Understanding Output-Based Pricing Systems

In recent years, Canada has implemented a distinctive carbon pricing regime, known as “output-based pricing systems” (OBPS), to incentivize emission reductions for large industrial facilities. This regime has come under heightened scrutiny as a more general carbon tax, the federal fuel charge, was cancelled in 2025 due to political controversy. However, OBPS regimes have received no prior economic analysis; commentators have mostly criticized the weakness of the emission trading markets within them. This article argues that OBPS should be viewed as primarily implementing a carbon tax with an intensity-based exemption. OBPS further introduces emissions trading into this carbon tax regime, but trading only worsens the regime’s performance by offering a distortionary production subsidy to low emitters and by weakening abatement incentives. Inefficient emissions trading markets are thus not OBPS’s main problem; the combination of carbon taxation with emissions trading may be fundamentally flawed. Moreover, the article highlights several previously neglected affinities between various pricing and regulatory instruments for achieving emission reductions, as well as the difficulty of identifying equivalences even among carbon pricing regimes.