Toward the green deal

By Brigitte Alepin + Julie Larocque + François Therriault
Illustration: Ryan Snook

As more than 15,000 participants meet in Copenhagen for the climate change summit, a number of serious issues are at stake

From 1990 to 2007, Canadian greenhouse gas (GHG) emissions rose by 26.2%. Canada is now seeking to lower these emissions by 20% relative to 2006 levels by 2020. To reverse the trend, we’ll have no alternative but to embark on a genuine green shift and attribute a monetary value to environmental virtue. Green taxation is one of the few tools Canada has available to achieve this goal.

If Canada and the US have made little use of green taxation and the polluter pays principle (PPP) in the past, they now seem to be increasingly inclined to move in this direction. For example, the Obama administration would like to levy carbon taxes on products from countries that haven’t committed to limiting their GHG emissions, while the Canadian government has announced that steps taken will be comparable to those of its trading partners (chiefly the US).

It is widely recognized that chartered accountants must continue to expand their horizons and learn to think about accounting in a new way. In the current economic, political and environmental context, CAs with expertise in green taxation will be in demand. The transition will be a lengthy one and these CAs will be able to take advantage of a new market niche, offering their clients sound advice on how to minimize the economic impact of a green shift.

The following guide will give readers a better idea of Canada’s position at the next international climate conference. It is a must-read for all CAs interested in honing their green taxation skills.

What is the Copenhagen 15th Conference of the Parties (COP)?
In referring to COP 15 in his opening remarks to the participating countries attending the Climate Change Summit Plenary in New York on September 22, 2009, UN Secretary General Ban Ki-moon said: “You have the power to chart a safer, more sustainable and prosperous course for this and future generations. Now is your moment to act.”

COP 15 is the name of the summit held in the Danish capital December 7 to December 18, 2009. The summit is expected to be attended by ministers and officials from 192 countries, more than 15,000 official participants, reporters and activists. Since the Kyoto Protocol commitments will expire after 2012, the Copenhagen conference is an important one. A second agreement is indispensable if we are to avert a legal limbo and prevent the serious environmental, political and economic consequences that could ensue.

Post-Kyoto negotiations began in Bali with COP 13 in December 2007. At that time, it was decided that the talks would be concluded at COP 15, which would allow enough time to ratify an agreement and to optimize the prospects for a new agreement coming into force in 2012. This timeline was based on past experience, which had shown that international negotiations could take more than two years and that another two years were needed to ratify the agreement.

How are the international talks on climate change progressing?
With COP 15 only days away, the state of negotiations is worrisome. A number of questions remain unanswered. For example, will the industrialized countries agree on common ambitious GHG reduction targets for the midterm? Will they provide the funding required to help developing countries? What commitment will the US be willing to make?

Even though nearly all countries recognize that climate change exists and that the problem is global in scale, they still haven’t agreed on how to share responsibility. Emerging countries continue to express dissatisfaction, accusing developed nations of failing to put forward concrete proposals, particularly measures aimed at helping the poorest countries take steps to combat global warming.

In July 2009, at the summit in Aquila, Italy, the G8 adopted the recommendations of the Intergovernmental Panel on Climate Change for 2050, agreeing to cut global emissions by 80% or more from 1990 levels. However, no global target was set for 2020.

In the US, the House of Representatives passed the American Clean Energy and Security Act of 2009 (HR 2454 or the Waxman-Markey Bill) with an objective of reducing US emissions. The bill, which proposes a cap-and-trade system, is currently awaiting a vote by the Senate.

What is Canada’s green plan for a post-Kyoto agreement?
At press time, Canada was proposing to lower its GHG emissions by 20% relative to 2006 levels by 2020, bringing them to 3% below the 1990 baselines.

How will Canada reach this target?
To achieve such an ambitious green shift, Canada will likely have no choice but to introduce a greener taxation regime or a cap-and-trade system. To do so, it will have to apply the PPP, which will inevitably trigger transfers of wealth (see PPP box below).

Why are transfers of wealth an issue in Canada’s green shift?
Transfers of wealth can occur between markets or provinces.

Between markets: going green will inevitably lead to additional costs for Canadian manufacturers, which in turn will create competitive disparities on interprovincial markets and between Canadian and foreign markets. For example, two steel companies would no longer be on an equal footing if one fired its furnaces with coal and the other with biogas.

Polluter pays principle

The PPP indirectly requires economic agents to take negative cost components into account in their production costs. In actual application, the challenge is to identify the polluters and quantify their negative externalities. The cost base should correspond to polluting emissions or the consumption of goods generating such emissions. The ideal tax rate should allow for optimal pollution reduction. Accordingly, this rate should equal the marginal costs of the damage caused to encourage these economic agents to take environmental action that would be less expensive than paying the tax.

Although this principle was adopted in 1972 by the Organisation for Economic Co-operation and Development (OECD), it has not yet been fully applied in Canada and the US. OECD Secretary-General Angel Gurría has stressed the importance of adopting the PPP and the role of green taxes in its application. “We need strong price signals to change behaviour, encourage the development of new technologies and end wasteful or polluting behaviour,” he says. “Green taxes, including a carbon tax and other taxes on polluting activities, can play an important role. In fact, the OECD can take some pride in its work in developing and advancing the polluter pays principle.”

As for transfers of wealth between Canadian and foreign markets, if a greener competitive product is available from another country, certain Canadian industries could be penalized in relation not only to other domestic industries but also to certain foreign markets. The European Union has already threatened to raise barriers on imports from countries that have a more flexible attitude toward environmental concerns. In addition, the protection of US businesses is a crucial component of the American Clean Energy and Security Act of 2009.

The Canadian government has a number of options to mitigate the adverse effects of wealth transfers between markets. Obviously, no matter which option the government chooses, it will have to comply with World Trade Organization agreements and region-al trade accords such as NAFTA. Ottawa also needs to keep public finances healthy and maintain a balanced budget over the long term. It could thus:

propose an international agreement under which the signatory states would require an equal and fair environmental effort from their companies and their citizens;
help Canadian companies maintain their international competitiveness by not imposing too heavy a tax burden;
pay particular attention to the manufacturing industry, agriculture and other energy-intensive industries;
introduce an environmental tax reform that would not increase taxes on businesses. For example, Ottawa could introduce a pollution tax and lower an existing tax.

Between the provinces: the provinces have divergent interests when it comes to a Canadian green shift. Alberta would prefer a provincial system that collects a tax on GHG emissions, which would allow it to retain its tax revenue and limit the drain of capital. Quebec, Ontario and BC would benefit more from a national tax administered by the federal government. There is also reason to believe that Manitoba, BC and Quebec would want to promote their hydroelectric power to gain a competitive edge.
To reduce the negative repercussions of provincial transfers of wealth, a number of competing alternatives are available to the federal government:

allocate GHG quotas fairly between the provinces, thereby reducing regional disparities and tensions (see Is a North American green deal a solution? below);
introduce a provincial revenue recycling system so the provinces themselves can alleviate the problems inherent in the transfer of wealth;
introduce a national revenue recycling system that could transfer revenue to the provinces by reducing income taxes, taxes, public spending or even by repaying the debt.

Is a North American green deal a solution?
Even though a reduced environmental effort that would favour Alberta and Saskatchewan has been defensible up to now (see box below), it is unlikely the other provinces or other countries would agree to bear the ensuing economic and environmental costs. That’s why a North American green deal could be an interesting option, both for Canada and its provinces and for the US.

Less environmental effort for certain provinces?

If Canada wants to remain the main supplier of energy to the US, it will have to allow the oilsands provinces to expend less environmental effort.

However, the provinces that lack this natural resource would be doubly penalized since, under the Canadian constitution, royalties from natural resources belong to the province in which they are located. The other provinces only indirectly benefit from oilsand exploitation through federal income tax, which amounts to a fairly insignificant sum annually. For example, in 2007, the federal income tax collected for oil and gas extraction totalled $2.2 billion, i.e. less than 1% of government revenue and 1.3% of industry revenue.

Since 1997, the environmental effort required to lower GHG emissions has been greater in Canada than in the US. This disparity seems to have quadrupled in 2009, creating a situation that could have economic implications for Canada. Environment Canada reports that Canada’s emissions totalled 747 million tons in 2007. Accordingly, with carbon at $100 a ton, a 1% reduction amounts to 7.47 million tons or savings of $747 million.

Furthermore, the oilsands play a role in the US energy security. Some 83% of Canadian tarsand oil is exported to the US and this industry is one of the main sources of the growth of GHG emissions in Canada. Unless economically feasible technological breakthroughs are made, setting the Canadian target too high would have negative consequences for the US, such as:

a scarcity of Canadian oil: Alberta and Saskatchewan would have to make a greater contribution to Canada’s environmental effort, which would lead to a drop in oil production;
the Canadian oil supply would be less reliable: the higher Canada’s reduction target, the greater the transfer of wealth and adverse effects of oil production cuts, which would weaken the country’s political and economic stability.

The ability of the US to pay and its GHG per capita profile are also reasons why Canada’s target should be less restrictive than that of its neighbour. Americans have a greater ability than Canadians to pay. According to the International Monetary Fund, for 2008, the GDP per capita was US$47,440 for the average American, compared with US$45,085 for the average Canadian. In addition, according to the OECD 2008 Key Environmental Indicators, US emissions per capita are still higher than Canada’s, despite the faster growth in Canadian emissions since 1990.

The importance of energy security for the US

Energy insecurity is the Achilles heel of US economic domination, and the country’s dependence on oil is a threat to its security. In 2006, Barack Obama explained, “All we really need to know about the danger of our oil addiction comes directly from the mouths of our enemies: ‘[Oil] is the umbilical cord and lifeline of the crusader community.’ These are the words of al-Qaeda.

“Focus your operations on oil, especially in Iraq and the Gulf area, since this will cause them to die off [on their own].” These are the words of Osama bin Laden.

“More than anything else, these comments represent a realization of US weakness shared by the rest of the world. It’s a realization that for all of our military might and economic dominance, the Achilles heel of the most powerful country on Earth is the oil we cannot live without.”

Although the Kyoto Protocol allows for a specific target to be set, only the European Union has taken this route and has announced it will do the same under a post-Kyoto agreement. Even though Canada and the US have neither a common market nor common political authorities, they can certainly learn from the European experience. Their economies are highly integrated under NAFTA and through extensive crossborder trade. They also have a long history of trade relations.

To conclude, whether or not a North American green deal be-comes a reality, under the current economic systems we can anticipate a higher energy bill for the US. It will have to bear the larger share of newly imposed Canadian environmental costs for oilsands exploration in Canada. In short, the environmental costs of a future reform will either be absorbed by profit or prices, or a combination of the two. Establishing a target to lower the environmental effort required from the oilsands provinces is consistent with economic thinking and solves the problem of North American energy and economic and political insecurity.

[This article reflects developments as of October 30th, 2009]

Brigitte Alepin, M.Fisc, MPA, CA, is president of AGORA Services de fiscalité inc. in Montreal. She is Technical editor for Taxation — small business

Julie Larocque, LLB, D.Fisc, is a tax specialist with AGORA

François Therriault, D.E.S.S. (Tax.), is a lawyer with AGORA