Latest / The Fiscal Policy Podcast with Fexingo: Government Budgets, Stimulus, and Public Spending / How Carbon Taxes Are Reshaping Public Budgets Worldwide
Transcript
- Lucas: So Canada has had a federal carbon tax since 2019, and last month the Parliamentary Budget Officer released its latest evaluation. The headline number that jumped out at me: the federal fuel charge is projected to raise about 13 billion Canadian dollars this fiscal year. That's real money. Luna: Thirteen billion. And that's just the federal piece. Provinces like British Columbia and Quebec have their own systems on top of that, right? Lucas: Exactly. And that's what I want to zoom in on today — carbon taxes as a fiscal policy instrument, not just an environmental one. Because the way governments design these things has huge implications for their budgets, for taxpayers, and for political sustainability. And we're at a really interesting moment, June 2026. Over 40 countries now have some form of carbon pricing, generating roughly 100 billion dollars globally each year. Luna: A hundred billion. That's a meaningful revenue stream for any government. But the design varies wildly. Some use it to cut other taxes, some just add it to general revenue. Lucas: Right, and that design choice is everything. Let's start with the most influential model — British Columbia's revenue-neutral carbon tax, launched in 2008. It was the first of its kind in North America. The idea was simple: price carbon, but return every dollar to taxpayers through cuts in income taxes and business taxes. For the first few years, it was a darling of economists across the political spectrum. Luna: I remember that. Even Milton Friedman fans liked it, in theory. A tax swap rather than a tax hike. Lucas: Precisely. And for a while, the data supported the hype. British Columbia's fuel consumption per capita dropped relative to the rest of Canada, while the economy kept growing at roughly the same pace. The tax started at 10 Canadian dollars per tonne of CO2 and climbed to 30 by 2012. Revenue neutrality was maintained — the government published an annual 'tax neutrality' report showing exactly how much was collected and how much was returned. Luna: But then something happened. Around 2013, the rate got stuck at 30 dollars per tonne. It stayed there for years. Lucas: That's the political friction point. In 2018, the British Columbia government tried to raise the rate from 30 to 35 dollars per tonne, and the opposition hammered them on it. The NDP government that came in later actually froze the rate at 30 dollars through 2021. And here's the fiscal consequence: because the tax wasn't rising with inflation, the real price of carbon actually declined. Revenue growth slowed. By 2023, carbon tax revenue in British Columbia was about 1.8 billion dollars — but if the rate had kept pace with the original schedule, it would have been closer to 2.2 billion. Luna: So the environmental signal weakened, and the revenue fell short of projections. That's a double hit. Lucas: Exactly. And this is a pattern we see across jurisdictions. The Canadian federal backstop — which applies in provinces that didn't design their own system — started at 20 dollars per tonne in 2019 and was supposed to rise to 170 by 2030. But in 2024, the government paused the planned increase from 80 to 95, citing affordability concerns. The revenue projection for 2026 got revised down by about 15 percent. Luna: So the political pressure to freeze or cut carbon tax rates is real. And it directly impacts the budget math. Let's talk about Sweden, though — they seem to have avoided that trap. Lucas: Sweden is the outlier. They introduced a carbon tax in 1991 at roughly 27 euros per tonne. Today it's about 120 euros per tonne — one of the highest in the world. And they've maintained broad public support. How? Because they used the revenue to cut income taxes and to fund green investments, and they exempted energy-intensive industries at first to ease the transition. Over time, the exemptions were phased down. Luna: So they managed the political economy carefully. They didn't just impose a tax — they told a story about where the money went. Lucas: That's key. Sweden's carbon tax revenue is about 22 billion kronor a year, roughly 2 billion euros. It's not a huge share of their total tax take, but it's enough to matter. And because it's been predictable — rising gradually with a clear schedule — businesses could plan. The result: Swedish emissions are down about 30 percent since 1990, while the economy grew 80 percent. Decoupling worked. Luna: But the Swedish model isn't easily replicable. They had a high-trust society, low corruption, and a relatively homogeneous political culture. France tried something similar and got the gilets jaunes. Lucas: Right, the French carbon tax was introduced in 2014, and by 2018 the rate was about 45 euros per tonne. Then the government announced a further increase to 55 euros, and the gilets jaunes protests exploded. The tax was seen as regressive — hitting rural drivers who had no alternative to cars. The government had not paired the tax with visible rebates or investments in public transit in those areas. The revenue went into the general budget, and people didn't trust that it would benefit them. Luna: So the fiscal communication failed. And the tax was effectively frozen. That's a cautionary tale for any government considering a carbon tax. Lucas: Absolutely. And it brings us to the question of what makes a carbon tax fiscally sustainable. There's emerging consensus among public finance economists that three elements matter: one, the revenue must be returned — either through tax cuts or direct dividends — so the majority of households don't lose money. Two, the rate path must be pre-announced and credible, so businesses can invest accordingly. And three, there need to be complementary policies — like investments in transit or retrofits — for households that are hardest to shift. Luna: Which brings us to an interesting case: Ireland. They introduced a carbon tax in 2010 and have been increasing it steadily. In 2025, they reached 50 euros per tonne. And they've ring-fenced a portion of the revenue for a 'just transition' fund — specifically for retrofitting low-income homes. Lucas: Ring-fencing is controversial among pure economists — they prefer revenue neutrality to avoid distorting incentives. But politically, it works. In Ireland, surveys show that support for the carbon tax increased when people learned the money was going to home retrofits. The Irish fiscal council estimated that by 2025, the carbon tax was generating about 500 million euros annually. That's about 1 percent of total tax revenue. Not huge, but meaningful. Luna: And the retrofits themselves reduce future energy costs for low-income households, so it's a virtuous cycle. The carbon price gives the signal, and the spending helps people respond. Lucas: Exactly. And this is where the conversation gets really interesting for fiscal policy nerds. Because the carbon tax is not just a Pigouvian tax — it's a tool that interacts with the entire tax system. For example, if a government uses carbon tax revenue to cut payroll taxes, it can boost employment. That's what happened in British Columbia in the early years. But if the carbon tax rate stalls, the employment boost fades, and you're left with a smaller revenue stream and less environmental impact. Luna: So there's a dynamic trade-off. A successful carbon tax should eventually reduce its own base — if it works, emissions fall, and so does the tax revenue. That's actually a design feature, not a bug. But it creates a budget hole down the road. Lucas: Exactly. If a government becomes dependent on carbon tax revenue to balance its budget, and then the tax works so well that emissions decline faster than expected, the revenue shrinks. That's a good problem to have, but it's still a problem. Some economists argue that carbon tax revenue should be used to pay down debt or fund investments that boost long-term growth, rather than funding ongoing programs that create dependency. Luna: Right. So let's look at the numbers. In Canada, the federal carbon tax revenue is projected to peak around 2028-2030, then decline as emissions fall. The Parliamentary Budget Officer has modeled that. By 2035, revenue could be 20 percent lower than the peak, even as the rate continues to rise. Lucas: That's a real fiscal planning challenge. And it's one that most governments haven't fully grappled with. They've focused on getting the tax implemented and surviving the political backlash. The long-run budget integration is still an afterthought. Luna: Honestly, this kind of deep dive into how a single tax instrument affects everything from income tax rates to long-run budget planning — that's exactly the kind of thing that makes this show worth supporting. If walking through the economy with us has made something click, and you want to help us keep doing this ad-free, you can find us at buy me a coffee dot com slash fexingo. No pressure, but it helps. Lucas: Yeah, it's a small gesture that goes a long way. So back to the fiscal dynamics. The question I keep coming back to is: can a carbon tax survive the political cycle? The evidence so far is mixed. British Columbia's tax survived a change of government but got frozen. Sweden's survived multiple governments because it was embedded in a broad tax reform. France's got derailed by a protest movement. The difference seems to be how the revenue is used. Luna: And whether the tax is seen as fair. If rural households are paying a disproportionate share and not getting visible benefits, the politics turn toxic quickly. Lucas: Right. That's why the 'carbon dividend' model — where every household gets a quarterly check — has gained traction among economists. It's transparent. Everyone can see that they're getting money back. The U.S. Energy Innovation and Carbon Dividend Act, which has been proposed but not passed, would do exactly that: a fee on carbon, with all revenue returned to households on a per-capita basis. Estimates suggest about two-thirds of households would come out ahead. Luna: But that bill hasn't passed. And in the U.S., carbon pricing has stalled at the federal level. Several states have their own programs — California's cap and trade, for example — but a national carbon tax looks politically unlikely in the near term. Lucas: True. But even without a federal carbon tax, the fiscal dynamics are still playing out at the state level and internationally. And the lessons from Canada, Sweden, France, and Ireland are being studied closely. One thing I find fascinating is that the World Bank's Carbon Pricing Dashboard — as of 2026 — shows that carbon pricing coverage has plateaued at about 23 percent of global emissions. That's up from 15 percent in 2020, but the growth has slowed. The low-hanging fruit has been picked. Luna: So the next phase might not be about expanding coverage, but about improving the design of existing systems. Making them more politically resilient, more aligned with fiscal sustainability. Lucas: Exactly. And that's where the fiscal policy lens is so valuable. The carbon tax is not just an environmental tool — it's a test of whether governments can design taxes that are efficient, equitable, and durable. The evidence so far suggests that when they get the design right, it works. When they don't, it backfires. Luna: And the stakes are only getting higher. As of June 2026, we're seeing more frequent extreme weather events, and the pressure to act on emissions is mounting. Fiscal policy is one of the most powerful tools governments have. Lucas: So the question for budget wonks like us is: how do we build carbon taxes that can withstand political headwinds and deliver both environmental and fiscal benefits? I think the answer lies in the details — the rate path, the revenue use, the complementary policies. And that's a conversation we'll keep following. Luna: For now, maybe the most important takeaway is that a carbon tax is only as good as its fiscal architecture. Get that right, and you've got a tool that can do double duty. Get it wrong, and you've got a political crisis and a budget headache. Lucas: Well said. And on that note, I think we've earned a coffee break.