{"id":2039,"date":"2020-03-17T20:24:07","date_gmt":"2020-03-17T20:24:07","guid":{"rendered":"https:\/\/www.rbc.com\/en\/economics\/2020\/03\/17\/beyond-tit-for-tat-how-canadas-federal-budget-should-respond-to-us-ira\/"},"modified":"2025-04-02T20:12:58","modified_gmt":"2025-04-02T20:12:58","slug":"beyond-tit-for-tat-how-canadas-federal-budget-should-respond-to-us-ira","status":"publish","type":"post","link":"https:\/\/www.rbc.com\/en\/economics\/canadian-analysis\/beyond-tit-for-tat-how-canadas-federal-budget-should-respond-to-us-ira\/","title":{"rendered":"Beyond tit-for-tat: <\/strong>How Canada\u2019s federal budget should respond to US IRA"},"content":{"rendered":"

The federal government faces a difficult task in its March 28 budget: to supercharge climate investments while inflation challenges consumer budgets, existing spending pressures fiscal room, and U.S. policy shifts the competitive landscape for green industry.<\/p>\n

American competition for climate-related industries will be top of mind when Joe Biden visits Ottawa this week. Through the recent Inflation Reduction Act<\/em> (IRA), the U.S. has issued an industrial policy challenge to the globe. Generous subsidies will attract green industry of the future to America, unless other countries respond. Money is already starting to flow southward.<\/p>\n

Canada might be tempted to match IRA, but needs to be careful. The U.S. focus on supply-side policies for climate action\u2014subsidizing clean energy to cut the cost of transition for consumers and firms and create demand for domestic green industries\u2014is a red herring. Existing climate policy in Canada tools can accomplish as many emissions reductions as IRA.<\/p>\n

Similarly, Canada doesn\u2019t have the scale or expertise necessary to compete in every growing climate-related industry, so matching IRA\u2019s depth and breadth risks quickly exhausting the funding envelope without generating positive feedback loops across the Canadian economy.<\/p>\n

Canada will need a focused response, to leverage its unique ability to contribute to global transition in a few sectors, and capture the value associated with made-in-Canada technology.<\/p>\n

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What\u2019s the big deal with IRA?<\/strong><\/h3>\n

When it was passed in August 2022, there was major fanfare for IRA. It reversed a period of relative stagnation in US climate policy and was lauded for its size and breadth. With time, it\u2019s become clear that IRA is a rethinking of climate policy entirely.<\/p>\n

IRA contains the typical mix of consumer incentives, government grants, and supply side subsidies aimed squarely at climate action. But its innovation is using its supply side climate policy as an anchor for industrial policy. By subsidizing the production of hydrogen, electricity and clean fuels, it aims to spur private investment that pass on production savings to consumer. This, in turn, improves the case for adopting technology that runs on clean energy, and as an added benefit, spurs development of domestic industry.<\/p>\n

IRA\u2019s treatment of low-carbon hydrogen, possibly a key clean fuel, is instructive. Since the US does not have a carbon tax to encourage industry to seek out hydrogen, high costs, limited production, technological uncertainty, and lack of infrastructure mean there has been limited uptake thus far. IRA subsidizes low-carbon hydrogen production for up to 10 years, allowing companies to sell the hydrogen at lower prices, spurring adoption and cutting domestic emissions.<\/p>\n

But by subsidizing production, the U.S. is also attracting industries that can innovate and capture new economic opportunities. This fusion of climate and industrial policy is novel: being a hydrogen producer, and owning hydrogen-related intellectual property, may pay dividends if hydrogen exports and hydrogen hubs take off.<\/p>\n

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Canada can match IRA but shouldn\u2019t. We already have climate policy.<\/strong><\/span><\/h3>\n

It\u2019s a common refrain that Canada cannot match IRA\u2019s largesse, but it\u2019s mostly a matter of prioritization.<\/p>\n

US IRA has been estimated to cost $369 billion over 10 years, but with its uncapped tax credits, some have the figure topping out at $800 billion. We estimate Canada\u2019s IRA-equivalent spend would be about $12 billion per year.[1]<\/a><\/p>\n

Strong, inflation-driven growth in nominal GDP and slow program spending thus far this year look poised to leave the federal government with some extra fiscal room in Budget 2023. If history is any guide, it\u2019ll be deployed against something. Holding debt-to-GDP constant, we think the government could spend about $20 billion per year more than it budgeted in the fall, even less considering about $5 billion already announced for health care enhancements. It probably shouldn\u2019t: economic risks are firmly tilted to the downside, and Ottawa is already deeply in the red. Nevertheless, prioritizing growth-focused investment with any budget windfall can be fiscally sustainable. Done smartly, Canada\u2019s IRA response could be just that.<\/p>\n

What wouldn\u2019t be wise is significant spending to match IRA\u2019s emissions-reduction subsidies. Carbon pricing, EV infrastructure investments, and forthcoming regulations for things like electricity, mean Canada\u2019s starting position on climate policy is strong. The emissions structure of our economy is different than the US. US investment in green technologies are also likely to drive down their costs globally, making Canada\u2019s transition easier. Canada needs to give its climate policy a lift \u2013 there are sectors where spending remains inadequate to 2030 (think buildings) \u2013 but this is separate issue.<\/p>\n

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There\u2019s more work to do on climate-smart industrial policy<\/strong><\/span><\/h3>\n

Industrial policy that recognizes how IRA has both strengthened and challenged Canada\u2019s ability to build green industry should be the focus of its IRA response. But smart industrial policy must recognize that strategy is the name of the game. An expansive approach that wages a subsidy war on too many fronts risks bad outcomes. Canada need not play ball in all sectors, nor for all parts of the supply chain in the sectors it chooses. Strategy is the name of the game. Here\u2019s how we think government should proceed:<\/p>\n

[1]<\/a> Accounting for the higher cost of decarbonization in Canada\u2019s oil sector and targeting 10% emissions cuts in line with IRA (Rhodium group).<\/p>\n

Recommendations: Canada\u2019s time to lead<\/strong><\/span><\/h3>\n

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Leverage our existing trade benefits first<\/strong> Canada has already secured priority market access, via hard-won concessions on a North American battery supply chain. The recent VW battery factory announcement is linked to expectations for IRA-driven demand for EVs in North America. Likewise, Canada\u2019s well-developed cleantech sector can leverage growing demand for clean technologies in the US with adequate export supports.<\/div>\n
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Cynthia Leach<\/b> helps shape the narratives and research agenda around the RBC Economics and Thought Leadership team\u2019s forward-looking economic and policy analysis. She joined the team in 2020.<\/p>\n

Previously, Cynthia was an executive at Finance Canada, most recently heading a team responsible for housing finance policy covering housing-related risks, mortgage lending and funding markets, and the commercial activities of Canada Mortgage and Housing Corporation. She also has experience in current economic analysis and fiscal policy.<\/p>\n

Cynthia holds an M.A. Economics degree from the University of Toronto.<\/em><\/p>\n

Colin Guldimann<\/b> joined RBC in 2019 as an economist. He holds a Bachelor\u2019s degree in Economics from the University of Ottawa, and Master of Arts in Economics from the University of British Columbia. Prior to joining RBC, Colin worked on mortgage, housing, and economic policy at the Department of Finance Canada.<\/em><\/p>\n