Please note that the wide-ranging exemptions that were embedded in France’s carbon tax proposal have also always existed and continue to exist in Swedish, Danish, Norwegian and Dutch carbon/CO2 tax laws. Germany, on the other hand, does not, nor has it ever, had a carbon or CO2 tax. These other nations do not have tax fairness laws comparable to the provisions in the French constitution in place.

Generally, GHGs arising from the combustion of fossil fuels in power production, petroleum refineries, aluminum smelters, cement plants and industrial chemical plants are and have always been carbon/CO2 tax exempt under most European tax systems.  Refineries, aluminum smelters, cement and chemical plants also have received free CO2 allowance allocations equal to forecast "business as usual" GHGs through 2012. This is true even for, say, BP, whose European ETS-covered operations realized a 24% growth in GHG emissions between 2005 and the end of 2008. 

It remains curious to me that Canadian carbon/CO2 tax proponents often refer to European carbon/CO2 tax models as "successful" but have never proposed or discussed the range of tax exemptions that typify the EU tax models. Of course, the rationale for the power sector and industrial carbon/CO2 tax exemptions is the prevention of job losses.

The important questions that Canadian CO2 tax and cap and trade proponents have avoided addressing to date include:

• If Canada imposed CO2 taxes on Canadian sectors that are CO2 tax exempt in Europe and elsewhere, how does the government of Canada protect Canadian export market shares from lower cost (untaxed), more GHG-intensive European petroleum, aluminum, cement and chemical exports?

• If Canada shorts the free allocation of Canadian GHG quota to Canadian sectors that receive free GHG/CO2 quota allocations equal to their "business as usual" GHG forecasts, how does the government of Canada protect Canadian export market shares from lower cost (uncapped), more GHG-intensive European petroleum, aluminum, cement and chemical exports?

• European, Japanese and US governments have reserved the right to impose GHG tariffs on imports from Canada if Canada fails to cut national GHGs 20% below 2006 levels by 2020. If Canada gives these sectors the GHG/CO2 "pass" that they currently receive under the European ETS and, in some sectors, under the proposed US Senate and House climate change bills, how does Canada achieve our national GHG reduction target?

The Answer?

Product Standards. Canada’s ultra low sulphur diesel regulation is a product standard. The government neither sets prices, nor selects the technologies the market will employ to comply with new product standards. 

A product standard regulates carbon content or supply chain GHG emissions at the first point of distribution of the regulated products, Canada should implement a series of GHG or carbon product standards that:

• Are at least as stringent as the European CO2 "benchmarks" for benchmarked sectors. The EU has developed emission benchmarks to determine best practices for "trade sensitive" sectors.  At this time, EU member states propose to freely allocate CO2 quota up to the benchmark emission intensity rates for EU ETS covered facilities for the post-2012 control periods. The benchmarked sectors are: aluminum, cement, ceramics, chemicals, glass, gypsum, iron and steel, iron ore, lime, mineral wool, non-ferrous metals except aluminum, pulp and paper, oil refineries. 

• Could reasonably ensure Canadian achievement of the 20% reduction target from 2006 levels by 2020. Most Canadian facilities in the EU benchmarked sectors discharge lower GHGs (absolutely and per unit of output) than the current draft EU benchmarks. Canada could contemplate initial product standards for these sectors that are technically more stringent than the EU benchmarks.

• For the electricity and biofuels sectors, combine the attributes of the existing US Renewable Fuel Standard and proposed US Renewable Electricity and Electricity Efficiency Standards into a single, more flexible Canadian Renewable Energy Standard.

With these product standards in place and our ability to prove at WTO, NAFTA and in US courts that our product standards are comparable in terms of environmental outcomes as the combination of regulations and GHG/CO2 quota allocations that are in place or proposed in Europe and the US, Canada should be able to successfully challenge the protectionist elements of the EU and US tax and cap and trade regimes.

Our ability to win any such trade dispute will rely, first, on our implementation of a Canadian facility-level emission reporting regulation that WTO, NAFTA and US courts would agree are "comparable" to section 40 of the US Code of Federal Regulations, part 75. This does not mean we have to implement reporting regulations that are identical to the highly invasive and administratively costly US emission reporting regulations.  But we do need to implement reporting regulations that are significantly more stringent than those that are in place federally or proposed by any Canadian province to date. 

As long as Canada fails to implement "comparable" (under WTO’s definition of "comparable", not the US definition) facility level reporting regulations, the EU, Japan and the US will maintain that Canada’s national GHG inventory claims cannot be verified. The WTO has in the past and will in the future uphold EU, Japanese and US GHG tariffs on our exports as long as the US can successfully make that case.

No investor likes to commit to a sector that can reasonably be forecast to be embroiled in a trade dispute in the near or medium term. Therefore, Canada must consider implementing new emission (pollutants and GHGs, not just GHG) reporting regulations as well as the key product standards as soon as possible, with the objective of having the regulations fully developed before the US Congress votes on a US climate change bill. 

Among the product standards, the Renewable Energy Standard is top priority.  Canada should implement the Canadian Renewable Energy Standard as soon as possible to demonstrate that we have equivalent-to-existing-US-and-EU renewable energy and fuel standards in place. Our goal should be to put this standard in place, by Order in Council, along with the new facility-level GHG reporting rules, between March 31 and July 31, 2010.

Canada should completely develop the other product standards (starting with reference to the EU benchmark studies and refining these standards in consultation with Canadian industry) including completing public consultation, by the July 31 deadline.

The other product standards can include clauses stipulating that these standards will not come into full effect unless/until the government of Canada finds that the US has implemented "comparable" standards. 

This approach positions Canada to provide the US with early warning that any highly protectionist US GHG quota allocation and trading scheme will be challenged by Canada, and also to communicate our view that product standards are more efficient than quota-based supply management for energy, building product and food markets. Canada’s move should cause a new debate to emerge in the US—which would be in Canada’s interest. 

This approach increases the odds that both Canada and the US will drop quota allocation and trading and shift to product standards, creating a more positive market signal.

Please note that credit trading and banking is a key element in all existing and proposed EU, US and Japanese product standards. It is not necessary to create, auction or allocation emission quotas to spawn a vibrant and disciplined secondary market for environmental attributes. Each of our product standards should allow for over-compliance credit banking and trading, and credit trading across sectoral boundaries.

Beyond these regulations, Canada also has to incorporate a new Class 27 Capital Cost Allowance regulation in Schedule II of the Corporate Income Tax Act, which new Class 27 regulation will focus on providing incentives for EXISTING plant operators to invest in GHG and pollution reduction measures. 

One year depreciation (same year "expensing of capital expenditures", in US tax lingo) is standard for investments that measure, control or reduce regulated emissions in the UK, EU and US at this time. 

Canada cannot attract the necessary new capital investment unless our tax act at least matches the one year tax deferral that is already available to investors in the UK, Europe and the US. The government of Canada should consider upping the ante by allowing entities that qualify for accelerated depreciation under the new Class 27 to bank (but not trade) CCA credits for up to 10 years.

I am not recommending that Class 27 credits become flow-through credits. I think the credits should not be severable from the equipment installations that qualified for accelerated depreciation. But the credit banking provision puts pressure on new technology adopters to become profitable in their Canadian operations—if they are not already—within 10 years.

I had hoped to draft at least two strawdog product standards and a new draft Class 27 regulation for illustration purposes by today, but have been unable to do so. I do anticipate, however, that I will be able to complete the two samples by the end of next week for consideration and criticism.

Special Note to Provinces About Green Bonds: Don’t Do It

Only the federal government can implement the Class 27 recommendation. Either the provinces or the federal government can implement the key product standards, but I do recommend these as federal initiatives. Given the potential for federal product standards, provinces will all consider additional measures to increase regional economic development opportunities.

Some provinces are considering other measures, such as issuing green bonds to raise financing for new green technology projects. With respect, I wish to recommend an alternative to that proposal.

Given current provincial deficit levels and the likelihood that interest rates will increase in the near term, provinces should not consider raising net debt (other than to retire existing, higher interest rate-bearing debt).

Under US federal tax law, interest income earned by private entities that lend capital in the form of debt to electric utilities and other key infrastructure projects is corporate income tax exempt, within some limits. I strongly recommend that provinces consider amending provincial tax law to incorporate income tax exemptions for interest income earned from loans to projects that meet certain environmental criteria. This approach should achieve the same objective as "green bonds", but mobilize private sector capital markets without increasing government deficit and debt levels.