Four provinces in Canada—Ontario, New Brunswick, Saskatchewan, and Manitoba—have refused to implement carbon pricing. Ontario dropped out of its cap-and-trade system after the provincial election earlier this year. These four provinces will therefore see the federal carbon backstop policy enacted at the beginning of 2019 which will see the carbon price rise from $10 per tonne in 2019 to $50 per tonne in 2022 in four $10 steps. Today the federal government announced how it would recycle the revenue. I am very pleased that the method that the federal government has chosen is one I have been advocating for: residents of the four provinces will receive refund cheques. This is the carbon fee and dividend system. It makes the carbon tax revenue-neutral, as 90% of the revenue goes back directly to households, and another 10% to small businesses. Large emitters receive relief through the output-based pricing system.

Putting a price on pollution is what economists call a "first-best" strategy. It provides an incentive to polluters to reduce emissions and invest in innovation to make pollution reduction even cheaper. It is a market-based instrument that should appeal to business-minded people. The alternatives, including regulation and command-and-control interventions, are less efficient and more costly. Efficient carbon pricing requires getting the price right. Fair carbon pricing requires distributing the revenue in a way that benefits citizens broadly. The new federal policy gets high marks on both counts. Refunding the carbon fee revenue directly to citizens ensures that money is not squandered on less efficient projects, and it makes sure that less-affluent households aren't worse off.

An editorial in the Globe and Mail called the new policy a spoonful of sugar that helps the carbon tax go down and compared carbon taxes to castor oil: good for what ails us but hard to swallow. That about sums it up. Carbon dividends are an eminently sensible and market-friendly policy. Political opposition against is are a toxic mixture of unscientific quackery and political demagoguery. The rebates envisioned under the new policy may well help put to rest the usual anti-tax line that the carbon tax is "another money grab". It isn't when the money goes straight back to citizens. In fact, many families stand to gain from the carbon dividend, especially less affluent households. Carbon dividends are not only good environmental policy, but they are also good social policy.

What are the key arguments in favour of a climate dividend?

There are several arguments that favour refunding tax revenue directly to households.

1. Introducing new taxes is difficult. People generally don't like a new tax. Therefore, voters will find it easier to embrace a tax policy when they get something tangible in return.
2. Children will receive the same amount as adults, which makes this a very family-friendly policy.
3. The administrative cost of the rebates will be low as it is handled through the exisiting federal income tax system.
4. Carbon dividends can be expected to become popular with voters and should make it difficult for future governments to take away these individual benefits.
5. Carbon pricing is similar to fuel taxes, where lower-income households pay a disproportionate share of their income on the tax. Per-capita rebates will reduce the burden to the lower-income households in Canada.

What will households get?

Tax filers will receive a carbon dividend through their income tax return, so presumably around April of next year most households will get an advance on the expected revenue from the carbon price for 2019. The government should be able to adjust the level as it sees the revenue stream for the full year, and then ensure that the carbon backstop remains revenue neutral. Households will receive 90% of the revenue, and the remaining 10% go to small businesses.

The rebate amounts will vary by province because each province has a different carbon footprint, and revenue raised in one province will stay in that province. Citizens in Saskatchewan stand the most to gain.

Recognizing the larger need for long-distance travel in rural areas, people living in rural areas will receive a 10% bonus on their refund.

On average, households will not be better off, but they also won't be worse off. Households with a large carbon footprint will come out negative, while households with a small carbon footprint (typically less affluent households in urban areas, and families with children) will come out better. Overall, the bulk of the carbon tax revenue comes from households' energy use, and to a smaller extent from industry. As industry is sheltered through the output-based pricing system, the overall revenue from industry will not be all that sizeable. As higher industry cost is passed through to consumers, the net contribution to the rebate comes mostly from exporting industries—provided they can pass on the cost to their foreign customers, which is not all that likely. As long as the administrative overhead of the carbon pricing system is not significant (based on BC's experience it won't), the average household will come out neutral. The most affluent households account for a disproportionate share of carbon emissions, and thus it will be the richest households that bear a disproportionate burden. This means that on balance the majority of households will come out slightly ahead.

How are large emitters treated?

Large emitters are those that emit at least 50 kilotonnes of carbon dioxide per year. These emitters will be subject to an output-based pricing system through which the carbon tax only applies to emission that exceed an industry-specific threshold that is defined by a percentage of that industry's average emissions.

Industrial sectors that are considered to be subject to a high level of international competition—cement, iron and steel manufacturing, lime, and nitrogen fertilizers—will have a starting point of 90 percent of average emissions, while all other industries have a starting point of 80 percent of average emissions. Consider a firm in one of these other industries that emits 120% of average industry-wide emissions per unit of output, and assume that the carbon price is $30/tonne at that point. The firm pays nothing on its first two-thirds of its emissions (80%/120%), and the carbon price is only applied on the remaining third. So the average carbon price this firm pays is only 1/3 of $30/tonne, or $10/tonne. Effectively, the average carbon price is much less than the marginal carbon price. As abatement decisions are made at the margin, it is the marginal carbon price that influences the decision, while the firm gets financial relief from not paying a carbon price on the part that is way above the industry's ability to abate pollution. This system is a variation of a "best in class" approach. Firms that are environmental laggards pay the tax, while firms that are environmental leaders avoid it.

What do small businesses get?

Small businesses will receive 10% of the carbon revenue. Businesses will incur a cost paying for their emissions, and may receive only a relatively small rebate in comparison. These businesses will pass on their cost as they should. The prices of goods from high-carbon businesses will go up more than the prices from low-carbon businesses, and that is precisely how consumers will see incentives to shift to the low-carbon businesses. The fact that businesses pass on the higher cost is actually a desired outcome. Consumers will get money back through the carbon dividend, which compensates enough for the higher cost of goods. Businesses that are heavy polluters should indeed worry: they will lose market share. Smart businesses invest in clean technologies and improve their environmental performance.

The Backgrounder: Support for Small and Medium-Sized Businesses shows the expected volume of funds available to small and medium-sized (SME) businesses during the next fiscal years by province. More details on how to access this funding will become available in early 2019. It is likely that funds can be obtained for upgrading equipment to make businesses more energy efficient and help lower their carbon footprint. A similar program exists to support municipalities, universities, schools, hospitals, non-profits, and indigenous communities.

Won't a carbon tax hurt businesses?

The evidence we have from British Columbia makes it pretty clear that effects on competitiveness are quite minor. The output-based pricing system also ensures that trade-exposed carbon-intensive industries are fairly sheltered from competitive pressure. Large firms pay the carbon tax at the margin, but their average is much lower as explained above.

More importantly, by refunding the carbon tax revenue, households will spend the money mostly on goods and services. Ultimately, the carbon tax will simply shift spending on goods from carbon-intensive firms to goods from low-carbon firms. The revenue recycling makes sure that there are no adverse macroeconomic repercussions.

What about the carbon tax politics?

There can be little doubt that the federal carbon backstop policy will become a political theme in next year's federal election. Conservative politicians in this country who criticize the carbon policy are disingenuous. Conservative leader Andrew Scheer promises an announcement of his party's carbon policy before the election in 2019. Why not now? Why doesn't have his party a policy today? After all, they had years to come up with a plan, and during Steven Harper's term they came up with nothing. The simple matter of the fact is that conservatives from Doug Ford to Jason Kenney, Scott Moe and Andrew Scheer reject climate change policy, and they offer no concrete alternatives that amount to effective emission reduction policies. It only amounts to window dressing. These politicians shrug off climate change: to some it's either a complete hoax (Trump), and to others its a problem for China ("we're too small, what we do doesn't matter"), and in any case it's bad for business when our Southern neighbour doesn't move in the same direction.

The climate denial argument is unscientific nonsense; hundreds of climate scientists and the data they have amassed are speaking a clear and unambiguous language: climate change is real. The Canada-is-too-small-to-matter argument may have intuitive appeal, but misses the fact that Canada is one of the highest per-capita carbon polluters in the world. At the very least we should not be much worse than the world average. Canada emits more than 50% more carbon dioxide per capita than Germany, for example. (The US performs even worse than Canada and emits 20% more per capita.) The concerns about competitiveness are largely addressed through the output-based pricing system. The average carbon cost for businesses will actually be quite small. Ultimately, many businesses that innovate will benefit from new export opportunities abroad. It is difficult to understand why conservative politicians villify sensible carbon policies. Their myopic anti-tax posturing is selling out future generations of Canadians who have to live with the effects of climate change.

Today's policy announcement from the Trudeau government makes good economic sense. They clearly understand the need to act on climate change and how to do it right through market-based incentives. They are brave to move ahead in the face of heated opposition. For Canadians, it's time to embrace lower-carbon options in their consumption and investment choices. Those who make these choices will be rewarded by paying lower carbon fees, and won't be out of pocket because of carbon dividends.

Will the carbon tax achieve the Paris targets?

Canada's Paris target is to reduce economy-wide GHG emissions by 30% below 2005 levels by 2030—equivalent to 517 megatonnes of carbon dioxide in 2030. Based on the experience in British Columbia, the carbon tax clearly brought down per-capita emissions, but the population and economy of British Columbia has grown at the same time and offset some of these reductions. As Canada's economy is growing and a number of fossil fuel projects (Alberta's bitumen, British Columbia's LNG) are still gearing up, meeting the Paris target will be very challenging. But without the carbon tax Canada will miss it by a mile. With the carbon tax Canada will at least be on the right trajectory. In short, the $50/tonne carbon price is not enough to reach the Paris target. It will need to rise to the $100/tonne range by 2030. The Policy Brief: pricing carbon to achieve the Paris goals brings together useful cross-country information, and the Report of the High-Level Commission on Carbon Prices, co-chaired by Joseph Stiglitz and Nicholas Stern, point the way. The federal carbon action plan target of $50/tonne is clearly setting Canada on the right path, although the 2022 price cannot be the ultimate target.