Author's note" The purpose of this article is to explain why carbon taxes can never be “revenue neutral.” I do not offer an opinion as to the effectiveness of carbon tax as a policy tool to reduce greenhouse gas emissions.
The public has an aversion to new taxes, because they instinctively know new taxes will expand beyond its original scope – and never go away.
The federal government is currently in the process of implementing a nationwide carbon tax, and trying to sell it with the promise that 90% of the revenues will go back directly to households. Ottawa claims the majority of households will incur a net benefit, details pending.
This claim of a “net benefit” is vaguely similar to claims of revenue neutrality – indeed, not only is the federal carbon tax revenue neutral, you can stand to gain money from a tax! How innovative is that?
The Revenue Neutral Carbon Tax in BC
On February 19, 2008, then-B.C. finance minister Carole Taylor introduced the provincial budget. It included a provision for the taxation of fossil fuels based on their carbon content.
With an election looming in May 2009, this was particularly daring from a political perspective; Vancouver was experiencing record-high gasoline prices. In addition, the environmental flank of the BC Liberal Party was seeking an answer to climate change.
Their solution was to market the tax as “revenue neutral,” under the premise that every dollar raised would result in an offsetting decrease in another tax.
Some Hansard snippets from Minister Taylor’s budget speech:
“Effective July 1, we intend to put a price on carbon-emitting fuels in British Columbia. This carbon tax will be entirely revenue-neutral, meaning every dollar raised will be returned to the people of B.C. in the form of lower taxes.”
“I want to repeat: this tax will be 100 percent revenue-neutral.”
“One thing is certain: it will be in legislation. Every dollar raised by the carbon tax will be returned to British Columbians in the form of tax reductions.”
The enshrinement in law took form with the Carbon Tax Act. In Budget 2008, the first year’s expected carbon tax receipt of $338 million would be offset with $217 million in estimated tax cuts for individuals and $121 million for businesses. As the carbon tax increased over time, other taxes would be reduced accordingly.
There were a few problems with claims of revenue neutrality.
First, any tax requires government resources to administer and enforce. These bureaucratic expenses will never result in achieving true revenue neutrality. This is equivalent to the second law of thermodynamics in government.
Since the carbon tax was first introduced, exemptions have been carved out, such as fuel destined for export, or to be used on international cruise ships. Programs were developed to exempt certain industries, such as through the Greenhouse Carbon Tax Relief Grant. (The latter case I find amusing, simply because there is one agency of government to collect the carbon taxes, and another to give it back – all of which involves frictional costs.)
The second problem is that the carbon tax was treated like any other revenue source. In the budget, it’s a direct line item on general revenues, not solely segregated to reduce other revenues. Like sales and personal income taxes, carbon tax revenue went into the big bucket of “taxation revenue” for government to spend as it saw fit.
In other words, budget expenses don’t care whether they are paid for by income, sales, liquor, property transfer, payroll, BC Hydro profits, or carbon taxes.
The third, and most powerful, problem is how to determine “neutrality.” It’s easy to determine how much was collected under the carbon tax; but whether any purported tax reductions happened because of the carbon tax became arbitrary.
For instance, in Budget 2016 (eight years after the carbon tax was introduced) government anticipated collecting $1,234 million in carbon taxes, offset by $1,733 million in “revenue measures.” As defined in the legislation, government has broad discretion what to classify as revenue measures.
Do we include income tax reductions? School property tax reductions? SR&ED tax credits? Children Fitness Credits? The arbitrariness made revenue neutrality a marketing exercise, especially looking at certain items that have been in existence well before the carbon tax – such as $400 million in film incentive and production services tax credit.
Revenues are Fungible
The word “fungible” is not used commonly in everyday language, but is an important concept which means interchangeable.
Each dollar of revenue the government collects is interchangeable with any other dollar it collects. In other words, tax dollars are fungible.
Governments decide how to raise money, how much to raise, and how to spend it. How those dollars are collected doesn’t affect how they are spent.
Carbon taxes are simply another form of revenue.
Even if carbon taxes are collected under the guise of reducing other taxes, the choice of which other taxes to reduce (if any) is ultimately an independent decision.
Linking carbon taxes with a reduction in income and corporate taxes, coupled with a “Climate Action Dividend” cheque for low-income earners is an easy political sell. But instead of tinkering around with income taxes and income-tested benefits (now called the “low income climate action tax credit”), government could have easily chosen instead to reduce the school tax or PST by a corresponding amount.
Because governments do not have fixed targets of revenues to collect, “revenue neutrality” is meaningless – such measurements can only defined by an arbitrary benchmark. Over time, the meaning of this arbitrary benchmark will fade away, just like it has in British Columbia. The current BC NDP government dispensed with the revenue neutrality fiction in their Budget 2018.
Using the methods the BC government historically used to track revenue neutrality, one could use similar methods to justify any future tax as “revenue neutral” – after all, if such a tax wasn’t collected, another tax would’ve had to take its place to raise the necessary amount.
Back to the Federal Carbon Tax
Division 7 of the Greenhouse Gas Pollution Pricing Act describes how federal carbon tax proceeds are distributed, specifically:
165 (2) For each province or area that is or was a listed province, the Minister must distribute the net amount for a period fixed by the Minister, if positive, in respect of the province or area. The Minister may distribute that net amount
(a) to the province;
(b) to persons that are prescribed persons, persons of a prescribed class or persons meeting prescribed conditions; or
(c) to a combination of the persons referred to in paragraphs (a) and (b).
The meaning of “prescribed” is the decision of the Minister of National Revenue, and the ability to distribute to any “person” means there is discretion to give back to individuals, corporations, trusts, or any other organization of the Minister’s choosing.
You can be sure that future governments will be very tempted to “prescribe” such funding towards groups that require political attention.
The playbook for the federal carbon tax will be eerily similar to British Columbia’s experience – right down to introducing it a year before an election.
To increase public acceptance, initial proceeds will be diverted towards the general electorate. After the election, the ability to designate federal carbon tax revenues to other areas will be too alluring, just as today’s provincial government has claimed that clean technology and investment in industrial emission technologies is a better use for the tax than reducing revenues elsewhere.
There is another phrase for this: tax and spend. Revenue neutrality was always a myth – and will continue to be.
Sacha Peter is a Chartered Professional Accountant and public policy analyst of the impact of legislative and regulatory changes. Currently he performs financial analysis of Canadian publicly traded securities and taxation consulting through his firm, Divestor Investments.