If we have to ditch the carbon tax, subsidies are the way to go

As the world faces the dual crises of climate change and biodiversity loss, governments are looking to policy tools that align economic activities with sustainability. Carbon taxes are often seen as the most efficient economic approach to reducing environmental harm. However, in Canada, political resistance is forcing policymakers to consider alternatives. 

Enter subsidies: While not as efficient, they can be a practical “second best” solution when carefully designed. 

Carbon taxes work by putting a price on emissions, incentivizing businesses and consumers to reduce their carbon footprint. Despite their economic efficiency, these taxes can be politically unpopular because they impose visible costs on specific groups.

In British Columbia, for example, the provincial carbon tax, once hailed as a model of environmental policy, has encountered resistance. Concerns about affordability and competitiveness have made it increasingly difficult to push for more ambitious carbon pricing. Nationally, similar dynamics have played out, with opposition to the federal carbon-pricing system limiting its potential scope.

Given these political challenges, subsidies may be a more politically feasible alternative to incentivize the adoption of low-carbon technologies and behaviours.

In fact, this "second best" approach already exists in Canada: Federal and provincial governments offer subsidies for electric vehicle (EVs) purchases, home energy retrofits and renewable energy installations. 

These subsidies are crucial in making green technologies more accessible and helping consumers and businesses transition to lower-carbon options. While not as economically efficient as carbon taxes, these subsidies can still reduce emissions by incentivizing shifts toward cleaner technologies.

However, subsidies also have limitations. They must be designed carefully to avoid unintended consequences, such as expanding markets in ways that offset the environmental benefits. 

Subsidies have political advantages over taxes because they provide direct benefits to specific groups, making them easier to implement and sustain. However, these same features can create significant risks. Once established, subsidies often become difficult to remove due to vested interests that form around them. This “lock-in” effect can lead to inefficient policies that persist long after they have outlived their usefulness.

Canada has already seen the risks of lock-in with fossil fuel subsidies, which continue despite global commitments to phase them out. Although the government has made some progress in reducing these subsidies, powerful industries that benefit from them have successfully resisted full elimination.

Subsidies can also have unintended environmental impacts. For instance, while subsidizing EVs helps reduce emissions from gasoline-powered vehicles, it can increase demand for vehicles overall, leading to higher road congestion, infrastructure costs, and resource extraction for battery materials. 

Additionally, the environmental benefits of EVs depend on the cleanliness of the electricity grid that powers them. In provinces such as Alberta, where much of the electricity is generated from fossil fuels, the gains from EV adoption are limited.

To maximize the benefits of subsidies, Canada must ensure they are well-targeted and designed to avoid common pitfalls. One way to achieve this is by setting time limits or sunset clauses on subsidies, allowing policymakers to periodically review their effectiveness and adjust or phase them out if necessary. 

For example, Canada’s federal EV subsidy could be revisited after a decade to assess whether it is still needed or if other policies, such as improvements to public transportation, could offer a better environmental return.

Policymakers should also prioritize “additionality” when designing subsidies. This means ensuring that the subsidy is incentivizing new behavior or investments that would not have occurred without government support. 

Recent studies show that a significant portion of EV subsidies in Canada went to households that would have purchased an EV regardless of the incentive, reducing the policy's overall effectiveness.

Moreover, Canadian policymakers must coordinate subsidy policies across sectors to ensure their environmental impact is maximized. For instance, subsidies for EVs should be coupled with efforts to decarbonize the electricity grid. 

As political resistance to carbon taxes increases, Canada must also somehow face the urgent challenge of climate change. Subsidies deployed wisely could drive transformational change, all while side-stepping the political and economic realities of carbon pricing.

Rashid Sumaila is a University Killam Professor and Canada Research Chair (Tier 1) in Interdisciplinary Ocean and Fisheries Economics at the Institute for the Oceans and Fisheries, and the School of Public Policy and Global Affairs, University of British Columbia.