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Report No. 5/95

The Impacts of Energy Taxes on CO2 Emissions and Farm Income in Prairie Agriculture.  By Tulay Yildirim, Varghese Manaloor and Richard White.  June 1995, Saskatoon, Saskatchewan.

The structural and technological changes that have taken place over the past several decades have resulted in an increased use of direct and indirect energy inputs in prairie agriculture.  In particular, the substitution of capital for labour has increased the reliance of agriculture on non-renewable energy use.  Canada's commitment to the international community to stabilze CO2 emissions at 1990 levels brings about the possibility of introducing economic instruments such as energy taxes, carbon taxes, and the removal or redirection of the current subsidies in order to meet these targets. The Climate Change Task Group (CCTG) listed these measures as potential tools to change the current incentive structure and, hence, the energy-use patterns.

The impacts of two policy options - the removal of the current provincial farm-fuel tax rebate programs and the introduction of a new energy tax - on CO2 emissions, net farm income, and government tax revenue in the Prairies were analyzed.  In order to assess the potential impacts of such policies, the elasticity of substitution between input pairs and the price elasticities of demand for inputs were estimated for prairie agriculture.  The estimated short-run elasticities of demand indicate that all inputs are price inelastic, with the exception of indirect energy.  Direct energy use is the least responsive to own-price changes.

In the first scenario, the effects of the removal of provincial farm fuel rebate programs were analyzed.  It was estimated that such a policy change would increase average fuel prices paid by farmers by 38.33 percent from their 1993 levels, with a subsequent 3.61 percent reduction in CO2 emissions from prairie agriculture.  The economic impact of these changes, a 1.16 percent increase in the cost of producing the same level of output, translates into a 5.78 percent, or $172,703,000, decline in net farm income in the Prairies.  Government revenues in the Prairie provinces are expected to increase by the total amount of rebates and subsidies that are currently in place.  In each province, the estimated change in tax revenues exceeds the predicted decline in farm income; clearly, there are economic gains to be had from this policy change.  Provincial governments could compensate farmers, in a nondistorting way, for the losses in farm income and society overall would still be better off.

In the second scenario, the effects of a new energy tax were considered.  It was estimated that a 13.4 percent energy tax results in an equivalent reduction in CO2 emissions (as in the first scenario).  Assumed to apply to all sectors of the economy, this tax was estimated to result in a 7.39 percent rise in fertilizer and farm chemical prices.  The impact of this policy option on farm income is slightly smaller than that of the first scenario; farm income goes down by 5.34 percent, or $159,418,000, from its 1993 level.  The estimated tax revenue from agricultural energy use is $122,251,000 - approximately 50 percent less than that of the previous case.  In this case, the estimated increase in government revenue falls short of the predicted decline in net farm income.

In summary, the removal of tax rebates and subsidies to farm fuel use and the introduction of a new 13.4 percent federal tax would result in the same level of reduction in CO2 emissions.  While environmental effects of these two policy options are equivalent, the removal of provincial tax rebates also offers economic gains. These benefits spring from two sources: first, it eliminates the distortions in resource allocation that result from provincial rebates/subsidies, and second, it results in net welfare gains.  Consequently, the removal of provincial tax rebates is a better policy option to achieve changes towards a sustainable agriculture.

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