Case of the Day: British Columbia's Carbon Tax
In 2008, the Canadian province of British Columbia enacted a tax on carbon-based fuels. The tax was intended to be "revenue-neutral," meaning that the proceeds from the tax were offset by reductions in other taxes on individuals and businesses.
In 2014, the Economist published a brief article summarizing the tax change and soe early evidence on its effects.
Read the article and answer the questions below. Since we are studying consumer behavior, we will ignore the effects on firms here and assume that all changes in taxes are fully passed through to consumers.
- What substitutes are available for carbon fuels in the short run? How would the number and closeness of substitutes be reflected in the shape of the indifference curves between carbon fuels and other energy sources? How would this affect the elasticity of demand? How might this be different in the long run?
- How would the carbon tax affect a consumer's budget constraint if there was no revenue-neutral provision, so that other taxes did not change? How would adding revenue neutrality change your answer? Relate this to the income and substitution effects?
- Is the effect of a revenue-neutral carbon tax a pure substitution effect for the average consumer? Explain.
- Does everyone end up with offsetting changes in after-tax income as a result of increasing carbon taxes and decreasing income taxes? If not, what consumers might be better off and who might be worse off?
- Would you expect carbon fuels to be a normal good or an inferior good? Why? Given this, would be effect of the tax on carbon-fuel consumption be larger or smaller if it were not revenue-neutral?