Economic Instruments for Environmental Improvement

The Government of Canada recognizes that economic instruments help promote environmental excellence and protect air quality, while also fostering economic growth.

These economic instruments can complement or substitute traditional regulatory command-and-control (CAC) measures to reduce air pollution. They include: green taxes, tax incentives, tradable permits, and subsidies.

The difference between economic instruments and traditional regulatory CAC measures is that instruments use market forces to induce behavioural change, while CAC measures dictate how polluters must control specific activities. Studies and real-world experience show that economic instruments can be more flexible, stimulate innovation, and lower costs for consumers and companies that want to green the way they do business.

Around the world, the use of economic instruments is a recent phenomenon. The U.S. took the lead in the late 1980's with several tradable permit programs. Permit trading is an economic instrument used to create pollution market in which companies facing high marginal abatement costs buy permits (emission rights) from companies operating at low marginal abatement costs, thereby minimizing the total costs of pollution abatement.  Companies trade these permits amongst themselves or through brokers or financial exchanges.

In the early 1990s, northern European countries such as Finland, Sweden, Norway, Denmark, and the Netherlands began levying a variety of green taxes. A second wave started in the late 1990s in France, Germany, Italy and the United Kingdom. Green taxes could be levied on emissions of pollutants or economic activities that are sources of environmental problems to modify the behavior of the polluters and at the same time generate revenue to finance environmental protection and conservation or other government programs. Ideally, the tax rate is set equal to the marginal damage to society of a pollutant at the socially optimal emission level.   By comparison, the economic instrument of choice in the United States has been tradable permits, largely because of the early success of a program to control acid rain that was implemented in 1993, and continues to operate today.

In Canada, economic instruments are being considered more and more. The federal, provincial and territorial governments are involved in a range of instruments such as economic incentives, green taxes and tradable permit programs.

For example, in recent federal budgets, Canada has provided incentives for the use of cleaner-burning ethanol fuels and the production of wind energy. For wind power, companies are eligible for payments of up to 1.2 cents/kilowatt-hour produced. Similarly, a Green Municipal Fund supporting environmental projects is managed at arms length from the federal government by the Federation of Canadian Municipalities.

Canada has also initiated a few tradable permit programs. Ontario has introduced a trading system for the electricity sector while Environment Canada has used a small cap and trade system to phase out methyl bromide; an ozone deleting substance, Perchloroethylene/tetrachloroethylene (PERC/TCE). A cap is a limit on emissions, which provides more certainty that a target will be reached.

Overall, the international experience to date has shown that an appropriate combination of traditional regulatory CAC measures and economic instruments can achieve significant reductions in air pollution. In Sweden, for example, the combination of strict regulations; removal of subsidies and implementation of environmental taxes has been very effective.