Worthwhile Canadian Initiative

More reactions to the Liberals' carbon tax proposal

The Liberals have provided more detail on their carbon tax proposal (48-page pdf), and it has received generally positive reviews. The basic strategy is to take the existing gasoline tax, re-interpret it as a tax on carbon, and to extend it to other sources of greenhouse gases. As an exercise in electoral politics, introducing a carbon tax without increasing gasoline taxes is actually a pretty clever trick.

We also have a better idea of what the Liberals would do with the $15b or so in revenues that the carbon tax would generate: income tax cuts for the lower- and middle-income brackets, another point off the corporate tax, and targeted transfers for low-income households who wouldn't benefit from the income tax cuts. That's a pretty sensible list, although income tax cuts for those earning $100k/yr isn't exactly what I call a priority.

Reactions from the other two parties are continuations of their original talking points. For example, the Conservatives' theme of shrieking "Eeek! A tax!" has evolved into this. And the New Democrats are intent on showing to the world their singular inability - or refusal - to understand economics.

The standard NDP critique of the Liberal proposal takes two forms:

A) $10/kg (rising to $40/kg in four years) per tonne of CO₂ is not enough to make a significant difference in ghg emissions, and

B) The Liberal plan will impose an unacceptably large cost on consumers.

The latter point is of course the CPC's position. And the NDP can fairly make point A) - except that according to this page, emitters will have to pay at least $35 per tonne of CO₂ emissions. If an increase of $40/tonne is not enough to attain the announced policy goal, then the NDP's floor of $35/tonne is clearly too low; the appropriate price should be well north of $40/tonne. But if emitters are going to be paying significantly more under the NDP policy than they would under the Liberal plan, it makes no sense whatsoever to appeal to point B): there is no reason to think that emitters will try to pass along the costs of a carbon tax to consumers, but will not try to pass along the costs of an even more expensive carbon permit. The NDP is trying to suck and blow on this issue, but all it's doing is making unpleasantly incoherent noises. Cap-and-trade is not an indefensible policy (to a first approximation, cap-and-trade and carbon taxes are equivalent), and it will almost certainly be a part of the policy mix in the near future. But if the NDP wants to be taken seriously in this debate, it has to abandon the notion that its plan will not affect consumers, and it has to explain how it is going to protect consumers in low-income households.

My view is that a carbon tax is a good place to start, but it's not going to be the last word. If you're more concerned about hitting the emissions targets than you are about price uncertainty, then cap-and-trade is the best way to go. And it seems clear that this will be a good description of our priorities in the not-too-distant future.

But we're not there yet. Right now, there are a lot of people who are worried about the effects of climate change policy on prices and about the potential for economic dislocations; a radical cut in emissions runs the risk of generating severe economic disruptions and wiping out electoral support for climate change policy for a generation or more.

As far as revenues go, the Liberal plan amounts to rescinding the Conservatives' 2 ppt cut in the GST. Not insignificant, but not particularly profound, either. Once it's been demonstrated that a carbon tax does not mean the end of the world, then there will be less electoral opposition to climate change policies. And as we learn more about the relationships between ghg emissions and prices, we can start introducing cap-and-trade measures with more confidence.

Reactions to the carbon tax: the good, the bad, and the ugly

The good: In addition to being good policy, there's some reason to be optimistic that the Liberals' carbon tax proposal will be good politics. According to one poll, more than 60% of Canadians approve of the general idea of carbon taxes. And even noted environmentalist David Suzuki endorses the idea. David Suzuki can't always be counted on to support sensible policies, but at least this time he's not going to be an obstacle.

The bad: As predicted, the Conservatives are spinning the carbon tax as, well, a tax. And since the CPC is unable to distinguish between smart and stupid taxes, they're coming up with stuff like this.

The ugly: The NDP's response is a confusing jumble of faulty analysis and short-sighted pandering.

Layton raises carbon tax alarm: NDP Leader Jack Layton launched a vehement campaign against carbon taxes yesterday and was quickly accused of alarmist pandering by prominent Canadian environmentalists.

Speaking to a fundraiser for an Ottawa homeless shelter, Mr. Layton said carbon taxes would raise home heating costs and hurt Canadians living on the margins. He said big corporations should bear the lion's share of Canada's climate-change tab and a federal ombudsman should ensure those costs aren't passed on to consumers.

"With energy costs soaring in Canada, we've got to ensure that the solutions to climate change don't aggravate an already dire situation for those who struggle to make ends meet," Mr. Layton said.

He said he supports a cap-and-trade system, which imposes penalties on industrial emissions above a certain level, or cap. Liberals, meanwhile, are preparing to announce a plan built around carbon taxes, which is expected to apply to a wider range of emissions and raise money for environmental efforts.

As far as the consumer is concerned, cap-and-trade will have exactly the same effect as a carbon tax, namely, to increase prices. The only potential difference is who is on the receiving end of that extra spending: with a carbon tax, the government gets the money, and with cap-and-trade, that money is rent for those who own the permits. If the permits are auctioned off by the government, the two programs are essentially equivalent.

But there's more to the NDP's position than a second-order difference of opinion on mechanics; there's also this sentence:

He said big corporations should bear the lion's share of Canada's climate-change tab and a federal ombudsman should ensure those costs aren't passed on to consumers.

It is at this point that one begins to despair of the NDP.

Could someone please explain to Jack Layton that corporations don't pay taxes? Only people pay taxes, and corporations are not people. And the people who pay corporate taxes are not the owners of the corporation, either: the people who really pay those taxes are workers (in the form of reduced employment opportunities) and consumers (in the form of higher prices).

The Liberals and Conservatives understand this point. The CPC is targeting the people who don't want to pay those costs, and Stéphane Dion is going after those who do. The NDP's niche appears to be voters who want someone else to pay the costs of reducing greenhouse gas emissions.

And if you give food to raccoons, they won't come back

From the Toronto Star:

More money for GM despite layoffs, McGuinty says:

Premier Dalton McGuinty says Ontario will give General Motors more money for new projects, despite thousands of layoffs announced by the automaker.

GM wants the Ontario and federal governments to contribute about $140 million towards a new engine plant in St. Catharines, Ont., and a new research centre in Oshawa.

GM has received about $250 million in provincial money, and recently announced layoffs of 1,400 workers in Windsor and about 900 in Oshawa.

But McGuinty says Ontario is still competing with U.S. states to land new automotive projects and must be prepared to pony up some cash.

Why do governments still think that they can win this game?

The Liberals' carbon tax proposal

Stéphane Dion and the Liberals are floating the idea of a carbon tax:

Liberals say carbon tax will be revenue-neutral: [I]nternal policy discussions are still underway and a number of proposals are under consideration. One proposal under study would replace the federal fuel excise tax - which applies to gasoline and diesel used for vehicles - with a more broadly based "environmental tax" to include other fuels such as natural gas, heating oil and coal-generated electricity.

That plan, proposed by economist Jack Mintz and Nancy Olewiler of the Sustainable Prosperity Institute, would leave the existing excise tax of 10 cents per litre of gasoline and four cents per litre of diesel unchanged. The authors estimate that applying the excise tax to other fuels would increase tax revenue by between $12 billion and $15 billion annually. The revenue could be used to substantially lower personal and business taxes and to fund tax credits related to climate change technologies.

If the Liberals follow through on this, they will have the distinction of being the only major party that has a sensible position on reducing greenhouse gas emissions: the Conservatives are unable to distinguish between smart and stupid taxes, and the NDP is busy pandering to those who think that gasoline prices are already too high (h/t to Paul Wells).

But I don't see why they have to make such a big deal about it being revenue-neutral. $12b-15b is a significant chunk of change - roughly the equivalent of the two GST percentage points that the Conservatives frittered away to no apparent purpose. A carbon tax will be regressive, so a good portion of those revenues should be used to compensate lower-income households. The Liberals seem to understand this point:

[Liberal finance critic John] McCallum said the Liberals are working out a plan where tax credits or some other mechanism will be necessary to ensure pensioners and other Canadians with fixed incomes, low wages or who are otherwise in zero or low tax brackets must also receive compensation.

"You may be sure that we would be acutely aware of people who have lower incomes or more difficult times and you could be certain we will do everything to look after those people," McCallum said. "Some of the lower-income people don't pay tax, so that would be a feature of any such program if we were to have one."

I don't know how it happened, but the Liberal Party of Canada has found a way to be relevant again.

Canada's income redistribution strategy: take from the rich, give to the median

There have been any number of MSM stories based on StatsCan's recent release on earnings and income. Median earnings from market income for individuals in 2005 are pretty much the same as they were back in 1980, and market income inequality has - by any measure - increased over the past 25 years.

This isn't really news - at least, not in the sense of 'revealing previously unknown facts'. Here are plots of average and median market income for unattached individuals and for for economic families of two or more people; the data are taken from Statistics Canada's Cansim Tables 202-0202 and 202-0203:

Although median market income in 2005 was the same as it was in 1980, it hasn't remained constant: the recessions of 1983 and especially 1991 reduced real median incomes considerably, and it's taken ten years to recover. And the widening gap between the average and the median indicates increasing inequality during this time; something we knew about already (see this post, and this one, among others).

Inequality in market income doesn't bother me much in itself; what really matters is inequality in income after taxes and transfers. If policy-makers are responding to rising inequality by improving its programs for redistributing income, then the effect on inequality of disposable income will be a wash.

Unfortunately, that's not what has been happening in Canada. Here is how net transfers have changed; the data are taken from Cansim Table 202-0704:

Net transfers to the highest quintile have decreased; income growth has been concentrated at the top end of the income distribution, so their tax payments have grown in proportion. But the main beneficiaries are not those with the lowest incomes; the increase in net transfers has been concentrated on the middle income groups.

Here are how the shares of (gross) government transfers have changed over the past generation:

The share of transfers to the lowest quintile has decreased since 1980, as has - albeit to a lesser extent - that of the second quintile. The winners in this reallocation are the middle and fourth income quintiles.

It's not hard to imagine an explanation for this; the median income group is likely to include the median voter. So every political party will be happy to sacrifice the lowest income group's interests (that group is either taken for granted or written off entirely) in order to gain popularity at the centre.

The federal government's proposed tax cuts are just as stupid as we'd feared

Sigh. The Conservatives set out an Economic Statement this afternoon, and it includes a measure to further reduce the Goods and Services Tax (GST) from 6% to 5%. From this, I infer that the Conservative government is willfully stupid:

• Reducing the GST is bad economics. Just ask anyone who has given any thought to the matter.
• Reducing the GST is bad - or at best, pointless - politics. Just ask voters.

Now, I can understand that the Conservatives are in the business of cutting taxes. But the intelligent way of implementing that agenda involves cutting stupid taxes and keeping (or even increasing) smart taxes. Sadly, that doesn't seem to be the Conservative way of implementing this agenda. According to Table A.1 on this page, the GST cut accounts for over 60% of the reduction in taxes over the next five years. Stupid, stupid, et cetera.

Okay, yes, they are accelerating the previously-announced rate at which the federal government would be reducing corporate taxes (Table A.2 from the same page), and that's a good thing. But it's not enough to dispel the odour of ideologically-driven amateurism.

Jockeying for position at the Bank of Canada

In my post on Mark Carney's appointment to the top job at the Bank of Canada, I said

That's twice in a row that a governor has been an external candidate - although he has worked there before. I suspect that Bank employees who are thinking about the top job will start sending their CVs to the Department of Finance or perhaps the IMF.

It's always gratifying to see one's predictions come true:

The Prime Minister announced today that Tiff Macklem, Deputy Governor of the Bank of Canada, has been appointed Associate Deputy Minister of Finance, effective 1 November. Mr. Macklem will also serve as Canada's Finance Deputy at the G-7, G-20, and the Financial Stability Forum.

Mr. Macklem will replace Mark Carney in these roles. Mr. Carney was recently appointed the next Governor of the Bank of Canada, effective 1 February 2008 and is joining the Bank of Canada as an Adviser to the Governor effective 1 November.

Tiff was in fact the person I had in mind when I wrote those lines: like Mark Carney (and unlike Paul Jenkins), he has a PhD, and (unlike Mark Carney)  he also has kept  in touch with academia (his article 'Aggregate wealth in Canada' is one of my favorite pieces of applied work). He's done everything that could have been expected of him, and done it very well; it would be a very bad signal to younger staffers if that particular career path turned out to be a dead end.

The next question is: who will be the next Senior Deputy Governor at the Bank of Canada? And - more pointedly - why would he or she accept the job?

The new Governor of the Bank of Canada...

...is Mark Carney.

That's twice in a row that a governor has been an external candidate - although he has worked there before. I suspect that Bank employees who are thinking about the top job will start sending their CVs to the Department of Finance or perhaps the IMF. The days of appointing a governor from within the ranks appear to be over.

It's also interesting that his background appears to be more in finance than in monetary economics. This probably reflects the problems the Bank will be facing in the next few months. Its monetary policy hasn't changed since John Crow's time, and there's little obvious need to revisit the basic policy: inflation has been low and stable for 15 years. It's time to focus more attention on financial markets.

Mulroney's economic legacy

Brian Mulroney's* memoirs came out this week. The initial reactions have so far concentrated on his settling of accounts with Lucien Bouchard, but there have been a few comments about Mulroney's desire to polish his claim to a positive judgment from future historians. This is of course the goal of all former politicians, but when it comes to economic policy, Mulroney's case is stronger than most:

FTA/NAFTA: The treaty and the 1988 election upon which it was largely based occurred when I was in grad school. At the time, my impression of the general consensus among economists was that the FTA was on the whole a good idea (we understand the theory of comparative advantage), but that it wasn't all that big a deal. The US and Canadian economies were fairly similar, and already highly integrated: all the low-hanging fruit from the gains to trade had been pretty well picked over. And that consensus pretty much characterises what actually happened. The canonical study of the effects of FTA/NAFTA on the Canadian economy is Dan Trefler's 2004 AER article (26-page pdf), which concludes that its effects were - after a not-inconsiderable period of adjustment - small and positive: "a 3-percent rise in earnings spread over eight years will buy you more than a cup of coffee, but not at Starbucks." Nor is this view confined to the ranks of trained economists: public opinion polls suggest that 70% of Canadians support NAFTA. Small wonder it has survived five federal elections since then.

The GST: If you asked a specialist in public finance how best to raise tax revenues without tanking the economy, the answer would be 'Consumption taxes. Theory suggests that these are the least harmful to economic growth, and available evidence supports the theory.' This advice would be accompanied by the caveat that consumption taxes are regressive; it would be a good idea to implement a program of direct transfers to low-income households in order to compensate. I haven't read Mulroney's memoirs yet, but I'd be surprised if the decision to set up the GST didn't follow this scenario. The GST has never been popular, but it too has survived five elections. Sadly, it was wounded in the aftermath of the Conservative victory in 2006, when it lost a percentage point. But the GST credit survives - and is still the only federal targeted transfer program aimed at supplementing the incomes of low-income households.

Inflation targeting: Strictly speaking, this was a decision taken by the Bank of Canada, but Mulroney's government lent whatever credibility it could to the project. Implementing it was a painful process - the recession of the early 1990's was a brutal affair - to Kim Campbell's and John Crow's cost. But again, this policy is still in place after five elections - and inflation has fluctuated  in a narrow range around 2% for some 15 years.

Fiscal Policy: Although the Liberals - and Paul Martin in particular - get pretty much all the credit for finally conquering the federal government deficit, they really only deserve about half of it. As documented here, slaying the deficit dragon required transforming an operating deficit of -3% of GDP to a surplus of 6% during the period 1984-2000. The Mulroney government turned the -3% deficit into a 2% surplus before the 1991-2 recession brought it back down again. The Liberals are to be congratulated for finishing the job - but then again, they were the ones who had created the problem in the first place.

Scrapping the NEP: As explained here, the National Energy Policy amounted to a transfer from producers of oil to consumers, with a significant amount of deadweight loss along the way. Since the Trudeau Liberal govt of the time had broad support among the winners and almost no support among the losers from this transfer, they had few qualms about efficiency losses. Similarly, it's unlikely that Mulroney had those efficiency losses in mind when the NEP was abolished: he was rewarding his base. Notwithstanding, the efficiency losses were removed.

These programs generated significant adjustment costs. It was Kim Campbell's sad fate to pay the electoral price for them, and Mulroney has played the role of piñata in numerous accounts of the history of those times. But his government can fairly claim to have either implemented or to have set the foundations for the policy mix that has made Canada's one of the world's best-performing economies in recent years.

*For non-Canadian readers: Brian Mulroney was Prime Minister between 1984-1993.

Who will be the new Governor of the Bank of Canada?

Bank of Canada Governor David Dodge will not seek second term:

Governor David Dodge has informed the Bank of Canada's Board of Directors and the Minister of Finance that he will not seek a second term as Governor.

While Governor Dodge's term continues until 31 January 2008, he indicated he is making his plans known well in advance to facilitate the selection and appointment of his successor.

Some early speculation:

If tradition is resumed, senior deputy governor Paul Jenkins would obviously be at the top of the list. But since outsiders are now considered viable candidates, names such as Don Drummond (chief economist at Toronto-Dominion Bank), Kevin Lynch (chief clerk of the privy council) and Stephen Poloz (chief economist at Export Development Canada) have bubbled to the fore.

Any of those three would be credible candidates, although the internal politics of the Bank would probably exclude at least one of them. But I wonder if the search committee will look to academia this time around. Off the top of my head, I can think of at least 10 professors with whom I'd trust the keys to the Governor's office.

Update - More early speculation:

One market source said Malcolm Knight, a former senior deputy governor of the Bank of Canada who now heads the Bank for International Settlements, might be a candidate. Deputy Governor Tiff Macklem and Mark Carney, the senior associate deputy minister at the Finance Department, are also considered sharp young forces that could be in the race.