Environment & Work,  Macroeconomics,  Research

No Correlation Between Inflation and Carbon Pricing

Canadian conservatives have repeatedly tried to pin the blame for post-pandemic inflation on the present federal government, and even personally on Prime Minister Justin Trudeau (with their ‘JustInflation’ label). The latest incarnation of that strategy claims the surge in inflation over the last two years is due to the federal carbon tax – which applies in those provinces (such as Ontario and Alberta) which have refused to participate directly in the Canada-wide carbon pricing system. In this report, originally published in Canadian Dimension magazine, Centre for Future Work Director Jim Stanford shows there is no empirical correlation or theoretical link between carbon taxes and economy-wide inflation.

Top Ten Reasons We Can’t Blame the Carbon Tax for Inflation

by Jim Stanford

From the onset of the post-COVID surge in inflation, Canada’s new breed of right-wing populists has worked hard to pin the blame for higher prices on the federal government. They rightly sense anger among Canadians about the impact of inflation on their real living standards. But they hope to divert that anger into further outrage at Justin Trudeau personally, and his government more generally – building on the virulent anti-Ottawa ideology fostered by the anti-vax movement, the so-called ‘truckers’ convoy’, and other far-right outbursts.

They face an uphill slog in their effort to scapegoat Canada’s federal government for inflation. After all, higher inflation has been almost universal across industrial countries since post-lockdown re-opening. Indeed, Canada’s inflation peaked sooner, at a lower rate, and has come down faster, than most other OECD countries. As of April Canada had the second lowest inflation in the G7, and the 6th lowest among the 37 countries of the OECD. If it’s all Justin Trudeau’s fault, he seems to have been more successful stoking inflation in all those other countries, than in Canada.

Other tropes in the right-wing narrative about inflation include resuscitating old-fashioned ideas that inflation results from government deficits and excessive money supply. Pierre Poilievre attacked the Bank of Canada for acting as Trudeau’s personal ATM, with its quantitative easing measures earlier in the pandemic. Never mind that most other central banks did the same, and more aggressively. Never mind that the Bank of Canada has since been engaged in quantitative tightening for a full year. Never mind that the money supply in Canada is now shrinking rapidly – mostly because of the slowdown in private credit creation caused by the Bank’s interest rate policies. (Poilievre & Co. never fret about the power of private banks to create money out of thin air, as they do in tens of billions every week, because that doesn’t fit with their anti-government hymn book.) And never mind that Ottawa’s pandemic deficits have quickly disappeared as the economy re-opened: in fact, the federal government ran a $3.1 billion surplus in the first 11 months of the 2022-23 fiscal year (final year-end numbers won’t be known for a few months).

As the credibility of Poilievre’s “Justinflation” narrative comes apart at the seams, the right has now seized another trope on which to hang their anti-government hyperbole: the carbon tax. On April 1 the federal carbon tax rose by $15 per tonne, to $65: the most recent in a 12-year timetable that will lift the tax to $170 by 2030. The tax applies directly in those provinces which are boycotting the federal carbon pricing program (like Ontario and Alberta); it indirectly underpins provincial carbon pricing systems in B.C., Quebec, and other participating provinces. Conservatives and their allies seized on the carbon tax hike as another opportunity to both attach the whole idea of carbon pricing, and also scapegoat Ottawa for all inflation (which, ironically, is decelerating faster than the populists can update their talking points).

There is no serious evidence the carbon tax has anything to do with the surge in inflation since the pandemic. Here are ten key reasons why this latest Conservative attack has no credibility:

  1. The surge in inflation since the pandemic has been experienced across almost all industrial countries, whether they have carbon pricing or not. The U.S., for example, has no carbon tax, yet experienced higher inflation than Canada. The same is true in Australia, Turkey, and other OECD countries without carbon pricing regimes. Japan and Korea both have carbon taxes, and their inflation has been even lower than Canada’s.
  2. Increases in the carbon tax have been gradual, and started long before recent inflation. The federal carbon tax first came into effect (at $20 per tonne) in 2019. It increased by $10 per year to 2022, and is now increasing at $15 per year until 2030. Inflation has swung wildly during this time. CPI inflation decelerated in 2019, after the biggest single increase in the carbon tax. It fell below zero for a while in 2020 (during the worst of the pandemic), and then surged to 8% by June 2022. Now inflation is decelerating rapidly – even as a larger ($15) carbon tax increase is absorbed. The Bank of Canada expects inflation over the coming 12 months to fall back within its target range (to around 2.5% year-over-year by spring 2024). In short, there is no visible correlation at all between carbon tax increases and the rate of inflation.

Federal Carbon Tax and CPI Inflation

  1. The impact of the carbon tax on final prices is small, even on fossil fuel products. For example, the latest annual $15 increase in the tax is equivalent to an increase of about 3 cents per litre in gasoline prices. At current average gasoline prices ($1.50 per litre), that’s a 2% increase. Gasoline has a 4% weighting in Statistics Canada’s overall CPI. So for gasoline (the biggest single direct fossil fuel component in the CPI bundle), a $15 carbon tax increase translates into a direct 0.08% increase in overall consumer prices (that is, less than one-tenth of one percent). 
  2. In the year ending in June 2022 (when inflation peaked in Canada), the price of gasoline increased by 75 cents per litre. So that increase was almost 40 times larger than can be explained by the change in the carbon tax in that time (which was raised $10 per tonne, or about 2 cents per litre of gasoline, on April 1 2022). Now, of course, gasoline prices have come back down – even as the carbon tax increased again.
  3. Clearly, it is other fluctuations in energy markets (not the carbon tax) that have dominated energy price changes, and the overall inflation rate. The world price of oil tripled between the beginning of 2021 and spring 2022 (from $40 to $120 US per barrel). That is equivalent to an increase in the carbon tax of around $300(Cdn) per MT. By that measure, the jump in the price of oil (driven by a combination of geopolitics and speculation on world oil futures markets) increased fossil fuel prices by 30 times as much as the $10 carbon price increase in the same period.
  4. In February of this year, Bank of Canada Governor Tiff Macklem reported to the House of Commons Finance Committee that the $15 per tonne annual increases in the carbon tax raise the average economy-wide price level by 0.1 percentage points. That can hardly be measured in Statistics Canada’s CPI calculations, and will clearly be overwhelmed (up or down) by other determinants of inflation.
  5. The whole point of the carbon tax is to stimulate economic adjustments aimed at energy conservation, investments in non-polluting energy systems, and shifts in final consumer demand to less carbon-intensive products. All of these things can lead to reductions in prices for many products. For example, the price of electric vehicles is coming down very rapidly as the technology and scale of that industry rapidly develop. The price of electricity will also come down as renewable sources become more widespread and cost-efficient (especially given huge reductions in battery storage costs). Solar powered electricity is already 28% cheaper than gas-powered in Alberta and Ontario, and that advantage will grow. 
  6. Once we consider the direct and indirect impacts on prices, the net effect of the carbon tax on the overall price level could be negative (that is, deflationary). That is the finding of a major international study of the historical impact of carbon taxes on price levels in several EU countries and Canadian provinces. The researchers found no significant impact of carbon taxes on inflation in Europe, and a slight deflationary impact in Canada. They attribute the deflationary impact largely to the stimulus to investment and supply in non-carbon-intensive industries that is being provided by the carbon tax.
  7. Most of the revenue from carbon pricing regimes in various provinces is rebated back to Canadian households, with a net mildly progressive distributional impact (with lower-income households getting more back than they pay in). Even funds that were retained by government would still be spent on public services or other welfare-enhancing activities. While this recycling of carbon tax revenue doesn’t affect the rate of inflation, it does help offset (especially for lower-income Canadians) the impacts of any inflation that is occurring (whatever its causes), and further enhances the net welfare benefits of carbon pricing.
  8. Of course, in any environmental debate, the impact of climate policies must be compared to the costs of inaction. Climate change is already having many negative impacts on the economy, including on inflation. The impact of climate disasters (droughts, floods, and more) on food prices has been widely acknowledged. Contributing to the alleviation of future climate -related costs is another anti-inflationary aspect of climate policy generally, including measures like the carbon tax.

In sum, blaming recent inflation on the carbon tax is just another attempt by right-wing populists to divert the legitimate anger of Canadians into destructive, anti-government channels. The carbon tax has no visible historical relationship to the rate of inflation. The real culprits in the current cost of living crisis, and higher energy costs in particular, are the corporations who have taken advantage of supply constraints, wars, speculative futures markets, and pandemics to increase their own profits. In Canada’s case, the oil and gas sector increased its aggregate profits by over 1000% between 2019 and 2022. Those profits are the direct result of the surge in inflation that damaged Canadians’ real living standards. By trying to blame the carbon tax (and government in general) for inflation, these companies (and the right-wing populists who ultimately endorse the dominance of business in our economy) hope to divert public anger safely away from any sort of anti-corporate perspective.

Of course, progressives have many ideas for improving climate policy in Canada, and the carbon pricing system more specifically. These include a stronger role for direct regulation of emissions (including hard caps on fossil fuel output), more emphasis on direct public investment (not just tax credits or other incentives for private investment), and stronger measures to lift the quality and fairness of jobs in new, sustainable industries.

So there are many criticisms that can be leveled at Canada’s existing carbon tax system. But causing inflation is not one of them.

Jim Stanford is Economist and Director of the Centre for Future Work. He divides his time between Sydney, Australia and Vancouver, Canada. Jim is one of Canada’s best-known economic commentators. He served for over 20 years as Economist and Director of Policy with Unifor, Canada’s largest private-sector trade union.