Is Revenue Neutrality in Carbon Taxation Possible in Practice? Lessons from the Canadian Experience

While the potential economic efficiency, equity, and political acceptability benefits of a revenue-neutral carbon tax have been well studied, a deeper question remains about the feasibility of revenue neutrality in practice. This article provides perspective on this issue by assessing different definitions of revenue neutrality and presenting an in-depth discussion of the motivations for the adoption of revenue-neutral carbon taxes. Two examples of carbon taxes and revenue recycling implemented in Canada are examined: British Columbia's revenue-neutral carbon tax (a carbon tax with offsetting tax cuts) and the Canadian federal government's fuel charge and climate action incentive tax credit (a carbon tax and dividend). The BC case serves to highlight the inherent difficulties of assessing revenue neutrality owing to uncertainty about what would have occurred in the absence of the tax. As time passes following initial implementation of the tax, it becomes increasingly difficult to determine whether, and to what extent, government revenue, income tax rates, the overall tax structure, and the tax base might have differed had the tax not been adopted. The federal example suggests that a carbon tax and dividend policy would be better able to ensure revenue neutrality.