Economic theory is clear that too much carbon will be produced if there are no associated costs—which is why the world faces our current climate problem. Pricing and regulating carbon emissions can both address the issue.
Carbon pricing reduces transition costs, in line with economic theory, because it acts as a financial incentive for consumers and businesses to modify their energy usage.
Carbon pricing changes the relative pricing of goods and services, and lower-carbon producers benefit while higher-carbon producers lose market share
It also raises the costs of goods and services—directly through higher retail prices, and indirectly through higher input costs. In turn, these higher expenses reduce residential and commercial purchasing power, thus decreasing demand throughout the supply chain.
Carbon pricing, too, changes the relative pricing of goods and services: Those that are cleaner to produce are priced lower than those that require larger carbon footprints. As a result, lower-carbon producers benefit while higher-carbon producers lose market share. Without mitigating factors, the impact of this substitution would be severe. However, carbon taxes imposed by governments generate revenues that are recycled back into the economy, offering essential offsets to the previously noted pressures and thus dampening the effects of carbon-pricing on economic growth.
For example, with carbon taxes in effect, drivers will pay more at the gas pumps, which might spur less driving or perhaps a shift to electric vehicles (EVs). However, households are also given a portion of the carbon tax they pay back and can use this rebate to buy other goods and services. Yes, they could continue to purchase higher-carbon goods but because of the carbon tax, their money will stretch further if used for lower-carbon goods and services, an incentive in itself.
Carbon taxes imposed by governments generate revenues that are recycled back into the economy
Other examples involve carbon revenues being recycled into the economy via funding, such as into investments that can accelerate progress toward a lower-carbon future, and into industries as well as toward consumers facing the most significant transition impacts in order to help mitigate associated costs. The latter example also addresses the likely unequal regional outcomes in the absence of policy intervention.
Pricing carbon is central to Canada’s emissions-reduction plan. However, the country hasn’t generally been having productive conversations about energy transition. Opponents often characterize carbon pricing as a material threat to the economy and prosperity, whereas proponents often suggest that emissions reductions can be accomplished without conversion costs to a lower-carbon future, such as claims that carbon-revenue rebates will fully offset any monetary impact on the consumer.
Economic modelling can uncover answers to important questions, including whether the current federally stipulated path of carbon pricing will help achieve our country's environmental targets
Addressing climate change and transforming the economy is exceedingly complex, so one should be skeptical of such black-and-white characterizations. This is where economic modelling can help shed light on answers to important question, including whether the current federally stipulated path of carbon pricing will help the country achieve our environmental targets, and what the impact will be on Canada’s economy, its industries, and its regions.
To help address these and other concerns, we used Deloitte Canada’s CGE model to examine carbon-emissions reductions, macroeconomic effects, and sector performance between 2019 (when the federal carbon price was introduced) and 2030 (when it’s set to reach the current planned peak of $170 per tonne). We analyzed different types of emissions, including those related to: combustion of fossil-based intermediate inputs; land use and animals in agriculture; fugitive emissions in industries; and household and government consumption. To isolate the impacts of carbon pricing, we compared a business-as-usual scenario (i.e., one with no carbon costs) to a policy scenario that had carbon pricing.
The policy scenario, with a forecast period of 2019–2030, introduced a price of $20 per tonne of carbon dioxide equivalent (CO2e) that increases by $10 annually—reaching $50 per tonne in 2022—and thereafter by $15 annually, ultimately reaching $170 per tonne in 2030. We focused solely on carbon pricing as the key policy instrument, excluding other emissions-reduction measures such as phasing out coal and implementing clean-energy standards. Based on historical data (i.e., Canadian average annual changes in emissions intensities), the model assumes efficiency improvements of 1.6% annually throughout the period studied.8
The federal government has indicated carbon pricing revenues will be transferred to consumers, but they should also be used for green investments in infrastructure and to aid business transition
From this, we see that carbon pricing is projected to generate substantial revenues—$63.8 billion annually by 2030. However, a critical point is how this money will be recycled back into the economy. At the moment, the federal government has indicated that these funds will be transferred to consumers, but we believe they should also be used for green investments in infrastructure and to aid business transition. In our model, we assumed roughly 55% would go to households, 21% to government, and 23% to private investments, reflecting the relative shares of these segments in the economy.
Key take-away: A gradual rise in carbon pricing to $170 in 2030 will drive major emissions reductions—bringing us close to our Paris Agreement commitment.
Overall, modelling indicates that Canadian emissions will decrease in response to our sample carbon-pricing policy, from 730 megatonnes of CO2e in 2018 to 537 megatonnes in 2030 (see figure 2). This represents a 26% drop in emissions, which brings Canada three-quarters of the way to its Paris Agreement target. The largest reductions are expected in the following sectors: electricity generation and transmission (–58%); general services (–43%); and mining, quarrying, and oil and gas extraction and refineries (–30%).
Modelling indicates that Canadian emissions will decrease 26% by 2030, bringing the country three-quarters of the way to its Paris Agreement target
Emissions are expected to increase 20% in the agriculture, forestry, fishing, and hunting sector due to exemptions from carbon-pricing policies. One notable development is that the electricity sector will see projected growth in its GDP share, because need for that energy resource will increase in a lower-carbon future (see figures 3 and 4).
Figure 3: Changes in GDP by industry, cumulative difference compared to the baseline by 2030, percent (%)
Figure 4: Changes in emissions by industry, cumulative difference compared to 2018 by 2030, percent (%)
Key take-away: Implementing carbon pricing involves transition costs, with trend rates of annual Canadian economic growth edging down from 1.7% to 1.6%.
A crucial issue about transition to carbon pricing is whether costs exceed benefits. A gradual rise in carbon prices, as outlined in the federal government’s current plans, will result in a slowdown of real GDP growth per annum by 0.08 to 0.13 percentage points. This translates to an economy that grows at a trend rate of 1.6% rather than our current estimate of 1.7%—still while bringing us just three-quarters of the way to our Paris Accord targets. As a result, by 2030, national real GDP will be 1.4% lower than if no carbon pricing were made. In the same period, as carbon prices rise to $170, overall costs for goods and services (measured by the GDP deflator) are projected to increase 0.9%—or about 0.1% per year.
Key take-away: Household purchasing power and consumption are slightly lower in our carbon-pricing scenario.
Direct price increases in gasoline, natural gas, and electricity will be felt by consumers—serving as an incentive for households to be more energy efficient and reduce carbon emissions. Although part of the carbon tax is expected to be returned to households in the form of tax credits that will offset a significant portion of their lost purchasing power, a loss will nevertheless be felt. Additionally, slower economic growth will lead to a slower pace of job creation with 88,000 fewer positions created by 2030. While that is a large number, put in context it represents roughly four months of job creation at current rates, yet stretched out over a period of almost a decade. The combination of these impacts will result in consumer spending that’s 1.9% lower in 2030 relative to a baseline with no carbon pricing.
Key take-away: Some industries will face more substantial challenges than others, so they’ll have to work hard to adapt to these pressures.
Higher prices will affect each segment of the economy differently, depending on production and consumption-emissions intensities. A few sectors will likely experience above-average declines in output (relative to baseline levels) due to their emissions-heavy activity. For instance, the mining, quarrying, and oil and gas extraction and refineries sector could see a 9% decline in real GDP by 2030, and the transportation sector is expected to decline by 4%. However, the renewable-power sector—among others—is likely to expand, with a projected 6% growth in GDP by 2030, assuming that low-carbon fuels can be substituted in the production process.
Despite carbon prices reaching $170, most sectors are projected to grow annually over the modelling period—though, as previously noted, more slowly than at baseline rates (see figure 5). One exception is the mining, quarrying, and oil and gas extraction and refineries sector, with an average annual economic-output decline of 0.1% between 2019 and 2030, compared with a yearly baseline growth of 0.7%.
Overall, our model indicates that the federal government’s carbon-pricing policy will shift the composition of the Canadian economy. For example, industries such as mining and transportation will contribute less while the utilities sector will contribute more.
Key take-away: The challenge of reducing emissions is different across the country.
As electricity generation moves increasingly toward renewables, some jurisdictions—including Eastern Canada, Alberta, and Saskatchewan—are expected to have steeper adjustment curves, given their reliance on fossil fuels. In contrast, Quebec and British Columbia, where hydro-power resources are plentiful, are likely to have easier paths.
Regional industrial output, including product type and concentration, will additionally affect adaptation across provinces. Although our model does not segment results by region, it’s possible to forecast figures for individual sectors. For example, real GDP in the mining sector is expected to decline by $16.9 billion by 2030. Given that 58% of mining occurs in Alberta—and assuming this share doesn’t change—it can be calculated that Alberta’s GDP in this sector alone will fall by a projected $9.8 billion. Although this figure may not seem large compared with the $334 billion in output produced by the province in 2019, this decline doesn’t include the domino effect on other industries, such as professional services, which rely on mining-sector activity. Still, despite these impacts, Alberta’s economy will continue to grow.
Our analysis shows putting a price on carbon will do the heavy lifting to bring the economy close to Paris Agreement targets but more is needed to meet those goals, and even more effort will be required to achieve the federal government’s even more ambitious target of a 40% to 45% reduction. The challenge, is how to close the gap. While imposing higher carbon prices can help, finding ways to facilitate large-scale funding for technology may have the greatest potential impact over the long run, partly because these technologies can lower emissions while creating considerable economic opportunities.
