Canadian tax journal / revue fiscale Canadienne (2022)
Ken Boessenkool, Mike Moffatt, Aaron Cosbey, and
Michael Bernstein*
* Ken Boessenkool is of the Max Bell School of Public Policy and the C.D. Howe Institute,
Vulcan, Alberta (e-mail: ken@sidicus.com); Mike Moffatt is of Smart Prosperity and the
Ivey Business School, Ottawa (e-mail: mmoffatt@smartprosperity.ca); Aaron Cosbey is of the
International Institute for Sustainable Development, Winnipeg (e-mail: aaronc@iisd.org); and
Michael Bernstein is of Clean Prosperity, Toronto (e-mail: mbernstein@cleanprosperity.ca)
________________________________
PRÉCIS
Pour les décideurs politiques canadiens, les aspects économiques d’un ajustement
à la frontière pour le carbone (AFC) sont relativement simples, mais dans la pratique,
quatre défis les rendent plus complexes. Premièrement, les régimes canadiens de
tarification du carbone ont été élaborés en partant de la base, principalement à
l’échelle des provinces plutôt qu’à celle du fédéral. Deuxièmement, un AFC canadien
doit respecter le droit commercial international. Troisièmement, alors que les taxes sur
le carbone sont appliquées sur les émissions de carbone à chaque étape de chaque
procédé industriel, il est extrêmement difficile d’appliquer un AFC à chaque procédé et
à chaque niveau d’une chaîne de valeur. Quatrièmement, il y a la question de savoir
que faire des recettes générées par un AFC.
La principale conclusion qui se dégage de l’analyse présentée dans cet article est
que la nature fédérale du Canada représentera initialement un défi de taille pour les
décideurs politiques. Étant donné que ce sont les provinces canadiennes qui ont été à
l’origine de l’élaboration des systèmes de tarification du carbone, il semble probable
que la plupart d’entre elles voudront continuer à le faire. Tout régime d’AFC (qui sera
nécessairement mis en œuvre au niveau fédéral) devra trouver des moyens de s’adapter
ou de tenir compte des différences entre les régimes provinciaux de tarification du
carbone. Cette adaptation n’est peut-être pas impossible, mais elle ne sera pas facile.
ABSTRACT
For Canadian policy makers, the relatively straightforward economics of a border carbon
adjustment (BCA) is complicated in practice by four challenges.
First, Canadian carbon pricing regimes have been developed from the bottom up, being primarily designed at
the provincial rather than the federal level. Second, a Canadian BCA must comply with
international trade law. Third, while carbon taxes are applied on the carbon emitted
at each stage of every industrial process, applying a BCA on each process and at each
level of a value chain is extremely difficult. Fourth, there is the question of what to do
with any revenues that a BCA generates.
The key conclusion that emerges from the discussion in this article is that the
federal nature of Canada will be an early and significant challenge for policy makers.
Given that Canadian provinces have led the development of carbon-pricing schemes,
it seems likely that most will continue to want to do so. Any BCA regime (which will
necessarily be implemented at the federal level) will have to find ways to accommodate
or account for the differences in provincial carbon-pricing regimes. That
accommodation may not be impossible, but it will not be easy.
CONTENTS
Introduction
Challenge One: Messy Federalism
Challenge Two: International Trade Law
Challenge Three: Sectoral and Value-Chain Issues
Challenge Four: What To Do with Revenues
Conclusion
INTRODUCTION
Canada has a plan to raise the federal benchmark price on carbon (CO2) emissions
from $40 per tonne in 2021 to $170 per tonne by 2030.(1) This steep increase in the
carbon price will create strong incentives to reduce emissions. But it will also create
difficulties for Canadian exporters, as well Canadian firms that compete against imports,
to the extent that other jurisdictions do not match Canada’s carbon price.
As a result, there are some significant, albeit practical, challenges to be addressed in the
design of Canada’s climate policies.
Putting the issue in the simplest terms, in 2030 exported Canadian goods with
an embedded $170 carbon levy will be uncompetitive with goods from jurisdictions
with a lower embedded carbon price. (For illustrative purposes, this ignores output based allocations [OBAs],
on which more will be said below.)
Additionally, goods that are imported from jurisdictions with an embedded carbon price of less than $170 per
tonne will be cheaper than domestically priced goods that bear the higher tax.
In a perfect world, this problem could be solved if carbon prices rose in lockstep across
all jurisdictions.
__________________________________________________________________________________________________________________________________________________________________________
(1) Canada, Department of Environment and Natural Resources, “Update to the Pan-Canadian
Approach to Carbon Pollution Pricing 2023-2030” (www.canada.ca/en/environment-climate
-change/services/climate-change/pricing-pollution-how-it-will-work/carbon-pollution
-pricing-federal-benchmark-information/federal-benchmark-2023-2030.html).
__________________________________________________________________________________________________________________________________________________________________________
However, things are anything but simple, and we do not live in anything like a
perfect world. Countries, such as Canada, that intend to impose increasingly stringent
carbon prices will have to find a way to protect their domestic exporters from lower carbon-priced goods from other jurisdictions,
as well as their domestic producers from lower-carbon-priced imports. The issue for those countries that impose higher
carbon prices has both a competitive aspect—the loss of production and jobs to a jurisdiction with lower costs
-and a climate change aspect—the shifting of production to a jurisdiction with a less stringent carbon-pricing regime, resulting in carbon
leakage (an increase in emissions in that jurisdiction as a consequence of more stringent policies in the producer’s home country).(2)
Carbon pricing in Canada has evolved from the ground up.
Canadian provinces, rather than the federal government, were the first movers in developing their own
carbon-pricing regimes.(3) When the federal government came to the table, it implemented a “backstop” that gave primacy to provincial initiatives.(4)
As a result, Canada is evolving toward multiple different carbon tax regimes that greatly complicate the
design of any border carbon adjustment (BCA) regime.
The pressure to design a Canadian BCA has been increasing in recent years.
A Canadian BCA may well be needed sooner than later, given how the development
of BCAs is occurring elsewhere. The European Union has set 2023 as a target date
for the implementation of its carbon border adjustment mechanism (CBAM) as part
of the European Green Deal.(5) Further, a recent summit between Canadian Prime
Minister Justin Trudeau and US President Joe Biden produced a “road map” for relations between the two countries that included a reference to BCAs.(6)
The most recent US proposal—the Fair Transition and Competition Act (the FAIR Act),(7) introduced by senators Chris Coons and Gary Peters
in the 117th US Congress—is also cause for worry. The FAIR Act, which at this point looks unlikely to pass, would roll up
all domestic regulatory climate-related charges and levy an equivalent charge at the border for covered goods.
The legislation contains several provisions that would be detrimental to Canadian exporters.
It would not credit Canada for its own regulatory charges, and it would exempt countries that the United States (unilaterally) deemed
to be taking adequate climate action, unless those countries were levying a BCA on US products.
_________________________________________________________________________________________________________________________________________________________________________
(2) European Commission, “Carbon Leakage” (https://ec.europa.eu/clima/eu-action/eu-emissions
-trading-system-eu-ets/free-allocation/carbon-leakage_en).
(3) Elizabeth Beale et al., Provincial Carbon Pricing and Competitiveness Pressures: Guidelines for
Business and Policymakers (Montreal: Canada’s EcoFiscal Commission, November 2015)
(http://ecofiscal.ca/wp-content/uploads/2015/11/Ecofiscal-Commission-Carbon-Pricing
-Competitiveness-Report-November-2015.pdf ).
(4) Environment and Climate Change Canada, Technical Paper on the Federal Carbon Pricing Backstop
(Gatineau, QC: ECCC, 2017) (www.canada.ca/content/dam/eccc/documents/pdf/20170518
-2-en.pdf ).
(5) European Commission, The European Green Deal, Communication from the Commission to the
European Parliament, the European Council, the Council, the European Economic and Social
Committee and the Committee of the Regions, COM (2019) 640 final (Brussels: EC, 2019)
(https://eur-lex.europa.eu/resource.html?uri=cellar:b828d165-1c22-11ea-8c1f-01aa75ed71a1
.0002.02/DOC_1&format=PDF).
(6) Prime Minister of Canada, Justin Trudeau, “Roadmap for a Renewed U.S.-Canada
Partnership,” February 23, 2021 (https://pm.gc.ca/en/news/statements/2021/02/23/
roadmap-renewed-us-canada-partnership).
(7) United States, Senate, A Bill To Amend the Internal Revenue Code of 1986 To Establish
a Border Carbon Adjustment for the Importation of Certain Goods, S 2378, 117th Cong.,
1st sess., July 19, 2021 (referred to as the Fair, Affordable, Innovative, and Resilient Transition
and Competition Act, or the FAIR Transition and Competition Act) (herein referred to as “the
FAIR Act”).
__________________________________________________________________________________________________________________________________________________________________________
It is therefore encouraging that Canada has now started consultations on a domestic BCA.
(8)
Before we get to the practical challenges associated with implementing a BCA, a
quick overview of the economics of BCAs is in order. As indicated above, differentials in
carbon pricing across jurisdictions can have both economic and environmental impacts.(9)
Other things being equal, jurisdictions with higher carbon prices may see firms leave for
jurisdictions with lower carbon prices in order to reduce the cost of their goods. The
environmental flip side of this economic dislocation is the risk of carbon leakage when
firms moving from a high carbon price jurisdiction to a lower carbon price jurisdiction
face lower incentives to reduce their carbon footprint.
Eliminating carbon leakage is conceptually simple: eliminate the embedded carbon
price for exports and apply the carbon price to imports. This is precisely what we do
in the case of the goods and services tax/harmonized sales tax (GST/HST) in Canada.
Goods and services that are exported from Canada are zero-rated—the GST/HST is
removed—and the GST/HST is applied to goods and services that are imported and
consumed in Canada.10 This system works particularly well in the case of the GST/HST
because it is a value-added tax, with the tax being applied to the increase in value at
each point in the supply chain, rather than just at the point of final sale.
In the same way, it is relatively easy, in theory, to deal with carbon leakage under
a straightforward carbon tax.
In a world in which all jurisdictions levied a straightforward carbon tax, even if at different levels of stringency,
all jurisdictions could remove the tax on exports and place the tax on imports, and the incentive that leads
to carbon leakage would disappear.
The economic objective of a BCA is to allow countries to apply different levels of
carbon pricing domestically without creating incentives for firms to relocate to jurisdictions with less stringent carbon pricing
(thus undermining those domestic efforts at carbon mitigation and potentially creating economic losses as a result of carbon
leakage).
______________________________________________________________________________________________________________________________________________________________________________________
(8) Canada, Department of Finance, “Government Launches Consultations on Border Carbon
Adjustments,” News Release, August 5, 2021 (www.canada.ca/en/department-finance/
news/2021/08/government-launches-consultations-on-border-carbon-adjustments.html).
(9) Beale et al., supra note 3, at 2.
(10) Canada Revenue Agency, “GST/HST on Imports and Exports” (www.canada.ca/en/revenue
-agency/services/tax/businesses/topics/gst-hst-businesses/charge-collect-imports-exports.html).
______________________________________________________________________________________________________________________________________________________________________________________
However, in the Canadian context, the relatively straightforward economics of a BCA is complicated in practice by four challenges:
1. Canadian carbon-pricing regimes have been developed from the bottom up,
being primarily designed at the provincial level rather than federally. Not only
do the provincial regimes impose different effective carbon prices, but the
mechanisms by which the various provinces attempt to keep their domestic
industries globally competitive differ. This diversity complicates the design of
a Canadian BCA.
2. A Canadian BCA must comply with international trade law. Trade law views
border adjustments for a tax (such as the GST/HST) in a much more straightforward way than it treats a regulatory regime.
The way that Canadian provinces, and the federal government,
approach carbon pricing is arguably closer to a regulation-based system than a tax-based system.
3. While carbon taxes are applied on the CO2 emitted at each stage of every
industrial process, applying a BCA on each process and at each level of a value
chain is extremely difficult, if not impossible, practically speaking. Therefore,
two questions arise: first, what criteria should be used to determine the sectors
to which a BCA should apply; and second, how far up the value chain should a
BCA be applied?
4. Finally, there is the question of what to do with any revenues that a BCA generates.
The remaining sections will address these four challenges in turn.
CHALLENGE ONE: MESSY FEDERALISM
As noted above, Canada’s carbon abatement policies have been largely driven by provincial governments,(11)
resulting in different methods of carbon pricing across jurisdictions.
Those methods range from carbon taxes in British Columbia and Alberta, to a federal backstop for provinces that do not have
their own regimes and a cap-and-trade system in Quebec (see table 1).(12)
More important for our purposes are the various ways in which provinces address the competitiveness and leakage challenges of their
carbon-pricing regimes. These include ad hoc rebates for energy-intensive export industries in British Columbia and ad hoc free emission credits in Quebec.
Alberta and the federal backstop use a much more formalized regime of allocations based on
OBAs targeting industries that are energy-intensive and trade-exposed (EITE).
_________________________________________________________________________________________________________________________________________________________________________________________
(11) Canada’s EcoFiscal Commission, The Way Forward: A Practical Approach to Reducing Canada’s
Greenhouse Gas Emissions (Montreal: Canada’s EcoFiscal Commission, April 2015)
(https://ecofiscal.ca/wp-content/uploads/2015/04/Ecofiscal-Commission-Report-The-Way
-Forward-April-2015.pdf ).
(12) For a complete list of carbon-pricing regimes by province, see table 1 in Tracy Snoddon, “Policy
Forum: Carbon Taxes and Fiscal Federalism in Canada—A New Wrinkle to an Old Problem,”
elsewhere in this feature.
___________________________________________________________________________________________________________________________________________________________________________________________
Canada’s EcoFiscal Commission has provided a helpful explanation of the mechanics of an OBA, which is worth quoting here:
TABLE 1 Method of Carbon Pricing Adopted in Canada, Selected Jurisdictions,
2008-2021
Province and type of regime and Description
British Columbia
Carbon tax with ad hoc adjustments for industries affected by foreign competition
* A comprehensive carbon tax at $10 per tonne was introduced
in 2008.a
* The application-based process provides an exemption for
exports of some fuels (such as natural gas and biomethane.b
and motor fuels.c) from carbon tax in certain circumstances.
* The carbon tax is applied to imports in certain restrictive
circumstances.
* Special programs are in place for certain industries (for
example, a “transitional incentive” for the province’s cement
industry).d These programs are revised periodically.
Alberta
Carbon tax with output-based allocations (the technology innovation and emissions reduction [TIER] system)
* Alberta’s Climate Leadership Plan was introduced in 2015.e
* The plan provided for a rising carbon price.
* Output-based allocations (OBAs) provided carbon credits for energy-intensive and trade-exposed sectors.
* The OBA system (implemented by the carbon competitiveness incentive regulation from 2015 to 2019)f
was replaced by the TIER system on January 1, 2020.g
Quebec
Cap-and-trade with ad hoc granting of free emission units for industries affected by foreign competition
* A cap-and-trade system linked to California was introduced in
2013. The implied carbon price is the market-clearing price
of emission units traded in the cap-and-trade system.
* Free emission units are granted to industrial emitters
“exposed to national or international competition.”h The
number of emission units provided to these trade-exposed
sectors will be reduced modestly over time.
* Fuel imported into Quebec was captured by the cap-andtrade system as of 2015 and amended in 2019.i
This system is arguably less cumbersome and arbitrary than British Columbia’s application-based system, though both systems
grant considerable latitude to the provincial government in deciding which emissions on exports are exempt from the
respective carbon-pricing regimes. Quebec’s implied carbon price has been consistently below the carbon price in other
fully priced Canadian jurisdictions.j
Federal government
Carbon tax with output-based allocations (the output-based pricing system [OBPS])
* In 2018, the federal government introduced a federal carbon backstop.k
* Initially, the backstop was designed to run to 2022 with a
carbon price of $50 in that year; it has been extended to 2030
with a target carbon price of $170.l
* The federal backstop is imposed, in whole or in part, in
provinces that do not meet what the federal government
deems to be equivalent stringency across provincial carbonpricing systems.
– British Columbia and Quebec have entirely provincial systems.
– Alberta has a hybrid system (industrial emissions are priced provincially and retail emissions are priced federally).
– Ontario has an entirely federal system (though it has indicated a desire to price its own industrial emissions, as Alberta does).
* The backstop has been applied loosely rather than rigidly.
– Quebec’s cap-and-trade system has an effective price on carbon lower than the federal benchmark.m
* The federal government’s OBPS is very similar to the OBA
system designed by Alberta.
____________________________________________________________________________________________________________________________________________________________________________________________
a Canada’s EcoFiscal Commission, The Way Forward: A Practical Approach to Reducing Canada’s
Greenhouse Gas Emissions (Montreal: Canada’s EcoFiscal Commission, April 2015)
(https://ecofiscal.ca/wp-content/uploads/2015/04/Ecofiscal-Commission-Report-The
-Way-Forward-April-2015.pdf ), at 12-13.
b British Columbia, Ministry of Finance, “Natural Gas and Biomethane Sellers: Carbon Tax
Act,” Tax Bulletin no. CT001, April 2019 (www2.gov.bc.ca/assets/gov/taxes/sales-taxes/
publications/ct-001-natural-gas-biomethane-sellers.pdf ).
c British Columbia, Ministry of Finance, “Fuel Sellers: Motor Fuel Tax Act and Carbon Tax
Act,” Tax Bulletin no. MFT-CT 001, October 2018 (www2.gov.bc.ca/assets/gov/taxes/
sales-taxes/publications/mft-ct-001-fuel-sellers.pdf ).
d Cement Association of Canada, “Cement Industry Welcomes B.C. Government Action on
Carbon Tax,” Cision, February 27, 2015 (www.newswire.ca/news-releases/cement-industry
-welcomes-bc-government-action-on-carbon-tax-516902481.html).
e Government of Alberta, “Alberta’s Climate Leadership Plan: Progressive Climate Policy,”
September 2018 (https://open.alberta.ca/dataset/428e517b-3bd4-4d3d-b197
-b0233c85647e/resource/f23497a3-6208-41d6-84da-c44416e1676b/download/
investorconfidenceclimateleadershipplanfactsheet.pdf ).
f Government of Alberta, “Carbon Competitiveness Incentive Regulation: Fact Sheet,”
April 2018 (www.alberta.ca/assets/documents/cci-fact-sheet.pdf ).
g Government of Alberta, “TIER Regulation: Fact Sheet,” July 2020 (www.alberta.ca/assets/
documents/ep-fact-sheet-tier-regulation.pdf ).
h Québec, Ministry of the Environment, “The Carbon Market: Allocation of Emission Units
Without Charge” (www.environnement.gouv.qc.ca/changements/carbone/Allocation
-gratuite-en.htm).
i Québec, Ministry of the Environment, “Fuel Distributors: Reporting Volumes Distributed
in 2021” (www.environnement.gouv.qc.ca/air/declar_contaminants/carburant-combustibles/
declaration-en.htm).
j Canada’s EcoFiscal Commission, supra note a, at 35.
k Environment and Climate Change Canada, Technical Paper on the Federal Carbon Pricing
Backstop (Gatineau, QC: ECCC, 2017) (www.canada.ca/content/dam/eccc/documents/
pdf/20170518-2-en.pdf ).
l Canada, Department of Environment and Natural Resources, “Update to the Pan-Canadian
Approach to Carbon Pollution Pricing 2023-2030” (www.canada.ca/en/environment
-climate-change/services/climate-change/pricing-pollution-how-it-will-work/carbon
-pollution-pricing-federal-benchmark-information/federal-benchmark-2023-2030.html).
m Canadian Institute for Climate Choices, “The State of Carbon Pricing in Canada”
(https://climatechoices.ca/reports/the-state-of-carbon-pricing-in-canada).
__________________________________________________________________________________________________________________________________________________________________________________________
Here’s how OBAs work. EITE firms are allocated emissions credits based on their level
of output (the O in OBAs). The number of credits or “allocations” (the A in OBAs) that
they get depends on a sector-specific performance standard, which sets a benchmark
for tonnes of GHG [greenhouse gas] emissions per unit of output. Effectively, firms get
an amount of credits that corresponds to what their total emissions would have been
if their emissions intensity of production had matched the standard. They then pay
the carbon price only on the emissions that they don’t have enough credits to cover.(13)
OBAs are an attractive way of addressing carbon leakage since they can retain
the incentive of firms to continue to reduce emissions, but do not increase firms’
costs as much as a fuel charge or a dollar-per-tonne-emitted tax would. Firms get
allocations based on an industry benchmark.(14) If their emissions are lower than the
benchmark, they can sell surplus credits to other firms. Firms with emissions above
the benchmark can pay the carbon tax at the prevailing rate on the difference, buy
carbon credits from firms with surplus emissions, or lower their average emissions.
___________________________________________________________________________________________________________________________________________________________________________________________
(13) Jason Dion, “Explaining Output-Based Allocations (OBAs),” Canada’s EcoFiscal Commission,
May 24, 2017 (https://ecofiscal.ca/2017/05/24/explaining-output-based-allocations-obas).
(14) “The OBPS [the federal output-based pricing system] requires covered facilities to compensate
for any emissions above a limit determined by the facility’s output multiplied by a standard equal
to some percentage of the sector’s average emissions intensity. For example, the standard for
styrene is 0.925 tonnes of CO2e per tonne of styrene, so a facility producing 100,000 tonnes
of styrene would have a limit of 92,500 tonnes of CO2e.” Aaron Cosbey, Michael Bernstein,
and Seton Stiebert, Enabling Climate Ambition: Border Carbon Adjustment in Canada and Abroad,
Report (Winnipeg: International Institute for Sustainable Development and Clean Prosperity,
July 2021), at 8.
___________________________________________________________________________________________________________________________________________________________________________________________
The number of jurisdictions that utilize the federal backstop has been shrinking.
Alberta, Ontario, and New Brunswick have opted for their own industrial carbon pricing system rather than using
the federal backstop—though admittedly all three have adopted some variant of the federal output-based pricing system (OBPS).
Still, it is entirely conceivable that within a few years the federal backstop will cease to operate in any province.
Provinces have an incentive to implement their own regimes because, while the
federal government uses carbon tax revenues to design a rebate system and some small programs for businesses in the
province where it collects the tax, a provincially designed regime typically gives the province full discretion in the use of the revenue.(15)
Provinces also have an incentive to design their own unique systems to better reflect
their economic priorities and industrial structures.
The provincially led development of carbon pricing creates at least four challenges for the development of a Canadian BCA system:
1. Despite the federal backstop, which has a target carbon price, effective carbon
prices are not the same across the country. Most starkly, Quebec’s cap-and trade system has had a lower effective
carbon price—in part because it links with California—than its neighbouring provinces, or indeed the federal
backstop.(16) Other provinces have also been permitted to implement their
own regional variations. These differences have the potential to create interprovincial competitiveness issues at the
margin for key industries. Imposing a single Canadian BCA regime—presumably at the carbon backstop rate—will replicate
these domestic competitive issues with imports and exports.
2. Different provinces have developed different ways of keeping their domestic
industries competitive. How a single Canadian BCA regime can account for
these provincial differences is not at all clear. For example, differences between
Alberta’s treatment of cement and natural gas under its technology innovation
and emissions reduction (TIER) OBAs and British Columbia’s producer-specific
application-based process will have to be aligned with any single BCA regime.
3. The existence of different provincial systems raises a complicated fiscal issue.
Alberta currently collects industrial carbon-pricing revenues that are used in
part to fund significant TIER payments to the province’s EITE industries. All
other provinces with their own regime have their own style of rebate system.
A single Canadian BCA regime designed to rebate carbon tax paid on exports
would have to account for these provincial payments in any calculation of tax
exempted on exports or applied to imports. But what would stop any provincial government from eliminating its rebate program,
so as to push the multibillion dollar cost of these payments onto a federal BCA while the province retained the revenues?
Would Alberta, for example, continue to collect the carbon tax, eliminate the multi-billion dollar TIER output-based system,
and have Ottawa rebate billions of dollars in tax paid by EITE sectors under a BCA?
And how will Ottawa calculate all this given an ad hoc system in British Columbia, TIER in Alberta, OBPS in Ontario,
and free emission units in Quebec?
This promises to make the equalization program calculations look like a walk
in the park.
4. Some provinces are using programs to keep EITE industries competitive in
order to serve other provincial policy objectives. For example, the TIER system
is being used by the Alberta government to treat different types of bitumen extraction differently, whereas a national BCA would rebate
any carbon tax paid on exports. A federal BCA would complicate the administration of such provincial policy levers, which the provinces
would almost certainly be unwilling to forgo, particularly given the constitutional assignment of natural resource
policy to the provinces.
__________________________________________________________________________________________________________________________________________________________________________________________
(15) Environment and Climate Change Canada, supra note 4.
(16) Canadian Institute for Climate Choices, “The State of Carbon Pricing in Canada”
(https://climatechoices.ca/reports/the-state-of-carbon-pricing-in-canada).
__________________________________________________________________________________________________________________________________________________________________________________________
These four points can be easily summarized. In light of vastly different industrial
structures across provinces,(17) it is hard to see a future in which all provinces willingly
cede the ability to design and implement their own carbon-pricing regimes. A single
BCA will have to find ways to accommodate or account for the resulting differences
in those provincial regimes. That will not be impossible, but it will not be easy either.
CHALLENGE TWO: INTERNATIONAL TRADE LAW
In addition to the economic and federal challenges of a BCA design, there are important international legal and trade considerations.
As Cosbey, Bernstein, and Stiebert state,
[t]here are two fundamentally different possibilities for BCA. One is tax-based, and the
other is regulation-based. A tax-based BCA would accompany a carbon tax, and would
function as a separate instrument from that tax, adjusting at the border to ensure that
imports face the same charges as the internal charges assessed under the carbon tax.
The legal space for such an adjustment in the WTO [World Trade Organization] is
GATT’s [the General Agreement on Tariffs and Trade] Article II:2(a)—the same provision that allows for adjustment of value-added taxes
like Canada’s Goods and Service Tax (GST). . . .
A regulation-based BCA would accompany some climate-related regulation. But it
would not in fact be an entirely separate instrument. It would, rather, be an extension
of the internal regulation to also cover imports. . . . This form—extension of an existing
internal regulation—is the only way such an “adjustment” could be legally performed
under WTO rules. GATT’s Article III allows that internal regulations that are applied
at the border can be treated as regulations under GATT Article III as opposed to being
treated as illegal border measures (e.g., excess tariffs, or quantitative restrictions). But
it notes first that only regulations described in GATT Article III:1 are eligible for such
treatment, and second that any such regulations must accord with GATT’s Article III:4,
which demands that ultimately foreign goods be treated no less favourably than domestic ones.(18)
____________________________________________________________________________________________________________________________________________________________________________________________
(17) For details, see Canada’s EcoFiscal Commission, supra note 11.
(18) Cosbey et al., supra note 14, at 7.
____________________________________________________________________________________________________________________________________________________________________________________________
In this context, it is relevant that the federal government argued, and the Supreme
Court of Canada agreed,(19) that the federal backstop and the OBPS constituted a
regulation, not a tax.
Both the federal OBPS and Alberta’s OBA system allow firms to pay for their carbon
production above the benchmark using “cash, surplus credits, or offsets, and presumably the use of those last two will involve
savings over the benchmark carbon price.”(20)
So designing a BCA by applying the carbon tax (in 2022, at $50 per tonne) to imports
will almost certainly result in treating foreign goods differently than domestic goods
and hence be offside with GATT. A possible solution would be to give importers full
access to the OBPS regime—though that would further complicate an already complex system.(21)
Another problem with such a regime is that while trade law allows for the rebate
of taxes at the point of export (provided that they are indirect taxes such as GST/
HST), it does not allow for the rebate of costs incurred under domestic regulations.
This would be a concern for any Canadian firms with export markets, since their
products would compete in foreign markets with similar products that had not faced
any carbon pricing. From this perspective, a direct carbon tax would clearly be preferable to an implicit carbon price with OBAs.
A cleaner solution from both a legal and a trade perspective would be to rely
exclusively on a carbon tax. In that case, the BCA would rebate carbon tax paid on
domestic exports and the tax would be applied to foreign imports, similar to the
adjustment for the GST/HST. As in the case of the GST/HST border adjustments, this
would raise no international-trade-law challenges. But a simple GST/HST type of
carbon tax with a straightforward BCA gives provinces less design flexibility to match
federal carbon-pricing policy to their own economic and industrial structures, compared to a system, say, with OBAs.
___________________________________________________________________________________________________________________________________________________________________________________________
(19) References re Greenhouse Gas Pollution Pricing Act, 2021 SCC 11.
(20) Cosbey et al., supra note 14, at 9.
(21) Ibid.
___________________________________________________________________________________________________________________________________________________________________________________________
C H A L L E N G E T H R E E : S E C T O R A L A N D
VALUE-CHAIN ISSUES
There are several questions around coverage of a BCA. They include, first, which
sectors should be included, and second, to what parts of the value chain should the
BCA be applied?
The first and most basic question for the design of a regulatory BCA is which sectors
it should cover. The focus of Alberta’s and Canada’s output-based calculations has
been on EITE sectors. The federal OBPS, for example, applies to facilities that have
annual emissions of 50 kt CO2e (CO2 equivalents). Gross annual emissions are used as
a proxy for EITE sectors, leading to the inclusion of 38 industrial activities grouped
into the following 11 sectors:
1. oil and gas production;
2. mineral processing;
3. chemicals;
4. pharmaceuticals;
5. iron, steel, and metal tubes;
6. mining and ore processing;
7. nitrogen fertilizers;
8. food processing;
9. pulp and paper;
10. automotive; and
11. electricity generation.
Alberta’s TIER system has a threshold of 100 kt CO2e, but firms with as low as 10 kt CO2e can apply to opt in,
as can firms that can demonstrate that they compete with 100 kt CO2e firms and are trade-exposed.(22)
In 2018, 71 facilities in Alberta applied to be included in the pre-TIER carbon competitiveness incentives regulation
(CCIR). Of those, 54 were approved, 10 were denied, and 7 were postponed, withdrawn, or pending as at December 2018.(23)
This again illustrates the ad hoc (or, more positively, flexible) nature of an OBA system compared to a pure carbon tax with a BCA.
The questions for policy makers are whether a rising price on carbon justifies
including a wider range of industrial activities and/or facilities, and whether the criteria ought to be widened.
Cosbey et al. suggest three criteria that could be used to design a Canadian BCA regime: size (contribution to Canadian gross domestic product [GDP]),
trade exposure (imports plus exports divided by imports plus domestic production), and emissions intensity (the ratio of emissions to GDP contribution).(24)
Whatever criteria are chosen, they will exclude some industrial activities, and the
argument for inclusion using those three criteria will grow as Canada’s carbon price
approaches $170 per tonne—assuming that key trading partners lag significantly
behind in carbon-pricing stringency. The solution is to regularly review coverage as
carbon prices rise (or more precisely, as the gap between Canada’s carbon price and
the prices set by those trading partners increases).
___________________________________________________________________________________________________________________________________________________________________________________________
(22) Government of Alberta, “TIER Opt-In Fact Sheet,” July 2020 (www.alberta.ca/assets/
documents/ep-fact-sheet-tier-opt-in.pdf ). The federal OBPS includes a similar opt-in provision
for firms with annual emissions of 10 kt CO2e or less.
(23) Alberta Climate Change Office, 2018 CCIR Compliance and Offset Workshop (Edmonton: Alberta
Climate Change Office, December 2018), at 22 (www.alberta.ca/assets/documents/aeos-2018
-ccir-compliance-offset-workshop-presentation.pdf ).
(24) Cosbey et al., supra note 14, at 21.
___________________________________________________________________________________________________________________________________________________________________________________________
A related question is where in the value chain a BCA should apply. For example,
when BC cherries are exported to the United States or elsewhere, should a BCA be
applied to compensate farmers for the cost of carbon tax paid on, say, tractor fuel?
Should a BCA take transportation costs into account?(25) With one important exception, Canadian OBAs focus only on
direct emissions—that is, emissions created by the operation of the facility.
The exception is emissions created in the generation of electricity, which is included in both the TIER system and the OBPS (in slightly different ways);
for this sector, the carbon price embedded in electricity costs has been
reduced. The impact of this exception varies among provinces, since several of them (British Columbia, Manitoba, and Quebec)
generate a large portion of their electricity through very clean hydropower.
Canada’s output-based allocation and pricing systems exclude indirect emissions.
Emissions are generally classified according to three categories:
scope 1 covers direct emissions from company-owned or -controlled sources;
scope 2 covers indirect emissions from the generation of purchased electricity, steam, heating, and cooling consumed by the reporting company;
and scope 3 includes all other indirect emissions that occur in a company’s value chain.
Products that are the result of long, complex value chains may have large amounts of embedded carbon costs that are not
covered. The longer the manufacturing process, the more opportunities there are to miss indirect emissions.
Such goods may therefore be uncompetitive against similar goods produced in lower carbon price jurisdictions, if they are high enough in the
value chain that their embedded carbon costs are significant relative to value added.
Alberta’s TIER system (and, similarly, the federal OBPS) incorporates indirect
(tier 2) emissions from industrial heat or hydrogen use, as well as industrial “emissions
produced during chemical or physical reactions other than combustion for energy
production.”(26) It is possible to include some indirect emissions, but governments
tend to do so only when emissions exceed certain thresholds.
This is where the length and complexity of value chains really start to matter; many small amounts of embedded emissions can add up to a lot in
a final product without ever being included in an OBA system.
Embedded emissions raise two additional questions that are flip sides of the same issue.
The first question concerns the treatment of Canada’s exports under other countries’ BCAs.
To the extent that Canadian exports have a higher carbon-intensity rating than the same goods produced in the destination country,
a BCA in that country—even if it is applied in a similar way to the treatment of domestic production—will harm Canada’s exports.
Cosbey et al. report that for many goods that Canada exports to the United States,
including “mining and extraction of energy and non-energy products, wood products,
_____________________________________________________________________________________________________________________________________________________________________________________________
(25) See David Giles, “Bill To Exempt Farm Fuels from Carbon Tax Dies with Federal Election
Call,” Global News, August 17, 2021 (https://globalnews.ca/news/8119375/bill-farm-fuels
-carbon-tax-federal-election).
(26) Government of Alberta, “TIER Regulation Fact Sheet,” July 2020, at 2 (www.alberta.ca/assets/
documents/ep-fact-sheet-tier-regulation.pdf ).
______________________________________________________________________________________________________________________________________________________________________________________________
chemicals, and electrical equipment,”(27) Canada’s emissions intensity is higher than
that in the United States. While Cosbey et al. caution against conclusions based on
highly aggregated data, it is not surprising that Canada’s northern climate would contribute to higher energy intensity in
the production of goods relative to its southern neighbour.
At the very least, this suggests that Canadian policy makers should pay extremely close attention to the US administration’s development of a BCA.
The goal for Canada would be to gain either a reciprocal exemption from both countries’ BCA, or
at least an adjustment of any US border charge to account for Canada’s carbon price.
The question on the flip side is how Canada should treat imports under a BCA.
Among the available options, a more rigorous approach would apply a carbon levy
to imports on a facility or product basis. Using facility- or product-level data would work for imports from trading partners that
have carbon-pricing regimes or collect data on emissions intensity—which presumably would include Canada’s largest trading partners for most goods.
When trading with a country with a BCA on its exports, Canada could presumably use the same data for imports.
Again, this argues for careful tracking by Canadian officials of the intentions of Canada’s key trading partners
regarding the implementation of their own BCAs.(28)
A more rigorous approach may not, however, be possible for goods traded with Canada’s less sophisticated trading partners.
In such a case, a benchmark approach, using a country or global average of embedded carbon, may be needed.
Whether the benchmark is Canadian-based or global, in either case there should be provision for
the ability of foreign producers to challenge the benchmark calculation, in order to
demonstrate that they are cleaner. Alternatively, producers could be asked to provide
data in the first instance, and only if they failed to do so would the benchmark be applied.
All of the issues around emissions coverage—from choosing which sectors to
include, to determining whether and how to include indirect emissions in both exports and imports—will become more pressing as the stringency of
Canada’s carbon pricing policy gets more out of line with the policies of its key trading partners.
Difficult tradeoffs are foreseeable between the desire for greater domestic stringency
and the desire to keep Canadian goods competitive internationally, given that some
of the policy levers affecting both objectives are controlled by those trading partners.
Even a BCA based on a pure carbon tax, providing an exemption for exports and
applying the tax to imports (similarly to the operation of the GST/HST), would not
capture upstream carbon emissions, since it would apply to a restricted list of largely
primary products.
Further, it is unlikely that any BCA would cover processed/manufactured goods
such as automotive parts. For example, under the European Union’s CBAM proposal,(29)
coverage for iron and steel is for basic products and only 11 immediate downstream derivatives
(including pipes, tubes, tanks, and structural steel). The proposal does not cover automotive parts.
The coverage of such products under Canada’s OBPS is also narrow, being limited to iron and steel, and even fewer derivatives.
To understand the practical implications of this approach, consider a steel tube manufacturer in Canada and one in the United States—
a simpler example than one involving the CBAM proposal, with 11 downstream products.
The basic loss of competitiveness comes not so much from an assumed BCA but rather from the differing Canadian and US carbon-pricing regimes.
The Canadian firm pays high prices for inputs, whether domestic (subject to carbon pricing) or imported (subject to a BCA),
while the US firm does not.
Under a BCA, at least the Canadian firm would not face low-priced import competition from the US producer.
Deciding which sectors to include and whether to include emissions at specific
stages in the value chain are difficult questions that any BCA must resolve. Addressing
these challenges will become more urgent as Canada’s rising carbon price approaches
$170 per tonne.
_____________________________________________________________________________________________________________________________________________________________________________________________
(27) Cosbey et al., supra note 14, at 25.
(28) Ibid.
(29) European Commission, supra note 5.
_____________________________________________________________________________________________________________________________________________________________________________________________
C H A L L E N G E F O U R : W H AT T O D O W I T H
REVENUES
Any BCA that applies a carbon price to imported goods will produce additional revenues. How those revenues are used will be closely
monitored by Canada’s trading partners, and will have implications for the compliance of the BCA with WTO obligations.
One option, with funds collected from foreign producers being funnelled back to Canadian producers, would certainly
be open to challenge as illegal subsidies.
Another option is to direct the revenues into general revenues. A third option, giving the money to foreign producers,
“would be a clear indication that the regime is about protecting the environment, not protectionism,”(30) and thus would help any BCA
regime to survive a WTO GATT challenge—though sending revenues abroad seems politically unpalatable.
The most trade-compliant option, according to Cosbey et al., would be to use BCA
revenues in ways that have nothing to do with protecting the covered sectors—for
example, to help affected foreign firms and countries to comply with data requirements.
As Cosbey et al. suggest,
[i]t’s likely that any BCA challenged under WTO rules would end up being defended
under GATT’s Article XX, described . . . as the General Exceptions to GATT rules. In
such an event, the most important feature of any scheme will be its ability to be justified
as a purely environmental measure.(31)
_____________________________________________________________________________________________________________________________________________________________________________________________
(30) Cosbey et al., supra note 14, at 20.
(31) Ibid.
_____________________________________________________________________________________________________________________________________________________________________________________________
The closer that Canada’s emissions reduction system comes to a pure carbon tax
that provides an exemption for exports and applies to imports, the less concerned
Canada will need to be about a potential challenge under WTO GATT rules. Revenues, like GST/HST collected at the border,
would presumably go into general revenues.
CONCLUSION
The key conclusion that emerges from this overview of some of the issues around
designing a BCA is that the federal nature of Canada, and the fact that provinces,
rather than the federal government, have taken the lead in designing carbon-pricing
policies, will be an early and significant challenge for policy makers.
Given that Canadian provinces have led the development of carbon-pricing
schemes, it seems likely that most will continue to want to do so. Any BCA regime,
which will necessarily be implemented at the federal level, will have to find ways to
accommodate or account for the differences in provincial carbon-pricing regimes. As
the foregoing discussion of key design issues attests, that accommodation may not be
impossible, but it will not be easy.