in unequal incidence

22. Policy implications
Greatest tool for policymakers to ensure equity of carbon tax is revenue neutrality
Revenue neutrality is built to eliminate burden created by carbon tax
Revenue recycled into economy through corporate/ income tax cuts, lump-sum transfers
Potential revenue raised is more than enough to restore pre-tax income of carbon tax
(Rivers, 2012) states that it would require $48m (0.27%) of carbon tax revenue to restore income to lowest income households
$1.6B (9.4%) of revenue would restore income of households below $36,000
23% of carbon tax revenue would restore income of all households below $54,000

23. conclusion Global warming is bad!
We must implement policies to preserve our planet
Market-based carbon pricing policies such as cap-and-trade and carbon tax are efficient and equitable ways to combat climate change
Due to revenue recycling, distributional household incidence is not a roadblock to implementing carbon tax in Canada