Why carbon taxes underperformed—and what Canada should do next

Consumer carbon taxes have always been a political lightning rod in Canada. But how effective are they when it comes to curbing carbon emissions and steering people toward greener alternatives like electric cars and heat pumps? And are there more effective alternatives? UBC Sauder School of Business Associate Professor Werner Antweiler’s latest working paper takes a deep dive into this hot-button issue, and in this Q&A he talks carbon pricing, consumer myopia and the best road forward. 

Your paper takes a hard look at carbon pricing. What was your focus?

We have been using carbon pricing to incentivize consumers to take up electric vehicles, heat pumps and other green investments — and it hasn't been especially effective. When you look at the data for Canada, we have been relatively stagnant in terms of reducing emissions, especially when it comes to transportation. The gains in efficiency have been largely offset by population growth. We have made some progress, but nowhere near enough. 

Now we’re seeing consumer-side carbon pricing being abandoned here in Canada. How bad is that for climate action? Perhaps surprisingly, the answer that you find in my paper is “not as bad as you might think.” My point is that we need stronger climate action, and that our consumer-side carbon pricing wasn’t going to be enough. Perhaps the demise of carbon prices on motor fuels will give us pause to figure out how to do climate action better, and ideally without the political backlash that we’ve seen about carbon taxes.

For economists, putting a price on pollution is the first best intervention; everything else is second best because it's not aimed directly at the amount of pollution. For example, when we subsidize EVs, it’s only indirectly linked to pollution, because it depends on how much that EV displaces an internal combustion engine vehicle. So when we look for alternative policies, we need to make them dependable environmentally but also as efficient as possible economically.
 

Why are people so resistant to carbon pricing?

Nobody likes taxes. And it’s easy to mischaracterize carbon pricing as a tax, when in fact most of the revenue was recycled to households in the form of rebates—and in B.C. also as income tax cuts. But most people only saw the higher prices at the pump and paid scant attention to the rebate cheques. Carbon pricing was marketed badly. People saw the pain but not the gain. With carbon pricing gone, less affluent households will actually be worse off than before.
 

Why aren’t people swayed by the savings that often come with energy-saving alternatives

Carbon pricing faces resistance because of something I call “consumer myopia” and economists more generally refer to as “internalities” or “capital bias.” Essentially it means people aren't looking sufficiently at the future benefits from driving an electric vehicle or using a heat pump, because those benefits accrue in the future and over time, whereas the purchase costs are upfront. That is the challenge of consumer myopia: it makes it so much harder to use an instrument like carbon pricing, because in the end, the carbon price would have to be really high to equal the effect you get from incentivizing the adoption of EVs or heat pumps using upfront rebates.

There are many possible reasons why people act myopically. It can be difficult to get a clear picture of what the future costs or savings might be, and that creates uncertainty. Also, some people have liquidity constraints, and can't afford to buy something more expensive upfront — so even though there might be cost savings down the road, they can’t finance it. Another problem is people may not care much about the future, and their choice is based on preference — so they’re focusing a lot more on today than tomorrow, and on the upfront purchase cost. There can also be quality differences in the products: for example, if you compare EVs and gasoline engine vehicles, you might worry about how you would charge an electric vehicle and how much that would cost. All of these can play a role in decision making.

So essentially, people suffer from a fixation on the purchase cost and do not take into account the long-term operating costs or savings from a switch — and the tradeoff with many energy-efficient devices is higher upfront costs against lower operating costs over time. For example, an EV costs more upfront because of the battery, but electricity is much cheaper than gasoline on a per-kilometer basis. So people need to actually look at the full lifecycle cost of an electric vehicle or heat pump, and if you’re too focused on the upfront purchase cost, you suffer from capital bias and excessively underestimate future savings.
 

You also describe how we don’t take into account the rising carbon prices.

The price of carbon was set to rise from $80 per tonne in 2024 to $170 in 2030. This would have made gasoline increasingly more expensive relative to electricity. But if you buy a motor vehicle and only look at today’s price gap, you fail to appreciate that over the lifetime of the vehicle your fuel cost will continue to rise. So here, consumer myopia is even more amplified because of buyers may mistake today’s policy for tomorrow’s policy. And some of this myopia is even justified because of policy uncertainty—the demise of carbon pricing on fuel has just proved the skeptics right.
 

So how does that misperception impact the effectiveness of carbon pricing?

Businesses are much better at amortizing costs than individuals. Businesses conduct a cost-benefit calculation and how an investment amortizes over time, using a commercial discount rate. But consumers tend to discount the future far more than a business does — so the discount rate is maybe 15 or 20 per cent rather than five per cent and that makes a huge difference when it comes to purchasing heat pumps or electric vehicles, because that means all the future savings are compressed and not taken into full account. Instead, people are focusing on that purchase price.

You can ask, “What carbon price would we need to entice somebody to make a switch from a gas vehicle to electric based on the cost difference?” If the cost gap is $10,000, instead of an $80 carbon price we would need a carbon price that's more like $950 to have the same effect as it would if people discounted the future correctly, like a business would. So that is something we can calculate, and my theoretical model actually reveals how much higher the optimal carbon price would need to be when people are subject to this capital bias. It’s a huge number, and there's no way we can raise the carbon price to something like that. 

So consumer carbon pricing just isn't going to deliver as much as we would like, and that's the reason why I think that the end of consumer-side carbon pricing need not be the end of meaningful climate action for transportation. Carbon pricing was never going to be as effective as it needed to be. It was well below the level economists call the “social cost of carbon” that reflects the damage from climate change. 
 

What are some better options when it comes to “carrots” and “sticks”?

Governments did put subsidies on EVs, but they got abandoned when the federal government funding ran out, and provincial governments are phasing out rebates. So what incentive schemes would entice people to overcome their consumer myopia and still buy EVs or heat pumps? And what’s a better design than the current flat subsidy which doesn’t link to emissions savings? This comes back to the question of how people use their cars or use their heat pumps: basically, incentives should be larger if people drive more, and less if they drive less. Currently our incentive scheme doesn’t correlate to the amount of emissions that come with the displacement of a gasoline engine vehicle. 
 

What approach would be most effective?

The main alternative is a subsidy, and subsidies today are essentially flat. So you buy an EV, and you get X dollars — in BC the provincial government was offering $4,000 and the federal government was offering $5,000. That isn’t optimal because it's not related to the amount of emissions. So the next question is, can we make it better? Can we offer a subsidy that’s tied to the level of emissions? I have two models. One is what I call a conditional subsidy, which is conditioned on the amount of driving and an eligibility threshold. Drivers would only get a subsidy if, say, the previous year’s usage was a minimum of 15,000 kilometers or 20,000 kilometers. That way the subsidy would only be going to those who have the highest emission savings. 

The second possibility would be to base a subsidy on actual usage. So if I report that last year I drove 6,000 kilometers, I get a subsidy that's proportional to 6,000 kilometers. If I drove 20,000 kilometers, I would get a higher subsidy. That way we can tailor the subsidy to those who would reduce emissions the most. 
 

In the end, what was the optimal approach?

My paper goes through the empirical exercise of simulating calibrated distributions of consumer myopia and vehicle usage. Then I ask, “How high should the subsidies be based on assumptions about what EVs cost, what gasoline powered cars cost, all the future fuel and operating costs, and this observed level of myopia?” and determine which policies deliver the best results.

It turns out the simple flat rate subsidy isn't all that terrible, but in terms of what actually delivers the most emission savings, the best policy is the one that takes into consideration the effect that we get from actual usage of the vehicle that is being replaced. So from a purely environmental point of view, usage-based policies are the right way to go. 

EV incentive schemes can also be made revenue neutral—a small fee on the purchase of many gasoline-powered vehicles can be recycled as a high subsidy on the purchase of fewer EVs. What matters is the price wedge at the time of purchase, and the government does not need to be out of pocket. Essentially, we shuffle money among the buyers of motor vehicles. As technology improves and batteries get cheaper, the price gap will shrink in any case.
 

Which current policies are left intact after carbon pricing is gone?

There is both a provincial and a federal zero-emission vehicle (ZEV) mandate in place, which sets sales targets for electric vehicles starting with model year 2026 and reaching 100 per cent for model year 2035. So in a very simple way that mandate is doing the same thing as a subsidy, but using a different compliance mechanism where the price wedge between an EV and gas-powered car will rise. The downside of the policy is that it isn’t based on vehicle usage and emission savings, as my policy alternative would favour. But the best-case scenario is that innovation will make EVs cheaper more quickly, and then the ZEV mandate won’t be needed much other than for providing certainty for investment decisions from automakers.

The zero-emission vehicle mandate is already law, so it is happening, and we also have the biofuels mandate that lowers the carbon intensity of emissions from anyone who is driving a conventional vehicle. In conjunction, they are very strong instruments and I fully expect them to deliver much more of an environmental effect than carbon pricing would have ever done. These policies aren’t perfect yet, but they can be made better, and I hope this is what governments will work on.  
 

What’s your bottom-line message?

Message one is: don't despair that consumer-side carbon pricing has vanished, because the carbon price that would have been necessary to achieve our climate goals would have been sky-high. Message two is: we do need an effective alternative, and today that is the combination of a zero-emission vehicle mandate and a biofuels mandate. In the last election, the Conservatives were arguing to get rid of the zero-emission vehicle mandate too, but that would have been very unfortunate because it’s one of the two policies that can, and likely will be, very effective. The point here is to fix it and make it better, not abandon it. I am deeply troubled by the head-in-the-sand attitude to climate change that is the political current in the United States and in some corners of Canada. My bottom line is simple: as the climate crisis is deepening, we need climate action that can deliver, fast and reliably.

What I hope to accomplish with my paper is to show that we shouldn't be abandoning electric vehicles and heat pump subsidies; there are ways to make them work better by targeting them better, without burdening government budgets excessively. Even without consumer-side carbon pricing, there are smart carbon policies that work. They just need to focus more on purchase decisions, not consumption decisions.