Background

The recent Ontario Energy Board (OEB) decision regarding displaying the cost of ‘cap and trade’ on customers’ bills has ruffled a few feathers.¹  In a decision relating to how bills that contain the new ‘cap and trade’ charges should be presented to consumers, the OEB decided in a report that such charges should not be presented in a separate line item.²  Rather, the OEB ordered the ‘cap and trade’ charges be merged into the delivery charges line item.  This comment will review and provide some critical assessment the OEB’s decision.

Briefly speaking, a ‘cap and trade’ regime is one where the government sets emissions targets for various emitters.  The emitters can either meet their targets by reducing their emissions or by purchasing emission allowances in a ‘cap and trade’ market.  These allowances are sold by the government or by other emitters who have been able to reduce their emissions below their target.  Under Ontario’s Climate Change Mitigation and Low-carbon Economy Act³, natural gas distributors are required to meet certain emission targets most likely through the purchase of allowances.⁴  When these distributors purchase these allowances, they then pass the cost of purchasing the allowances onto the customers.  Among many questions related to design of the ‘cap and trade’ regime, was the question of bill presentment, or what will the final customer bill look like?  Very relevant to this question was whether the charges would be a separate line item or whether they would be merged into the general delivery charges item.  The OEB had issued a preliminary report inviting comments from all interested participants regarding various aspects of the regime, including the question of bill presentment.⁵

The OEB received almost forty comments.⁶  Almost all of them addressed the question of bill presentment with the overwhelming (almost unanimous) majority arguing in favor of transparency in the bill presentment, i.e. that the ‘cap and trade’ charges be a separate line item.

The arguments in favor of making the charges a separate line item mostly revolved around the following three headings: 1) transparency, 2) impacting customer behavior by making them aware of how much it costs, and 3) customers’ preference for a separate line item.  The transparency argument came in various forms.  Given that the ‘cap and trade’ charge is new, it is important for customers to see exactly why their bills would suddenly rise.  Furthermore, some of the parties argued that the ‘cap and trade’ charges had nothing to do with the delivery of gas to the customers, and as such merging the charges into delivery charges was not accurate.  The customer preference argument was advanced by Enbridge, which commissioned a study to ask residential customers about their views on the charges.⁷  The study found that 86 per cent of the customers wanted to see a separate line item.  Union Gas also conducted a similar study, with 92 per cent of those surveyed saying that it was important or very important to see a separate line item contain the charges.⁸

As to the customer impact, several commenters made the point that in order for the ‘cap and trade’ charges to achieve the true goal of the ‘cap and trade’ regime, namely reduction in emissions, it was important for customers to see what the regime was costing them.  That way, individual customers could make their own decisions regarding their consumption of natural gas and alternative measures that would lead to lower emissions-related behavior such as the purchase of more energy-efficient appliances.⁹

On the other side, only the OEB and Environmental Defense argued that a separate line item was not needed due to concerns about customer confusion, although Environmental Defense seemed open to it being a separate line item if more information were presented on the bill.  In response to the OEB’s concerns that a separate line item may confuse customers, many comments highlighted the fact that there were already many charges in a bill, as well as the need for more proactive customer education.

At the conclusion of the process, the OEB decided not to require a separate line item, but rather have the charges merged with the delivery charges.

Comment

There are two main criticisms of the OEB’s decision.  One is grounded in political economy and the other in consumer behavior microeconomics.  I will briefly address the political economy argument, but I will focus most my comments on the second point.  The focus of this section is the assertion by the OEB in its final report that:

For the vast majority of low volume customers, a separate line item will not provide any form of meaningful price signal. Customers other than voluntary participants cannot avoid the Cap and Trade program-related costs which will be borne by the Utilities and allocated to them. The most important driver of consumer behaviour, in the OEB’s view, is total price. This has been borne out by research that the OEB has undertaken in the past in relation to consumers’ response to electricity bills. This research showed that low volume customers are much more focused on the total amount owing on their bill than on individual line items.¹⁰ (Emphasis added)

This assertion argues that if a customer is faced with a price P^T=P^c+T, that it does not matter whether the customer see the final price P^T or whether the customer sees the two components separately, namely the price of the commodity P^c plus a per unit charge T.  At a basic level of analysis, this is correct.  A simple microeconomic model of consumer behavior can prove this.  But this model assumes that the only item that the customer is consuming is the commodity, which in this case is gas.  I will return to this point in the second part of this section.

The other aspect of this assertion is the assumption that the ‘cap and trade’ charges are truly an emissions-controlling measure and not a disguised tax.  It is with respect to this assumption, that the next section comes into play.

a. The Political Economy of Merged Charges

Milton Friedman is said to have regretted his role in designing the system of withholding income taxes, a system he blamed for the growth of government spending (and taxing).¹¹  Similarly, commenting on value added taxes, he observed that such taxes are invisible and hence it makes it easier to raise.¹²  Indeed, he observed that every European country with value added taxes saw government spending rise sharply after they introduced the tax.¹³  The idea of tax invisibility has been addressed by political economists, especially in the field of public choice.

Some political economists have referred to the idea of fiscal illusion and tax salience.¹⁴  In a nutshell, these theories look at the lack of complete information available to taxpayers regarding various tax regimes such as the true costs of the taxes they pay versus the true benefits they receive from government spending.  This allows governments over time to raise its taxes without facing much of a backlash from taxpayers.  As such, while the ‘cap and trade’ charges are not taxes per se, they are charges not associated with the cost of producing the commodity being consumed in that the price is being set by a government agency.  Hence, they have some features of taxes, and therefore can be susceptible to the same government temptations to raise revenues using the charges as an excuse.¹⁵

While these theories have some empirical support, they do require a more sophisticated analysis of how government fiscal policy interacts with energy policies, something that is beyond the scope of this short commentary.  I simply raise this point to highlight one objection to merging the ‘cap and trade’ charges into general delivery charges.  I do not necessarily ascribe these theories as the reason for the OEB’s decision.  Indeed, such theories do not operate on any intentional design by politicians, but rather they point out the unintended consequences of these invisible tax regimes.

b. Consumer Behavior

Returning to the OEB’s assertion that customers only look at the final price, as I mentioned earlier, that assertion is correct if customers are only interested in the one commodity, namely natural gas.  If, however, what consumers, or at least a subset of them, are interested in is not just natural gas, but also emissions by their gas supplier, the analysis is more complicated.  Economists typically model customer behavior as follows: If a customer, whose income is I, is interested in consuming commodity x (say natural gas) and all other goods y, then customer behavior can be modelled by solving the following:

max_x,y U(x,y) subject to P^xx + y ≤ I,

where U is the utility derived from consuming x and y, P^x is the price of x, and the price of y is normalized to 1.  The result will be a demand function of x that will depend on P^x and I.  If the new ‘cap and trade’ regime results in a per unit charge of T that is added to P^x, then the new objective function to be optimized is as follows:

max_x,y U(x,y) subject to (P^x + T)x + y ≤ I.

The reader can see that indeed, all that matters is the sum of the prices, as the resulting demand function will now depend on (P^x + T) and I.

Suppose that customers also care about the amount of emissions that they are causing, including those caused by their gas supplier.¹⁶  Now the utility of the customer comes from consuming x, em, and y, where em is the amount of emissions the customer is responsible for.  For simplicity, I will assume the emissions are all related to consumption of x.  Now the customers’ behavior will be derived from:

max_x,em,y U(x,em,y) subject to P^xx + P^emem + y ≤ I,

where P^em is the price of emissions that the customer pays.¹⁷  Notice that if the amount of emissions are linearly related to the amount of gas consumed, then the OEB’s assertion is correct.¹⁸  But if the amount of emissions are not linearly related to the amount of gas consumed, then one cannot state with generality that all that matters is the combined price.  The resulting demand function will be expressed as a function of P^x, P^em and I.  This means that the customer needs to know both P^x (the price of the natural gas) and P^em (the price of the emissions) to properly make their utility-maximizing decisions.  If what the customers sees is simply the sum of those two prices and can’t distinguish their individual impacts, any decision they make most likely will be sub-optimal.

To understand whether customers only value the consumption of gas (or any other fuel) or also the reduction in emissions, one must look to the empirical evidence.  There is an existing literature regarding the impact of tax saliency on customer behavior.  For example, three economists found that posting tax inclusive prices in supermarkets reduced demand compared when only pre-tax prices were posted and the tax was simply added on at the register.¹⁹  Similarly, another economist found that when drivers paid road tolls each time they drove on such roads, the introduction of electronic payment systems (which allow the driver to drive through and be billed automatically thereby not forcing the driver to face the toll price) meant that drivers were less concerned about the tolls.  This allowed toll prices to rise 20 to 40 per cent above toll roads where no electronic payment options were present.²⁰  These results are inconclusive when it comes to whether the OEB was correct or not.  This is because these studies deal with taxes where the only goal of the tax is revenue.

When it comes to pollution or emissions control, there is one very relevant study.  Nicolas Rivers and Brandon Schaufele, two Canadian economists, examined the impact of British Columbia’s (BC) carbon taxes on the gasoline consumption.²¹  In BC, carbon taxes are displayed at the gasoline pump.  This means that customers can see the amount of tax they are paying as they pump their gas.  If indeed, all that customers cared about was the combined price, then whether the price of gasoline increased by $0.05 or whether the carbon tax increased by $0.05 should not matter for the impact on gasoline consumption.  Yet, the study reports that consumers exhibited a greater response to an increase in the price of emissions than to an equally sized increase in the price of the commodity being purchased;

A five cent increase in the market price of gasoline yields a 2.1 per cent reduction in the number of litres of gasoline consumed in the short-run, while a five cent increase in the carbon tax, a level approximately equal to a carbon price of $25 per tonne, generates a 8.4 per cent short-run reduction in gasoline demand. These results lead us to claim that the carbon tax is more salient than market-determined price changes: carbon taxes produce larger demand responses than tax-exclusive price increases.²²

The authors offer several explanations for their results, some having to do with the specifics of BC’s tax regime, while others having to do with customer preferences and views on emissions and taxes.  What matters, however, is that the study demonstrates that customers are quite able to process various pieces of information when presented to them and that the final price is not all that matters.

While this is the only Canadian study that I could find on point,²³ other studies of tax salience (some I mentioned above) demonstrate that, at the very least, more of these studies are needed.  Simply asserting that all that matters is the final price is simply not empirically true.

Conclusion

The OEB missed a valuable opportunity to contribute to the science surrounding customer behavior with respect to emissions.  Had the OEB allowed the ‘cap and trade’ charges to be a separate line item, there have been an opportunity to test the salience of the charges with respect to customer behavior.  This would have provided valuable information for future design of these charges and other environmentally related regimes.  Additionally, if the results of the Rivers and Schaufele apply equally to Ontario, the OEB could have achieved even more emissions reductions by itemizing the costs of ‘cap and trade’.

Although the OEB asserted that its studies showed that only the final price mattered, it would have been helpful had they presented the details of that study in their Staff Report.  This would have allowed the commenting parties a chance to examine the questions of saliency and customer preferences.  While two of the gas utilities presented survey-evidence regarding their customers’ desires to see the charges separated from delivery charges, the vast majority of the comments were also devoid of any empirical evidence.  Indeed, most of them presented no economic arguments, theoretic or empirical, whatsoever.

The public in all provinces in future proceedings will be better served if more economic theory and evidence is marshalled to examine the subtleties of regime design.  Given the presence of vast theoretical studies, and a growing body of empirical evidence, bringing these studies to such proceedings is not that onerous a task.  Indeed, more work should be done by all parties, and for that matter academics, in order to have more meaningful discussion of these issues.

* Moin Yahya is a Professor of Law at the University of Alberta and an acting member of the Alberta Utilities Commission (AUC). The commentary here is purely academic in nature and does not reflect on the merits of any proceedings past or pending before the AUC, nor is it to be taken as official AUC commentary on any of the issues discussed. It should also not be taken as official AUC commentary on the OEB.

1. No one story captures the response to the OEB’s decision, but one can get the sense of it from stories such as “Kathleen Wynne says she is being transparent about cap-and-trade costs” CBC News (7 December 2016), online: <http://www.cbc.ca/news/canada/toronto/wynne-cap-and-trade-1.3885571>. Additionally, a Google search of “ontario cap and trade transparent” yields numerous results showing dissatisfaction with the OEB’s decision.
2. Ontario Energy Board, Report of the Board regarding the Regulatory Framework for the Assessment of Costs of Natural Gas Utilities’ Cap and Trade Activities, EB-2015-0363 (Toronto: OEB, 26 September 2016),  at p 33,  online: <https://www.oeb.ca/oeb/_Documents/EB-2015-0363/Report_Cap_and_Trade_Framework_20160926.pdf>.
3. Climate Change Mitigation and Low-carbon Economy Act, SO 2016, c 7.
4. Supra note 2 at 1, 3.
5. Ontario Energy Board, Staff Discussion Paper on a Cap and Trade Regulatory Framework for the Natural Gas Utilities, EB-2015-0363 (Toronto: OEB, 25 May 2016), online: <http://www.ontarioenergyboard.ca/oeb/_Documents/EB-2015-0363/Cap_and_Trade_Staff_Discussion_Paper_20160525.pdf.>.
6. See list of comments on June 24, 2016, online: <https://www.oeb.ca/industry/policy-initiatives-and-consultations/consultation-develop-regulatory-framework-natural-gas>.
7. Enbirdge Gas Distribution Inc, Ontario Energy Board (“Board”) – Consultation to Develop a Regulatory Framework for Natural Gas Distributors’ Cap and Trade Compliance Plans  EB-2015-0363 – Staff Discussion Paper, Comments of Enbridge Gas Distribution Inc (22 June 2016), at p 15, online:  <http://www.rds.ontarioenergyboard.ca/webdrawer/webdrawer.dll/webdrawer/rec/532593/view/>.
8. Union Gas Limited, EB-2015-0363 – Consultation to Develop a Regulatory Framework for Natural Gas Distributors’ Cap and Trade Compliance Plans – Union Gas Limited Submission on Discussion Paper (22 June 2016),  p 14, online: <http://www.rds.ontarioenergyboard.ca/webdrawer/webdrawer.dll/webdrawer/rec/532661/view/>.
9. See comments of IESO, SEC, LPMA, and Enbridge on June 24, 2016, online: <https://www.oeb.ca/industry/policy-initiatives-and-consultations/consultation-develop-regulatory-framework-natural-gas>.
10. Supra note 2 at 34.
11. David Gamage & Darien Shanske, “Three Essays on Tax Salience: Market Salience and Political Salience” (2011) Tax L Rev 65 at 19, 41.
12. Ibid at 21, n 11.
13. Ibid.
14. See e.g. Werner W. Pommerehne & Friedrich Schneider, “Fiscal Illusion, Political Institutions, and Local Public Spending” (1978) 31:3 Kyklos 381; Brian Dollery and Andrew Worthington, “The Empirical Analysis of Fiscal Illusion” (1996) 10:3 J. Economic Surveys 261; Gamage & Shanske, supra note 11.
15. Already the revenues expected from the ‘cap and trade’ have not been what the Ontario government expected. See “Ontario is expecting smaller cap-and-trade revenues in 2017 and 2018 than originally planned” Canadian Press (1 May 2017), online: <http://business.financialpost.com/news/economy/ontario-is-expecting-smaller-cap-and-trade-revenues-in-2017-and-2018-than-originally-planned>.
16. Even if only a subset of customers care about emissions, the results qualitatively are the same.
17. This can be in the form of a carbon tax, ‘cap and trade’ charge, or any other cost associated with reducing emissions.
18. If em = ax, where a is a constant, then the effective price facing the customer is P^x + aP^em.
19. Raj Chetty, Adam Looney & Kory Kroft, “Salience and Taxation: Theory and Evidence” (2009) 99:4 Am Econ Rev 1145.
20. Amy Finkelstein, “E-ZTax: Tax Salience and Tax Rates” (2009), 124:3 Quarterly J Econ 969.
21. Nicolas Rivers & Brandon Schaufele, “Salience of Carbon Taxes in the Gasoline Market” (2015) 74 J Environmental Econ & Mgmt 23.
22. Ibid at p 24.
23. The article contains citations to many other American studies.