The goal of this session is to introduce you to the basic economic policy problem of externalities and the prototypical solutions to it. By the end of this session, you should know (or, in some cases, recall):
You should also be able to demonstrate that you:
Left to its own devices, what is the firm's problem? Maximize profits.
Does the firm have to care about environmental damage?
Why or why not?
Imagine a situation with:
Now, what happens if:
the firm has the right to pollute?
the victim has the right to prevent any and all pollution?
Assume that, in this case, rights are tradeable.
Market-based tools:
carbon taxes
cap-and-trade systems
Regulatory tools:
Spending tools:
Hybrids policies (flexible regulations) are almost always what gets implemented
Combinations of most of the above now exist in many jurisdictions
This is a broad category of measures that basically involve the government regulating one of:
Federal and provincial programs currently implement standards of all different types
Small engines (Off-Road Small Spark-Ignition Engine Emission Regulations, SOR/2003-355 under CEPA, 1999)
Light duty vehicles (SOR/2014-207 under CEPA, 1999)
Alberta regulates upstream venting and flaring (AER Directive 60)
Federal Reduction of Carbon Dioxide Emissions from Coal-fired Generation of Electricity Regulations (SOR/2012-167 CEPA, 1999)
Economic critiques
Easiest (IMO) to start with two questions:
Market-based approaches to emissions control essentially:
Cap-and-trade programs are the prototypical market-based approach for pollution
First implemented widely in the context of acid rain in the 1990s
Now implemented in the European Union (EU-ETS) and in a joint Quebec-California market (WCI) among others for carbon emissions
Implementation in each market varies in terms of:
Example : Quebec’s cap-and-trade system
Remainder of the Regulation includes penalties for violation and appendices establishing industry-level conditions
Example : Quebec’s cap-and-trade system
The system has been expanded to recognized allowances from the California and, at one point, Ontario systems for compliance in Quebec
From an individual firm’s point of view, the markets are unified and you can purchase or sell allowances to entities in any market. In practical terms, this ensures a common price between California and Quebec
Pure cap-and-trade approaches provide quantity certainty and let the market determine the price of allowances/offsets/licenses/rights to emit
The introduction of price mitigation (reserve allowances, etc.) cuts against that price certainty, allowing emissions to rise if prices get too high
Average cost of the policy to firms depends on the emissions allowances allocated free of charge, the auction prices, and perhaps the volatility of prices through the year
Marginal cost – the value of an incremental emission or emissions reduction – is determined by the market price for allowances
Economists favour market-based approaches in general because of:
Environmentalists have tended to favour cap-and-trade approaches because of emissions certainty, although that was challenged by relatively weak targets in the EU for many years
A carbon tax sees the government act, effectively, as the default seller of emissions allowances and total emissions are not capped
Prototypical carbon tax implemented in BC in 2007
A reasonable proxy for a carbon tax in some ways is implemented in Canada under the Greenhouse Gas Pollution Pricing Act (GGPPA), but that’s better described as a hybrid policy
Average cost of the policy to firms will generally be equal to the price ($/tonne) applied through the tax
Marginal cost – the value of an incremental emission or emissions reduction – is the same as the average cost: the value of the tax
Example: BC's Carbon Tax Act, SBC 2008, c 40
What’s covered by the tax? fuel at point of purchase (s. 8) or imported fuel (ss. 9-10) or fuel used in BC that was not otherwise taxed (s. 11)
Exemptions (s 14) and credits (ss 14.1 – 14.2)
Collection mechanics and penalties
Carbon tax rates for different fuels (Schedule 1)
Economists favour carbon taxes for the same reasons as cap-and-trade:
Environmentalists have tended to favour cap-and-trade approaches because of emissions certainty
Most emissions pricing policies contain some elements from each policy type
Flexible regulations: regulations with some ability to trade credits for over-compliance or to substitute with financial compliance (i.e. paying a fee)
Output-based pricing systems: elements of cap-and-trade (allowance issuance, trading rules, offsets) combined with carbon taxes (gov’t sets a fixed price for sale of reserve allowances)
The GGPPA, for example, has a consumer carbon tax combined with an output-based pricing system for larger emitters
Alberta’s Alberta's Technology, Innovation and Emissions Reduction Regulation is an output-based pricing system with government as default seller of carbon credits
Renewable fuel and vehicle emissions regulations allow flexible compliance (trading)
Clean Fuel Standard allows for flexible compliance and a credit market
Example: Alberta's TIER Regulation
Facilities emitting more than 100kt/yr are covered (s.3), with an opt-in (s.4) or aggregation (s.5) for facilities emitting more than 10kt/yr if there is a covered, competitor facility
Each product has a benchmark, which you can think of as a rate at which allowances are issued (0.2974 tonnes of allowances per barrel of bitumen, for example) (s.6)
Facilities may have facility-specific benchmarks (s. 7)
Facilities where compliance costs exceed competitiveness thresholds may qualify for a higher benchmark (s.8)
Example: Alberta's TIER Regulation
Facilities must report emissions and output, as well as on-site heat and power generation if applicable
Allowable emissions (s. 9) are equal to the sum of:
Example: Alberta's TIER Regulation
Any gap between allowable and actual emissions must be trued-up (s. 13(2)) by:
A facility which has more allowable than actual emissions may be issued emissions performance credits (s. 20) which can be banked or traded
Key differences between a program like TIER and a pure carbon tax charged on every tonne of emissions will be the average cost of compliance
No bright line between carbon pricing, carbon taxes, cap-and-trade, and hybrid policies
Key takeaways and what I expect you to remember, and be able to reproduce:
The goal of this session is to introduce you to the basic economic policy problem of externalities and the prototypical solutions to it. By the end of this session, you should know (or, in some cases, recall):
You should also be able to demonstrate that you:
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