IOL-DBQ CARBON DIOXIDE EMISSIONS AND FEDERAL ENERGY POLICY April, 1991 Imperial Oil DRI/McGraw-Hill Carbon Dioxide Emissions and Federal Energy Policy: A Discussion of the Economic Consequences of Alternative Taxes Cumulative Reduction in Carbon Dioxide Emissions and the Associated Cost (Reduction) In GDP (Million tonnes and billion 1981 dollars at factor cost. 1990 to 2005) 1000 - Carbon Tax Extreme 900 '5 800 5 700 -- - GST Extreme a 600 -- t: 500 IE Motor Fuel Tax Extreme/ 400 . Carbon Tax Moderate 8 Gas Guzzler Extrem?e if 300 -- . GarGuzzIer Moderate 3 100 MotorFGel Tax Moderate 100 200 300 400 500 600 700 800 900 Cumulative Reduction in GDP Diagonal Line Represents $1000 Per Tonne C02 Reduction Cost Prepared for Imperial Oil Ltd. by James A. Osten George Vasic David West DRl/McGraw?Hill March 18, 1991 Contents Executive Summary Introduction Reference Case 27 27 28 28 31 Goods and Services Tax- Policy Assumptions Economic Impacts Regional and Industrial Impacts Energy Results Carbon Dioxide Results \l (0003?! Scenario Assumptions Methodology Macroeconomic Assumptions Regional and industrial Notes Energy Assumptions 33 938331252 Gas Guzzler'Tax I Policy Assumptions Economic Impacts Regional and Industrial Impacts Energy Results Carbon Dioxide Results 13 13 16 Macroeconomic and Energy Policies Macroeconomic Policy Energy Policy Carbon Tax Policy Assumptions Economic Impacts Regional and Industrial Impacts Energy Results Carbon Dioxide Results Comparison of Results 39 40 40 4 1 43 Motor Fuel Tax Policy Assumptions Economic Impacts Regional and Industrial Impacts Energy Results Carbon Dioxide Results 45 Conclusions Comparison of Regional and Industrial Impacts Across Scenarios 49 Appendk Executive Summary Carbon dioxide is produced in varying amounts by every economic activity in Canada. The Canadian govem- ment, in cooperation with other nations, is committed to reducing the potential environmental consequences of greenhouse gases such as C02. An effective control policy would cause carbon dioxide and Other greenhouse gases to diminish with a minimum effect on the day-to- day Operation of the Canadian economy. This study analyzes the economic consequences of curbing C02 emissions through the proposed introduction of both Carbon and Gas Guzzler Taxes, and increases in the newly introduced Goods and Services and Motor Fuels Taxes. A Carbon Tax causes the most direct impact on since the tax is in proportion to the emissions. Electric utilities would have considerable incentive to build new nuclear or hydro plants, since these sources produce no C02. The Canadian oil and gas industry, which is heavi- ly concentrated in The paper, chemicals and primary metals industries would face severe cost increases. Production of coal would falter while heavy oil would virtually cease to be a usable resource. Those provinces with extensive nuclear and hydro power would experience an accelerated switch to electricity, especially for electric heat. The Gas Guzzler Tax falls on the production and sale of motor vehicles in the commercial and family-size catego- ries. Since Ontario produces many such vehicles. the greater onus of the tax is borne in that province. In general, manufacturing industries fare poorly. Also, Cumulative Reduction In Carbon Dioxide Emissions and the Associated Cost (Reduction) in GDP (Million tonnes and billion dollars ($1981) at factor cost. 1990 to 2005) 1000 Carbon Tax Extreme 'GST Extreme 600 -- _o 500 -- ?8 Motor Fuel Tax Extreme 3 400 -- 8 . Carbon Tax Moderate CE Gas Guzzler Exter?e 300 :3 200 Gae'Guzzler Moderate 5 100 Tax Moderate 100 200 300 400 500 600 700 800 900 Cumulative Reduction in GDP February 1991 1 Executive Summary Carbon Dloxlde Emissions Growth? 1978 to 2010 Reference Case 700000 CE 650000?? 8 600000?- a; aria 550000 GST25 15 coz 4500001975 1990 1995 1990 1995 2000 2005 2010 TX25 Motor Fuel Tax Moderate TX100 Motor Fuel Tax Extreme trade is adversely affected since Canada would import proportionately more vehicles. The Goods and Services Tax was introduced on Janu- ary 1, 1991 at a rate of 7 percent. This tax is increased to 10 percent in the moderate version and 25 percent in the extreme case. The main thrust of the GST is to raise revenues for the federal government. How those revenues are respent and the workings of the Canadian economy in the aftermath of large tax increases are set forth by this case as a basis of comparison with the other three tax cases more focused on carbon emissions. The GST does in fact reduce C02 emissions. The Motor Fuels Tax falls on consumers. In the ex- treme tax case, the trade balance is improved, the ex- change rate rises and interest rate effects are-nil. infla- tionary increases are moderate, and overall economic effects are small. Consumers do switch from large to small cars. What all the scenarios show is that direct taxes are a blunt instrument. The major impact on C02 comes from new nuclear plants replacing coal-fired generation. Secondary improvements in C02 emissions occur from automotive efficiency gains. conservation, and increased use of natural gas. The Gas Guzzler Tax is a particularly inefficient way of reducing C02 emissions since its pn- 2 Imperial Oil GUZSO Gas Guzzler Moderate GU2100 Gas Guzzler Extreme COZLOW Carbon Tax Moderate GST10 GST Moderate 002 Carbon Tax Extreme GST Extreme mary effect is to reduce manufacturing activity and im- balance existing international trade patterns. In 1990, Canada will emit about 500 million tonnes of C02 while consuming over 12,000 petajoules of energy and producing a GDP of 684 billion dollars. In the Ref- erence Case, C02 emissions rise to 616 million tonnes by 2005 while energy consumption grows to 16,000 peta- joules and GDP to 1072 billion dollars ($1990). The in- creasing reliance upon fossil fuels in the Reference Case causes C02 emissions to grow faster than total energy consumption, while conservation and rising energy prices contribute to a substantially lower energy growth rate than that for GDP. Taxes on are taxes on energy consumption. Coal has the highest C02 emissions per unit of energy, while natural gas is half that of coal, and nuclear and hydro p0wer have no C02 emissions. The simplest way to re- duce C02 emissions from energy is to substitute natural gas. nuclear and hydrOpower for coal. The Carbon Tax is set in proportion to carbon content. Thus the Carbon Tax causes a high propensity to switch fuels. Generally, the taxes reduce consumption of the items taxed, be they large cars, moror fuels, carbon content or economic activity. For each of the tax cases, two alternatives were pre- pared featuring a moderate version and an extreme ver- sion of the tax. For example, the Carbon Tax is intro- duced at $50 per tonne of carbon emitted in the moder- ate case and at $200 per tonne in the extreme case. Consequently, a total of eight different tax scenarios are compared with a moderate and extreme version of each of the four taxes. All of the cases can be compared in terms of their eco- nomic efficiency in reducing C02 in a measure of dol- lars per tonne. The cumulative loss in real GDP be- tween 1990 and 2005 is a measure of the social invest- ment made in C02 reduction. Also. the tax revenue collected on energy consumption by the given tax would i. be a measure of the relative burden on society of under- Executive Summary taking 02 reduction by use of taxes. The cumulative reduction in C02 emissions is the result. In principal. the best policy to reduce C02 would be the one most cost effective. Cost effectiveness is shown by comparing cumulative 02 emissions with cumulative GDP reductions in Chart 1. If a line were drawn at the ratio of $1000 per tonne of C02 emissions avoided. most of the scenarios would be to the left. indicating a cost of less than $1000 per tonne. The Gas Guzzler Tax is clos- est to the right, indicating a higher cost. In Chart 2. the results of the eight scenarios are compared for the an- nual level of C02 emissions. February 1991 3 Introduction Carbon dioxide is one of several greenhouse gases that are considered contributors to global warming. Many developed nations are accepting global warming as an inevitable consequence of the buildup of greenhouse gases in the atmosphere. There is no doubt that C02, methane, CFCs and nitrous oxide are increasing in at? mospheric concentration. Thus. g0vernments around the world are seeking new actions that limit the build up of greenhouse gases. The essence of policy measures is to reduce the emis- sion of carbon dioxide by taxing energy consumers. Grand goals such as a 20 percent reduction in carbon dioxide emissions from current levels have been pro- claimed. The Canadian Minister of the Environment has set a goal of stabilizing carbon dioxide emissions in 2000 at current levels. Such goals for carbon dioxide emissions imply new energy policies, including new taxes. Canada has already had experience in reducing carbon dioxide emissions by large amounts. From 1980 to 1983, carbon dioxide emissions in Canada fell from 456 million tonnes to 404 million tonnes as calculated using C02 coefficients and energy consumption. The economic circumstances that led to a reduction of carbon dioxide were severe. Energy prices nearly doubled during this period and a very deep recession occurred. No consumer would willingly return to the 20 percent interest rates and double-digit unemployment rates that characterized the economy of this era. The reduction in C02 from 1980 to 1983 was not brought about by environmental policy. However, examination of this era serves to indicate the potential dangers in a single-minded greenhouse-gas emission reduction plan. Energy policies did have much to do with the reduction of carbon dioxide emissions in the early 19805. Natural gas was substituted for petroleum, and massive new hy- droelectric generating stations featuring ?ooding of the LaGrande River Basin reduced fossil fuel consumption in Quebec. Ontario Hydro constructed the Pickering and Bruce nuclear stations while Gentilly and Point Le- preau were built in other provinces. All of these mea- sures helped reduce carbon dioxide levels. Carbon diox- ide reduction was initially accomplished by recession, inflation and fuel gy policies altered industrial consumption patterns. High energy prices encouraged pulp and paper compan- ies to install bark boilers, which have one of the highest C02 emissions rates. Wood burning releases 100 tonnes of C02 per petajoule, while natural gas releases 49 tonnes. Hydroelectric sites do not produce carbon dioxide. However, they do flood large areas of vegetation, which reduces the absorption of by Bo- dies of water such as oceans and lakes also. absorb C02. The point is that biomass and hydro projects also inter- act with the environment. Scientific evidence offers few- er certainties than would be desirable for informed pub- lic policy. Other environmental concerns were heightened in the past decade. Nuclear accidents at Three Mile Island and Chernobyl have heightened concerns about nuclear safety. Also, the final resting place for spent nuclear fuel is as yet undecided. Clearly, the experience of the 1980 to 1983 price shock and recession was painful for energy consumers and pro- ducers. Economic shock was accompanied by govem- ment intervention in market decisions. Such events ulti- mately disrupt normal economic, commercial and politi- cal decision-making. In particular, political decisions carry an inherent responsibility to all parts of society such that a single-minded goal is usually unworkable. Tradeoffs must be made between C02 reduction, eco- nomic growth and other environmental issues. In many forums, the Canadian government has dis- cussed the use of taxation to effect environmental goals. Economic analysis of such options will help the govem- ment make prudent decisions. While the details of the proposed Environment Canada policies are still taking shape, newspapers and govern- ment agencies have been discussing various taxes. Four February 1991 5 Introduction REFERENCE 650000?? TX25 4 tn '0 2 moo??- COZLOW 5 GUZ100 TX100 550000-?- It GST25 l5 500000?- 450000?-? 400009 1975 1980 1985 1990 1995 2000 2005 2010 TX25 Motor Fuel Tax Moderate GUZSO Gas Guzzler Moderate COZLOW Carbon Tax Moderate GST Moderate TX100 Motor Fuel Tax Extreme tax cases are representative of possible policies?a Car- bon Tax, increases in the Goods and Services (GST), increases in the Motor Fuel Tax, and a Gas Guzzler Tax involving a one-time sales tax on larger cars followed by higher annual registration fees. Of particular interest is the effect such taxes would have on the macroeconomic and industrial structure of the Canadian economy. Energy-intensive industries ob- viously would have the primary impacts in terms of fuel choice, cost of doing business. trade patterns, and invest- ment. Electric utilities would face complex choices, with massive consequences for C02 emissions. This study, commissioned by Imperial Oil Ltd, is a for- mal analysis of the economic impacts and reduced levels resulting from selected government tax policy. In order to proceed with this analysis, DRI/McGraw-Hill has developed the appropriate assumptions to fully re- flect the consequences of the government tax policy within its existing economic and energy modeling system. Reference Case In the Reference case, current policy stays intact, there are few disruptive events, and economic growth pro- ceeds at a normal rate. World oil prices rise in real terms. the economy grows at 3% per year, inflation is moderate. and the federal deficit is in retreat by 1998. 6 Imperial Oil GU2100 Gas Guzzler Extreme 602 Carbon Tax Extreme GST25 GST Extreme Resource prices increase in real terms such that mining, manufacturing and services all substantially contribute to economic well-being. Energy demand growth averages 1.7% per year, about 0.55 the rate of increase of the entire economy. Conser- vation programs, demand management. automobile effi- ciency, and real price increases temper energy demand growth. Natural gas demand is enhanced by increased use in electricity generation and more stringent require- ments for clean fuel. Nuclear power overcomes the cur- rent irnpasse, and both Ontario and New Brunswick con- struct new nuclear stations. Energy development focuses on replacing the diminish- ing supply of conventional crude oil with such projects as Hibernia, Terra Nova, Beaufort and Oil Sands. The Mackenzie Delta pipeline is constructed in 1999, thus ensuring ample supplies of natural gas to meet growing demands. Canadian electric utilities spend over 30 bil. lion dollars on conservation and demand management. with a target of 11,000 megawatts of generation equiva- lent by 2010. In 1990, C02 emissions reach 500 million tonnes. Car- bon dioxide emissions continue to rise, reaching 616 mil? lion tonnes in 2005 and 664 million tonnes in 2010. The level of carbon dioxide emissions have been calculated by province for the period form 1978 to 2010 based upon C02 coefficients obtained from Energy Mines and Re- sources and the Ontario Ministry of Energy. Scenario Assumptions There are nine scenarios developed for this study, in- cluding a Reference Case and four tax cases, each with a moderate and an extreme version. This section dis- cusses the methodology used in the analysis and the key assumptions made for eachscenario. - . Methodology A comprehensive modeling exercise includes several steps. First. the assumptions are carefully prepared. The tax cases are contrasted to a base case which is a long-term trend forecast extended to 2005. The 15 years, 1990 to 2005, measure both the initial and the long-term economic impacts of the aforementioned tax increases. The results of models reflect how society would adapt to new policies. New taxes imply that consumers and pro- ducers would face higher costs, while governments would have more revenues. The macroeconomic im- pacts of tax changes include in?ation, growth, exchange rates, investment and trade, and are relatively easy to identify. The microeconomic effects on specific industries are much more difficult to establish without a comprehen- sive framework such as those provided by related indus- try models. Since most of the taxes are aimed at energy consumption, a large scale model of Canadian energy markets is also used in this study. The energy model is used to calculate energy consump- tion. Total C02 emissions are derived from energy de- mand using C02 coefficients developed for models by Energy Mines and Resources, and the Ontario and Brit- ish Columbia Ministries of Energy. Several aspects of how 02 tax policies will impact soci- ety are addressed in this study at the level of Macroeco- nomics, Regional, Industry and Energy. The Macroeco- nomic model has an associated industrial model with an imbedded input-output framework to establish impacts at the level of industrial detail. The Energy model mea- sures effects on oil and gas supply as well as energy de- mand and trade. The Regional model shows the distri- bution of effects across provinces, particularly the differ- ences between the producing and consuming regions of Canada. Imperial Oil Ltd. is undertaking a comprehensive analy- sis of alternative tax policies on the Canadian economy and C02 emissions. The assumptions used in this analy- sis reflect twc?altematives for each policy-21 moderate compromising policy, and an extremely harsh, repressive policy. The key assumptions that are required to ana- lyze the government tax policies are as follows: Each of the taxes has a different incidence based upon the level of the tax. its intended incidence. and its intended consequence. For example. a car- bon tax would be set in dollars per tonne of carbon emission on fossil fuels, the GST increased across the board on all goods and services, the motor fuel tax raised in cents per litre for gasoline and road diesel, and a gas guzzler tax established on the least fuel-efficient passenger cars and light trucks (new and existing) in Canada. The total tax reve- nue is calculated using the Canadian Energy Model. .- How the tax revenue is spent is of major impor- tance to the economic results. Essentially, govem- ment accrues the extra revenues from the new tax until budget balance is achieved. The tax revenues are then spent on transfers and new programs. The same government spending pattern is applied to all of the scenarios. In addition to the spending patterns imposed in these scenarios, various forms of trading or cross crediting could be allowed. The carbon content of each fuel is Specified. Com- bustion efficiency can alter the amount of C02 emitted. Carbon taxes are based upon the C02 emission coefficients. C02 emissions are calcu- lated by fuel, sector, and province. International competitiveness is a critical aspect of taxation policy. In a mild tax case we assume that other countries are adopting similar policies so that international competition is less significantly af- February 1991 7 Scenario Assumptions fected. In the extreme cases, the full debilitation of international trade brought about by taxation would occur. International cooperation is ultimate- ly the deciding factor for a successful C02 emission reduction plan. International competitiveness is reflected in the Macroeconomic model through the exchange rate and relative price effects on trade. Macroeconomic Assumptions This section identifies the policy responses assumed for the carbon tax scenarios. Since policy can have a sub- stantial impact on the economy, it is critical that the be- havior assumed by the fiscal and monetary authorities is identified; It is also important that these assumptions are consistent, so that comparisons between. scenarios are appropriate. In each scenario, a tax policy was introduced that ulti- mately attempted to lower C02 emissions. This had the direct effect of raising federal government revenue and in?ation while weakening the economy. In light of the direct changes to the economy, the following responses were assumed in all cases: Monetary Policy Short~term interest rates were increased by the amount of the increase in'in?ation, thus real short-term interest rates were unchanged. No additional adjustments were made to long-term rates, which move by approximately 25-35 basis points for each 100 basis points (or 1 percent) move in short-term rates. This response was consistent with the Bank of Canada?s unwillingness to accommo? date any increase in in?ation, and therefore was as- sumed to respond to increases in in?ation with an equal dose of higher interest rates. Fiscal Policy All net revenue flows from the increased taxation were used to lower the deficit until it achieved balance. This simply re?ects the reality of the current deficit, which has stagnated near $30 billion in each of the last five years; and a debt-to-GDP ratio that is at its highest level since World War II, and is still growing. In our base case, the National Accounts deficit balanced in 1998 (ap- proximately 4 years later than the Department of Pi- nance is projecting), but the higher tax revenue acceler- ated that by up to 2 years. Once the deficit was bal- anced, it was assumed that the federal government would respend all additional revenues; thus the im- provement in the deficit in the year it was balanced was maintained to the forecast horizon. In the moderate 8 Imperial on cases, this improvement was roughly 37-38 billion; in the extreme cases it was $12-$14 billion. The impr0vement was larger in the exteme cases because the momentum from the sharper tax increases caused the deficit to bal- ance sooner than in the moderate cases. Thus. relative to the base case that showed a gradual reduCtion in the deficit over time, the improvement required to balance the budget was greater the sooner it took place. Federal government respending was divided between additional spending on current goods and services, trans- fers to persons, and income tax cuts. This division is intended to spread the respending over the principal revenue and expenditure components so that a similar balance'betwe?en programs could be maintained. Since the amounts for each component were allocated to maintain a given impr0vement in the deficit, the specific mix chosen has little bearing on the overall simulations effects. Other Key Factors b- The Canadian dollar was allowed to float; no addi- tional adjustments were made to it. The effect of the higher interest rates and improved trade bal- ance (from the weaker economy) typically caused a mild appreciation at the beginning of the period; subsequently, the higher inflation and reduced competitiveness caused it to weaken. b? The wage response to inflation changes was not accelerated; thus the effects of the policies were unanticipated in labor negotiations prior to their impact on reported inflation. The federal government was not assumed to initi- ate any new stabilization policies in the face of the weaker economy that emerged prior to the re- spending of revenue gains. This reflects the oner- ous level of the deficit and debt that does not per- mit aetion on any meaningful scale. However, the full effect of the automatic stabilizers (such as un- employment insurance) were operational, as was the maintenance of the same volume of spending on goods and services and transfers to the provinces. Other Notes Compounding. Care must be taken when interpreting nominal values because of the effects of compound growth. For example, by 2005 the economy in current dollars is more than three times its present size. A fed- eral deficit equivalent as a share of GDP to its $30 bil- lion level today is 590 billion in 2005, as is a debt of $1.05 trillion (compared with $350 billion at the end of fiscal 1989?90). Deficit Changes. An explosive dynamic can cause large changes in the deficit from seemineg small initial im- pacts. This is because extra revenue, for example, re- duces the deficit directly, which in turn lowers the debt and subsequently interest payments. These in turn low- er the deficit, which again lowers interest payments. etc. To illustrate, a $1 direct change in the deficit in 1990 will lead to a $4 change by 2005, with the $3 effect on inter- est payments dominating the original change. Regional and Industrial Notes The eight macroeconomic simulations described in the previous section were used to construct corresponding simulations using Industrial and Regional models. Using an input?output structure and the final demand categories of the macroeconomic model, the industry model produces forecasts of industrial output for ap- proximately 40 industries. The regional model then uses the output of the industrial and Macroeconomic models to simulate economic activity within seven regionS~(six provinces and the Atlantic region) in a dynamic, simulta? TABLE 1 Scenario Assumptions neous fashion, while ensuring the add?up to the pre- viously solved national levels. It is important to recognize that output in the industrial and regional models is defined at factor cost, while total output (real GDP) in the macroeconomic model is de- fined at market prices. Real output at market prices/ less indirect taxes/plus government subsidies is. by defi- nition. equal to real output at factor cost. As a result, in the extreme case, real output at market prices declines by a cumulative amount of $100 billion, while real out? put at factor cost declines by a cumulative $566 billion. The difference between these two declines is the cumu- lative amount of increased indirect taxes that are col- lected as a result of carbon taxes. Energy Assumptions Each of the four tax scenarios has a moderate and an extreme scenario for a total of eight scenarios. The en- ergy assumptions for the moderate cases are the same except for slight modifications of the carbon tax and gas guzzler cases. The extreme case has accelerated conser- vation. more natural gas vehicles. and more nuclear and less coal consumption. There are slight modifications of the extreme case assumptions made for the carbon tax and gas guzzler (see Table 1). Energy Assumptions Used in the Moderate and Extreme Alternatives of Each Tax Scenario Moderate C02 Coal Plants none after 2003 Nuclear Plants Alberta adds gas. other provinces add Extreme none after 1998, existing coal plants replaced with other fuels such as nuclear all add Nuclear plants nuclear or hydro as required. Carbon Tax case has additional 900 megawatts Conservation and Demand Management 200 megawatts per year added to Carbon Tax case has additional 7200 megawatts 400 megawatts per year added to Reference Case 11.000 megawatts total in Reference Case Natural Gas Vehicles 2% of new car sales 10% of new car sales February 1991 9 Scenario Assumptions CHART 1 Energy Demand is Lowest for 25% GST 1 17000?? 16000?? 15000 13000?- Petajoules 12000?? 11000?- 10000?? 9000 I 1 975 1 980 TX25 Motor Fuel Tax Moderate TX100 Motor Fuel Tax Extreme CHART 2 I 1985 1990 1995 GU230 Gas Guzzler Moderate GUZ100 Gas Guzzler Extreme 002 Carbo COZLOW Carbon Tax Moderate 11 Tax Extreme I 2005 2010 GST10 GST25 GST Moderate GST Extreme Carbon Tax Revenues Are Highest 700% 60000?? CO2 I 4' 50000?- I GST25 40000?? d? :95 a .p ?(100 to I .- 10000REFEREN 4000?} i i i i 1975 1980 1985 1990 1995 2000 2005 2010 TX25 Motor Fuel Tax Moderate GUZSO Gas Guzzler Moderate COZLOW Carbon Tax Moderate GST10 GST Moderate TX100 Motor Fuel Tax Extreme GST2 GST Extrem 10 Imperial Oil (302 Carbon Tax Extreme Scenario Assumptions . coz I 70?- I a 60?? a Ed SEE-5355405 3 40__ 30?? 201975 1900 1985 1990 1995 2000 2005 2010 1X25 Motor Fuel Tax Moderate GUZSO Gas Guzzler Moderate COZLOW Carbon Tax Moderate GST10 GST Moderate TX100 Motor Fuel Tax Extreme GU2100 Gas Guzzler Extreme COZ Carbon Tax Extreme GST25 GST Extreme CHART 4 Nuclear Capacity Is Highest for Carbon Tax 35m (:02 30?00 GST25 25000?? cozLow GST10 3 1?s; REFERENCE 15000?? 100001975 1980 1985 1990 1995 2000 2005 2010 TX25 Motor Fuel Tax Moderate GU230 Gas Guzzler Moderate COZLOW Carbon Tax Moderate 00 Motor Fuel Tax Extreme GUZ100 0 GST Moderate Gas Guzzler Extreme 0 Carbon Tax Extreme GST25 GST Extreme February 1991 11 Macroeconomic and Energy Policies Fiscal policy, especially taxes and respending. are the initial causes of the results of this study. The price changes induced by the taxes have further effects on interfuel substitution. And the consequences of the taxes?C02 emission reductions?must be measured against other environmental policies. Macroeconomic Policy The principal macroeconomic issues involve respending. The federal government can recycle the tax revenue by deficit reduction, cutting other taxes. increasing trans- fers to individuals through such things as the GST credit and program Spending. Spending is divided between deficit reduction, transfers, and programs. De?cit Reduction All of the tax revenue is used to reduce the deficit until the budget is brought into balance, which would be in the late 19905. Federal budgetary balance is achieved by 1998 in the base case and by 1996 in some of the energy tax cases. The tax rates have a smooth implementation, such as introducing the GST at a rate of from 1 percent to 2 percent per year. thus causing a continual increase in government revenues. Transfers Government transfers include the proposed GST credit, which causes a transfer payment to low income individu- als whose existing level of income and spending patterns make the GST regressive. Since all of the proposed taxes are regressive, additional transfers or credits are consistent with current government views on respending. There are other ways of offsetting tax revenues. The personal income tax could be reduced or adjustments made to other taxes such as unemployment insurance (UL) and the Canadian Pension Plan or Quebec Pen- sion Plan. Program Spending There are numerous prospective programs that could improve environmental quality such as assistance to in- ternational efforts toban CECsandclean-up of-the - Great Lakes. Government program Spending is tar- geted on specific activities which have in turn effects on economic activity such as energy demand. Federal programs could also address interfuel subStitu- tion and promote conservation, demand management, electricity use in mass transit, and nuclear generation. thus significantly reducing fossil fuel consumption in Canada. Recycling. Many communities have begun voluntary recycling programs. Also, many newspapers and maga- zines want to use recycled paper for ecological reasons and public recognition. The petrochemical industry re- cycles plastics and will be able to increase recycling dra- matically in the future. Federal program monies could be spent on promoting recycling programs. Great Lakes Cleanup. The Great Lakes clean up con- sists of water treatment plants for effluent at the point of entry, such as towns and mills with discharges into rivers and streams that flow into the Great Lakes. Mass Transportation. There are subways, light rail transit, commuter trains, and VIA rail and bus lines that provide enormous transportation services at relatively low emissions of pollutants per passenger. Rail Electri?cation. Electricity generated by nuclear or hydroelectric sources could be used to power railroads. Conservation and Demand Management. Electric utilities have made enormous commitments to conserv- ing electricity. Ontario Hydro is committed to spending several billions of dollars to reduce the demand for elec- tricity at specific sites and for specific processes. Nuclear Plants. Atomic Energy of Canada Ltd. (AECL) is the major provider of nuclear technology in Canada. Several nuclear stations have been partially funded by AECL. either through research and develop- ment or provision of technology. Nuclear generation of February 1991 13 Macroeconomic and Energy Policies CHART 1 Nuclear Investment ls Highest for Carbon Tax 6000 1990 Millions I il- 1975 1980 1 985 1 990 TX25 Motor Fuel Tax Moderate Motor Fuel Tax Extreme electricity would require a major contribution by the federal government to induce provinces such as Sas- katchewan, Manitoba and British Columbia to add nu- clear capacity. Investment The base case investment provides for the energy, infra- structure and producing capacity of an economy growing by nearly 3 percent per year. The base case capital stock is nearly fully employed. with both domestic demand and exports of Canadian goods growing. The pattern of growth is very much a re?ection of Canadian traditional in resources and includes several megapro- jects. A major reduction in allowed C02 emissions would im- pact the investment profile in two ways. First, the me- gaprojects such as OSLO and Hibernia could be can- celed. Development of large scale oil projects is not necessarily linked to Canadian demand for petroleum products, so these projects could proceed if world oil prices are high enough. A concerted effort to reduce world oil consumption would probably chill the econom- ic prospects for development of either or both of these projects. A program to reduce oil and coal consumption would lead to the closing of refineries and coal mines?a sig- nificant reduction in the capital stock of Canada. Con- 14 Imperial Oil GUZBO Gas Guzzler Moderate GUZ1OO 2 Gas Guzzler Extreme I 1995 2000 2005 2010 COZLOW Carbon Tax Moderate GST1O GST Moderate C02 Carbon Tax Extreme GST25 GST Extreme verting railroads to electricity would cause a reduction in the demand for diesel locomotives. Change of economic activity from coal and oil to electricity would cause con- siderable investment by the utility sector. Nuclear plants costing on the order of Darlington would be add? ed, while the existing coal plants would presumably re- main in the rate base but not be used. In a real sense, the loss of wealth caused by capital that is retired before its useful life ends represents a large loss of wealth for Canada. Second, the need for clean energy resources such as nat- ural gas, nuclear and hydro power will result in a major shift in investments from the base case. While these investments may be subsidized by government programs. the overall cost to the economy will be dependent upon the relative cost of these new sources of energy. To a large extent, these energy resources are capital in- tensive, with enormous initial investments, low operat- ing costs, and fairly long pay back periods. The profile of new investments implies that the Canadian economy will receive a strong initial stimulus from investment and a considerable increase in b0rr0wing and ultimate repay- ment of debt. There are two aspects of the energy resources invest- ment, including the loss of part of Canadian current economic infrastructure and the large scale investments required in new technologies. In terms of the economic CHART 2 Utility Fuel Cost Increases With Carbon Tax 8000 Macroeconomic and Energy Policies 7000?? 31990 Millions 1 I I I 1 1975 1980 1 985 1 990 TX25 Motor Fuel Tax Moderate TX100 Motor Fuel Tax Extreme impacts of a carbon dioxide tax, provision is made for effects on potential GDP, delay or cancellation of mega- projects, and expanded investment in new areas. Ultimately, the economic implications of C02 taxes will be evident in Canadian international competitiveness. If investments offer poor returns and lead to losses in in- ternational markets, the overall economy will suffer. International Competitiveness Canadian international competitiveness is concentrated in resource-based energy intensive industries such as metals, pulp and paper, and energy. A major conse- quence of raising the price of energy is a loss in interna- tional competitiveness. Another effect of high taxes on energy consumption is increased inflation. The full effect of higher inflation would lead to a combination of higher interest rates and a depreciation of the exchange rate. In the moderate policy cases. the assumption of a coop- erative international regime is made. Most countries would impose policies symmetric to those in Canada. In GUZ3O Gas Guzzler Moderate Gas Guzzler Extreme I 1995 2000 2005 2010 COZLOW Carbon Tax Moderate GST10 C02 Carbon Tax Extreme GST Moderate GST2 GST Extreme particular, the U.S. would mirror Canadian polices so that there is little effect on the exchange rate. In the extreme policy regime. Canada goes it alone. High taxes on energy consumption are borne by the manufacturing and resource sector. Canada becomes less competitive in international markets. A decline in international competitiveness would lead to depreciation of the Canadian dollar. This is accomplished in the model by fixing the Canadian dollar at its real exchange rate. International considerations are critical. Note that if the U.S. reduced C02 emissions by 30 percent it would delay the doubling of world atmospheric 02 concentra- tion from 80 to 85 years at a cost to the U.S. of 150 to 200 billion per year. The benefits to the U.S. would be minimal since mainly the agricultural sector and low lying tidewater regions are affected by global warming. The Third World, which has a major portion of its econ- omy in the agricultural sector. has much more serious economic exposure to global warming. Thus the as- sumptions we make on international cooperation are of the greatest consequence for C02 emissions and global warming. February 1991 15 Macroeconomic and Energy Policies CHART 3 Carbon Dioxide Emissions by FUel Type, Electricity Consumption Adds 1 Tonnes per Terajoule Eastern s! Western Energy Policy interfuel Substitution Events in the past decade accentuate the importance of electricity fuel choice in determining energy market trends. All of the critical fuel switching decisions in- volve electricity and the fuels used to generate electric- ity. The most effective policies to reduce carbon dioxide emissions are those that reduce C02 emissions from the electric utility sector. Canadian consumers have undertaken a massive Switch in fuel sources in the past decade as a consequence of rising oil prices. government programs and expansion of natural gas pipeline availability. Electric utilities have avoided oil and chosen nuclear, hydro eleCtricity and coal. Paper companies have installed numerous bark 16 Imperial Oil Satural Ref. Case Average Average Electricity Electricity Ref. Case 1990 2005 Electricityax Caress 2095., A boilers and now rely upon wood waste for much of their fuel requirements. Electricity has maintained its role as a superior good? electricity demand has grown faster than the economy as a whole. This means that electricity has grown very rap- idly in electricity-only uses such as air conditioning, and has partially replaced fossil fuels in areas such as space heating. Since it takes about three units of fossil fuel to generate one unit of electricity, which then replaces about one to two units of fossil fuel, there is a potential net increase in carbon dioxide emissions when electricity is used for space heating. Other interfuel substitution is imposed in the scenarios. Nuclear power is introduced in all of the regions. Natu? ral gas vehicles are added at a rate of 10 percent of new vehicles. Price induced substitution is measured within the energy model. The net result is a major change in market shares across cases. Carbon Tax The carbon tax is a matched focus to carbon dioxide reduction: it exactly corresponds to what is being dis? couraged. In comparison, the goods and services tax has the broadest focus, with a tax increase on everything, irrespective of carbon content. guzzler taxes are narrowly focused, with direct taxation only on the transportation sector. The carbon tax is assessed in dollars per metric tonne of carbon contained in the C02 emissions. (Carbon is 12/44 of carbon dioxide.) One barrel of petroleum has about 0.122 tonnes of carbon content, and thus would have a tax of $24.40 per barrel in the $200 extreme car- bon tax scenario. There are two carbon tax scenarios: a $200-per-tonne extreme tax; and a $50-per-tonne moderate tax. In the extreme carbon tax scenario, the carbon tax is first applied in 1993 at the rate of $25 per tonne of carbon emissions. After.l993. the extreme tax increases by $25 per year until reaching $200 in 2000. The real value of the carbon tax is maintained in 1993 dollars. Thus the $200 tax in 2005 amounts to $381 in as-spent dollars. The moderate tax starts at $10 per tonne and is in- creased by $10 per year, reaching $50 per tonne in 1997 or $57.87 in as?spent dollars. The moderate tax reaches $87.28 in 2005 in as?spent dollars, reflecting a somewhat lesser rate of inflation than in the extreme carbon tax scenario. The carbon tax causes a reduction in C02 emissions in three ways: weaker economic activity, price-induced conservation and efficiency, and fuel switching. While the carbon tax is massive and causes a substantial reduc- tion in economic activity, fuel switching is potentially the biggest source of C02 reductions. For example, nuclear power would be unaffected by a carbon tax, while coal and other fossil fuels would be penalized by such taxation. Thus. electric utilities would be strongly at- tracted to nuclear power in the carbon tax case. In the carbon tax scenario, Canadian utilities add over 7,200 gigawatts of nuclear capacity above and beyond the Reference Case by 2005. More nuclear capacity is also added in the other scenarios. However, in the narrowly based tax scenarios, much of the C02 impact comes from a weaker economy, conservation, and vehicle effi- ciency. is de- pressed: there are fewer homes. cars. factories. office buildings and electric power plants, and personal income is over 7% lower in real terms by 2005. This reduced economic activity affects carbon dioxide emissions. In- deed, in the extreme scenario. reduced economic activity accounts for about 34.5 million tonnes of carbon dioxide reduction?a 5.6% reduction in total carbon dioxide emissions and more than one-quarter of the reduction in carbon dioxide. The remaining three-quarters of the reduction is a result of interfuel substitution, along with price changes and conservation efforts. Interfuel substitution includes using natural gas rather than other fuels. Natural gas use is only partially pro- moted by the carbon tax. Natural gas emissions of 49 tonnes of carbon di0xide per terajoule are only two- thirds those of fuel oil (at 73 tonnes). Thus the carbon tax amounts to Over $8 per gigajoule for fuel oil and about $5 per gigajoule for natural gas. There is more of an incentive to switch from natural gas to primary elec- tricity?thereby saving $5 in taxes per gigajoule?than there is to switch from fuel oil to natural gas at a savings of $3 per gigajoule. Additional government policies promoting natural gas are assumed in the extreme carbon tax case. Specifical- ly. natural gas vehicles reach 10% of new vehicle sales by 2005. This reduces carbon dioxide emissions by 1.4 million tonnes (about 1% of total emissions reductions). Switching from oil to gas in other sectors provides another 1.8 million tonnes of carbon dioxide reducrion. In total, switching from oil to other fuels accounts for about 2% of carbon dioxide reduction. The results of the extreme carbon tax case suggest that the switch from coal to nuclear fuel (a 7200 megawatts increase in nuclear and a 5900 megawatts reduction in coal capacity) accounts for 32% of the toral reduction in carbon dioxide. The reduction in exports of electricity accounts for another February 1991 17 Carbon Tax TABLE 1 Conservation Fuel Elticiemx Lie?gm hin 7% (price) 1% (oil) 6% (price) 1% (NGV) 2% (small cars) Carbon Dioxide Emissions Reduction Is 32% From Nuclear Power (Percent) Reduced Economic Sector Adm Residential. Commercial, industrial 8% Transportation 9% Electric Utility 9% 26?/ 20% (price) . 2% (explicit conservation) 1% (Natural Gas) 2% (exports) - - Conservation and price effects are the second major source of carbon dioxide reductions. Conservation in the Residential, Commercial and Industrial sectors amounts to 9% of the total emissions reductions. The increase in efficiency of motor vehicles accounts for about 2% of emissions reductions while price effects, on the transportation demand for fuel, account for another In the electric utility sector, an additional 20% of carbon dioxide reductions are associated with price effects. Provinces with the highest carbon content of electricity Alberta, Saskatchewan and the Atlantic region) face particularly high prices for electricity and substan- tial price-induced changes. Consequently, these regions drastically cut back on the use of coal in electricity gen- eration. The electric utility sector actually accounts for two- thirds of the C02 emissions reduction. Conservation, interfuel substitution, and economic impacts broadly affect electricity consumption as well as utility fuel choice. Most of the impact of the carbon tax scenario occurs because of discrete actions by large entities such as gov- ernment and electric utilities. The scenario assumes that motor vehicle efficiency is monitored and fuel qual- ity standards set by government. Nuclear switching by utilities is also assumed, since the carbOn tax on coal would otherwise add several billion to annual utility op- erating costs. The cost of constructing new nuclear ca- pacity is substantially above that of coal plants. Fuel costs however, are very small for nuclear plants?about $180 million for the 7200 megawatts in 2005?while the equivalent coal costs would be over 6 billion. The life- 18 Imperial Oil time costs of nuclear plants (capital, fuel and other op- erating expenses) are anticipated to be less than those of coal plants in the extreme carbon tax scenario. The government would have enormous amounts of addi? tional revenue once carbon taxes are imposed. In the moderate case, this ranges from $13 billion in 1995 to $23 billion in current dollars by 2005. In the extreme case. the revenue gains range from $33 billion in 1995 to $177 billion in nominal dollars by 2005. The government is thus expected to fund broad-based conservation, sub- stitution. and conversion, as well as part of the nuclear program. A major increase in government energy pro- grams?over and above all of the past and existing in- volvement in energy?would be expected to accompany an extreme carbon tax. Government already has over- whelming control over electric utility supply capacity decisions. Already, provincially-owned electric utilities are promoting significant programs in electricity conser- vation. Government program expenditures would include ener- gy initiatives to help achieve C02 objectives. The cost of electric utility conservation programs are about $40 billion over the 1990-2005 period. Also, the cost of con- structing 7200 megawatts of nuclear power is major. Additional expenditures would be required to fund Atomic Energy of Canada Ltd. and find a solution to nuclear waste disposal. The huge government revenue increases in the extreme carbon tax scenario would have a pervasive impact on society. The massive tax increases?which are close to those in the extreme goods-and-services tax (GST) case, and stabilize C02 emissions at 1990 levels?lead to an enormous increase in the size-of government. and in- duce radical changes in the relative price of fossil fuels. Carbon Tax Moreover, many of the decisions concerning energy use trade balance is initially boosted by the weak econ- would be mandated by g0vernment. Electric utilities orny; subsequently this reverses as higher capital would face heavy taxes unless they switched to nuclear spending boost imports. power. And consumers would face European-level prices for petroleum products. Extreme Case The following discussion presents difference from base- except as noted) analysis of the carbon tax scenarios in the order of their 1995 2095 macroeconomic, regional/industrial, energy, and carbon Real GDP 4.9 _2.4 diox1de impacts. CPI Level 2.0 6.4 10.1 Exchange Rate (US. cents) 0.4 1.8 -1.9 Interest Rates percent) 0.1 2.0 1.3 Trade Balance ($billion) . 2.9 2.5 ?2.9 Pollcy Assumptlons Business Names. Investment -4 8 -2.2 3.7 The introduction Ofa carbon tax raises Inc?pmaof A ?Direct Revenue Impact (Sbillion) 32.6 100.0- . 176.5 oil, natural gas and eleCIricity by the following amounts: In the extreme case in?ation is increased by per- Percent Difference from Base in Price in 2005? cent -2 percent per year, leaving the CPI with a Natural cumulative increase of 10.1 percent by 2005. Inter- Qqal 911 Gas Electricity est rates are up by a similar amount, though; the Moderate 705 15,7 15,1 34 Canadian dollar initially appreciates but later drOps 333 33-9 75-3 33'2 below base case values as a result of the erosion in *Thepn'ces represent changes in aggregate national indices and are our competitiveness and weaker trade balance. not directly comparable to the more spec1fic prices referred to in the Energy Resuns sedim- The surge in capital spending mitigates the impact on the economy after the year 2000; nevertheless. real GDP is reduced by a maximum 3.1 percent in Economic lmpacts 1999. Notably, we have assumed that the rcspend- ing of revenues from the carbon tax helps support the capital spending program, which exceeds 1 per- MOde'ate case cent of GDP at its peak. (Percent difference from base. except as noted) As in he at erate cas . the consumer and hous- iaas 2cm 2095 . 0d . . . . . Reaare severely hit. In addition, the indirect ef- CPI Lave, 0:6 0:8 1:8 fects of the weaker economy leave capital spending Exchange Rate (us. cents) 2.3 -0.3 ?0.9 (despite the meSlOI?l of funds to support the nu- Interest Rates percent) 1.0 0.0 0.1 4? Trade Mame (million) 3.3 0.2 clear program) in negative grounduntil 200 The Business Nonres_ Investment _4_6 -23 31 real trade balance is also reduced in Virtually every Direct Revenue Impact 13.0 17.2 23.3 year. culminating in a drop equivalent to 2.4 per- cent of GDP by 2005. In the moderate case, the CPI initially increases by 0.8 percent in 1994: by the forecast horizon it is 1.8 Regional and Industrial Impacts percent above base case values. Interest rates and the dollar initially rise through the mid 19905; sub- sequently rates drop back and the dollar slides be- low base values as our competitiveness is eroded. The introduction of a carbon tax raises the price of coal. oil, natural gas, and electricity, causing a decline in de- mand for these commodities. The carbon tax scenarios result in a large negative impact on real output by the p. The level of real GDP is reduced by a maximum mining industry; national mining output declines 3 cu- 1?3 percent in 1994 and 1995, before tapering Off to mulative 10.6 percent in the extreme case relative to the _0_3 percent by 2005' base case, compared with a 6.6 percent decline in aggre- gate output. The declines in mining output for Canada The consumer is hardest hit throughout, dropping increase Steadin over the simulation horizon until the 1.7 percent below the base case by 2005. Capital trough is reached at the turn of the century, with mining spending is reduced until the late 19908, when high- output down about 20 percent by the year 2000. Related er investment turns this positive. The nominal industries suffer similarly severe declines in the extreme February 1991 19 Carbon Tax scenario, with petroleum and coal refining down 9.1 per- cent and chemicals down 4.9 percent; b0th drops repre- sent the largest negative impact of all scenarios. Given the large relative weight of Alberta?s mining in- dustry, Alberta suffers nearly a 14 percent cumulative decline in mining output and an 8 percent decline in aggregate output in the extreme carbon tax scenar- io?the largest drop for any region in any of the scenar- ios. By the year 2000, real mining output in Alberta is down 31 percent (or $55 billion in real 1981 dollars). The large decline in output gives the province 3 10.5 percent total decline in employment and a 4.5 percent total decline in real disposable income. This translates into dramatically higher unemployment erage 10.4 percent in Alberta over the 16-year period, compared with 5.5 percent in the base case. The area?s deteriorating economic environment results in an aver- age annual out-migration of 11.5 thousand people in the extreme carbon tax scenario, compared with an average annual in-migration of 14.3 thousand people in the base case. In turn. this results in a cumulative 6.7 percent TABLE 2 Cumulative Declines In Industrial Output and Employment far Severe Carbon Tax Case ?96 Decline (90-2005l lilatiunal Alberta Ontario GNP at Factor Cost 6.6 8.1 6.8 Total Goods Output 7.4 9.7 7.1 Mining Output 10.6 13.9 6.5 Petroleum and Coal Output" 9.1 9.1 9.1 Chemicals Output 4.9 4.6 5.0 Transportation Equipment Output 6.3 5.6 6.5 Pulp and Paper Output 6.1 5.8 6.2 Housing Starts 9.8 23.5 18.4 Employment 0.6 10.5 0.6 Unemployment Rate? 0.6 4.9 0.1 Real Disposable Income 3.3 4.5 2.6 Cumulative Declines In Industrial Output and Employment for Moderate Carbon Tax Case %Deciine(90-2005) Martina Alttena Ontario GNP at Factor Cost 1.8 2.8 1.9 Total Goods Output 2.2 3.4 2.0 Mining Output 3.5 5.0 1.6 Petroleum and Coal Output 3.2 3.2 3.2 Chemicals Output 1.2 1.0 1.2 Transportation Equipment Output 0.6 0.2 0.7 Pulp and Paper Output 1.6 1.3 1.6 Housing Starts 3.0 16.8 5.7 Employment 0.2 3.7 ?0.4 Unemployment Rate? 0.2 1.4 ?0.3 Real Disposable Income 1.8 3.1 1.7 'Percent declines re?ect relatively constant share of regional output in base case. 20 Imperial Oil decline in population in Alberta relative to the base case, and a 24 percent drop in housing starts (compared with a 10 percent cumulative decline nationally). Energy Results Energy demand is the only focus of C02 reduction. To achieve reductions in C02 emissions. either energy de- mand must be reduced or consumers induced to switch to fuel and power sources with lower carbon content. Fuel price changes would likely induce such switching. Energy prices are appreciably higher in the extreme car- bon tax scenario. The tax of $381 ($200 real) per tonne of carbon translates into $7.59 per gigajouie of light fuel oil. Light?fuel oil'prices are increased by 45.7% from $17.47 per gigajouie in the Reference case to $25.46 in the Extreme Carbon Tax scenario. The tax on natural gas is $5.16 per gigajouie while that for coal ranges from $9.38 in Ontario to $10.56 in Saskatchewan. Coal is still cheaper than natural gas even after the differential in carbon taxes is applied to the purchase prices. Coal prices would be different for each region of Cana- da. based on the carbon content of the coal used and the subsequent tax applied. Ontario uses imported coal with an average C02 content of 90.23 tonnes per terajoule. The price of imported coal includes tranSportation and is about three times the minemouth price of western coal. Alberta uses subbituminous coal with a C02 con- tent of 94.2 tonnes per terajoule. The carbon tax on Alberta coal would thus be greater than on Ontario coal. Saskatchewan uses [ignite with a C03 content of 101.68 tonnes per terajoule. Most of the western coal is used directly at the minemouth. thus avoiding transpor- tation costs and achieving a lower overall purchase price. TABLE 3 Energy Price increases Are Dominated by the Carbon Tax (5 Per Gigajoule In 2005) C02 Content Extreme (Tonnes/ Carbon Reference Carbon Euel Ieraimiiel Iax Case Ian LFO 73.11 7.59 17.47 25.46 HFO 80.65 8.38 12.06 20.11 Industrial Natural Gas Canada 49.46 5.16 12.85 19.94 Ontario 49.46 5.16 13.87 21.92 Electric Utility Coal Alberta 94.2 9.79 1.74 11.53 Sask. 101.68 10.56 1.85 12.42 Ontario 90.23 9.38 5.89 15.33 Canada 13.47 Carbon Tax CHART 1 Industrlal Gas Prices Rise Carbon Tax 1w 12EBEEBW I SO ENCE 1975 1980 1985 1990 995 2000 2005 2010 Motor Fuel Tax Moderate TX25 GUZSO Gas Guzzler Moderate COZLOW Carbon Tax Moderate TX100 - Motor Fuel Tax Extreme GST Moderate GUZ100 Gas Guzzler Extreme CO2 Carbon Tax Extreme GST25 To reduce energy demand. the carbon tax case reduces carbon tax reduces energy demand the most. The car- economic activity. Energy demand in total is the second bon tax has a strong negative effect on demand in all lowest in the carbon tax extreme case. The electricity sectors. demand and electric utility fuel decreases in the GST extreme case outweigh the carbon tax on total energy demand. If only sectoral energy demand is counted, the The carbon tax and associated reduction in economic activity causes energy demand to decrease by about 9% CHART 2 Coal Prices Are Highest for Carbon Taxes C02 coztow BEN11?? 1975 1980 1985 1990 1995 2000 2005 2010 TX25 Motor Fuel Tax Moderate GUZBO Gas Guzzler Moderate COZLOW Carbon Tax Moderate GST10 GST Moderate TX100 Motor Fuel Tax Extreme GU2100 Gas Guzzler Extreme 002 Carbon Tax Extreme GST25 GST Extreme February 1991 21 Carbon Tax 40? I I cozLow I a ENCE am 5 251975 1980 1905 1990 1995 2000 2005 2010 1X25 Motor Fuel Tax Moderate TX100 Motor Fuel Tax Extreme by 2005. Consumer sectors are hit the hardest as both Residential demands and Transportation demands de- cline by Over 12%. Electric utility fuel demand represents primary energy and includes both domestic and foreign consumption of electricity. Domestic electricity demand is also counted within the sector totals. Exports of electricity offer a direct way of reducing carbon dioxide emissions without impacting domestic demand. The carbon tax case has almost no exports of eleCIricity since the carbon tax is not applied in the U.S. Canadian utilities would be scrambling for available hydropower and outbidding U.S. utilities in the extreme carbon tax case. The reduCtion TABLE 4 Energy Demand By Sector (Petajoules) Reference Extreme Sector Dilierence Eerceut Residential 1408 1236 172 12.2% Commercial 1 049 950 99 9.1 ?36 Industrial 4412 4041 371 8.4% Transportation 2545 2224 321 12.6% Own Use 1109 1087 22 2.0% 10523 9538 985 9.4% 22 Imperial Oil GUZSO Gas Guzzler Moderate Gas Guzzler Extreme COZLOW Carbon Tax Moderate COZ Carbon Tax Extreme GST10 GST Moderate GST Extreme in electricity exports reduces primary energy demand by about The energy demand decreases are also noticeable for the effect on energy production. Heavy crude oil pro? duction declines by 500 compared with the Refer- ence Case. There is no additional investment in crude bitumen or oil sands facilities. Nuclear power is the principal winner in this scenario, with over 7200 mega- watts of new power plants online by 2005. Transportation demands are lowest in the carbon tax case. Despite little change in the motor gasoline price. travel per capita actually declines from 9500 kilometres in 1990, to 8500-9000 kilometres in the extreme carbon tax case. The trucking sector contributes much of the decline because the carbon tax reduces economic aCtivity and transportation requirements. Diesel demand is par- ticularly affected, since rail and road use are significant- ly below the Reference Case level. Intermodal shifts in transportation are small, since all types of tranport fuel use decrease in the extreme car- bon tax scenario. Consumer-based transportation?road and air?is significantly affected by the drop in income and rise in carbon taxes. The trucking sector is hit the hardest by the carbon taxes. since carbon taxes have a more negative effect on goods producrion (and hence distribution services) than on the total economy. Electric utilities incur the largest fuel cost increases in the carbon tax case despite a massive shift to primary electricity. Coal prices in Western Canada are up to eight times as high in the extreme carbon tax case as in the reference case. The paper industry in Ontario would face energy costs of up to 50 percent of RDP in the extreme carbon tax case. Other energy-intensive industries would face simi- lar increases. Many industrial establishments provide for part of fuel requirements by their own generation or use of waste wood. However, incremental production would depend upon purchased fuel and power. The increase in energy Ontario paper industry is typical of cost increases for other provinces and industries. The carbon tar-z scenario is not friendly to energy-intensive industry, historically a strength of Canada?s economy. Carbon Dioxide Results It is clear that C02 emissions can be reduced from the Reference Case levels. But for most scenarios there are still increases in C02 emissions. Indeed, the goal of flat emissions below 500 million tonnes is Only achieved in the extreme carbon tax case. C02 emissions reductions are obtained at a huge reducuon in GDP and as a conse- quence of a massive shift to nuclear fuel, with an over- whelming cost to energy-intensive industry. The only major lever that Canada has to lower C02 emissions is electric utility fuel choice. By 2005, utility emissions range from 84 million tonnes in the extreme carbon tax case to 170 million tonnes in the Reference Case. No other sector has as great a potential swing. Transportation emissions range from 150 to 174 million tonnes, while the industrial sector ranges from 195 to 209 million tonnes. Industrial energy demand and C02 emissions are tar- geted in the carbon tax cases with severe consequences for energy-intensive industry such as mining, paper, chemicals and primary metals. Canada?s international competitors are often Third World countries with lower wages and less stringent environmental standards. A self-imposed increase in the cost of producing goods in Canada is unlikely to be matched. Residential and commercial C02 emissions are modest and account for only 10% of Reference Case emissions. This is because the electric utility emissions are credited to the utility sector. Policies directed at the consuming sectors would have a negligible effect on total C02 Carbon Tax TABLE 5 Carbon Dioxide Reduction Are Concentrated In The Electric Utility Sector In The Extreme Carbon Tax Case (Million tonnes of carbon dioxide) Economic Conservation Inter Fuel Sector Activity and Price Substitution Total Residential 0.2 4.4 0.4 50 Commercial 0.6 0.5 2.8 Industrial 9.3 3.8 0.6 13.? Transportation 12.2 10.5 1.4 23.9 Electric Utility 12.2 28.5 45.7 86.4 Total 34.5- 48.9 48.6 131.8 Share (96) 26% 37% 37% 100% emissions compared with policies directed at electric utilities. In the carbon tax scenarios. C02 emissions are reduced by 8% for the $50 tax, and by 21% for the $200 tax by 2005. While these reductions are larger than those gen- erated in the other tax scenarios, they are also more concentrated. The electric utility sector accounts for 67% of C02 emissions reduction in the moderate case. and 65% in the extreme case. The transportation sector accounts for about 20% of the total reduction. and the other three sectors-residential. commercial. and in- dustrial-represent only a very small share. Carbon dioxide emissions are reduced by 21.4% in the extreme carbon tax case. Reductions by sector are about in line with the reductions in energy demand. The elec- tric utility sector shows a 50.7% decrease in carbon diox- ide emissions compared with an 8.8% reduction in fuel use. The switch from coal to nuclear fuel accounts for half of the decrease in carbon dioxide in the utility sec- tor, while the reduction in exports of electricity accounts for about and conservation and price effects ac- count for the remainder. The C02 impact of one Darlington-type nuclear station is about 19 million tonnes of emissions reduction per year. The combined C02 emissions reduction achieved in the extreme case for the residential, commercial, and industrial sectors is 21.4 million tonnes, or about the same as one Darlington station. The emissions reduction from the transportation sector is 23.9 million tonnes, again equal to about one Darlington. The moderate case again shows that C02 emission re- ductions are small in the nonutility sectors: residential, commercial, and industrial C02 emissions decline by 4.3 million tonnes per year and transportation emissions decline by 8 million tonnes. In contrast, electric utili- February 1991 23 Carbon Tax CHART 4 Carbon Dioxide Emissions Growth Are Lowest for Carbon Tax 70000e REFERENCE 650000?? In 500000?- CO2LOW1 a 550000" All" ?3 GST25 500000?? 002 4500001975 1980 1985 1990 1995 2000 2005 2010 TX25 Motor Fuel Tax Moderate GUZSO Gas Guzzler Moderate COZLOW Carbon Tax Moderate TX100 Motor Fuel Tax Extreme GU21OO Gas Guzzler Extreme 00.? Carbon Tax Extreme GST25 GST Moderate GST Extreme ties, which account for two-thirds of the impact, reduce Comparison of Results emissions by 32 million tonnes. Thus. the carbon tax is primarily a tax on coal and elec- A comparison of the results of the carbon tax scenarios tric utilities. Most of the economic impact, however, is with those of the GST. motor fuels tax, and gas guzzler borne by other sectors. tax scenarios can be found in the Appendix. CHART 5 Utility C02 Emissions Are Lowest for Carbon Tax 20% REFERENC 180000-?? 1 - $60000 g?a 0' 5140000?- . cozLow 'o ?wv?h g120000?? 851% 3 3 . GST25 80000?? (:1975 1980 1985 1990 1995 2000 2005 I2010 TX25 2 Motor Fuel Tax Moderate GUZBO Gas Guzzler Moderate COZLOW Carbon Tax Moderate GST10 GST Moderate TX100 Motor Fuel Tax Extreme GUZ1OO Gas Guzzler Extrem C02 Carbon Tax Extreme GST25 GST Extreme 24 Imperial Oil Carbon Tax CHART 6 Transportation C02 Emissions 180000? 170000?- 3 160000?? a 150000?--? 60 8 ?5 140000?? 130000?- 120000 1 i 41 1' i 1975 1930 1995 1990 1995 2000 2005 2010 TX25 Motor Fuel Tax Moderate GUZSO Gas Gunler Moderate COZLOW Carbon Tax Moderate GST10 GST Moderate TX100 Motor Fuel Tax Extreme GUZ1OO Gas Guzzler Extreme 002 Carbon Tax Extreme GST25 GST Extreme February 1991 25