The Carbon Tax Revenue Menu

Getting the politics to align for a carbon tax requires the right blend of honey and vinegar. For years, advocates’ and opponents’ attention alike has focused on the vinegar – the tax part. Lately, though, we’ve noticed growing interest about how to best spread the honey — the potentially huge revenues a carbon tax would generate. Here’s a primer on the options: what they are, how they would work, their merits and drawbacks, and who’s pushing them hardest.

Setting the initial tax rate at $15/T CO2 and increasing it by that amount each year (reflecting the maximum carbon tax rate and ramp-up of Rep. Larson’s bill) we estimate that the Treasury would take in approximately $80 billion in revenue in the first year. (This calculation uses the Carbon Tax Center’s spreadsheet model.) This amount would rise each year, though at slightly less than a linear rate as carbon reductions kicked in, reaching around $600 billion by the tenth year.

The allure of carbon tax revenue also offers a growing incentive for other nations to match a U.S. carbon tax in order to avoid WTO-sanctioned border tax adjustments, capturing the revenue themselves. Indeed, Brookings economist Adele Morris calls a carbon tax a “two-fer” because along with a growing revenue stream would come substantial CO2 emissions reductions. For the U.S., based on historic price-elasticities, CTC’s model projects a 30% reduction in climate-damaging CO2 emissions by the tenth year, compared to 2005 levels.

Six hundred billion (again, that’s the projected take in the tenth year from an ambitious carbon tax) is a lot of revenue, equivalent to around a quarter of federal tax receipts. As Ian Parry and Roberton Williams recently explained in “Moving U.S. Climate Policy Forward: Are Carbon Taxes the Only Good Alternative?” (Resources for the Future), the efficiency advantages of a carbon tax depend on using the revenue wisely. Not surprisingly, there are loads of claimants. Here’s a guide to the most prominent ones, sequenced more or less from the political left to right:

a) “Dividend.” Climate scientist James Hansen contends that to support a steadily-rising CO2 price, the public needs to see the money — every month. He calls his proposal “fee & dividend.” Senators Cantwell (D-WA) and Collins (R-ME) introduced the “CLEAR” bill which uses “price discovery” via a cap to set its carbon tax which would begin at a price between $7 and $21/T CO2, increasing 5.5% each year. CLEAR would return 75% of revenue via direct “dividends” and dedicate the remaining 25% to a fund for transition assistance and reduction of non-CO2 emissions. Rep. Chris Van Hollen (D-MD) also introduced a cap & dividend bill in the Ways & Means Committee. It relies on a cap to set the CO2 price indirectly, aiming for 85% reductions (over 2005 levels) by 2050.  Because of its similar emissions trajectory, we’d expect Van Hollen’s bill to generate similar revenue to Rep. Larson’s bill: roughly $80 billion in the first year, rising to about $600 billion within a decade. Both the CLEAR bill and the Van Hollen bill bear the intellectual and organizing stamp of social entrepreneur Peter Barnes, who founded “Cap & Dividend,” and Peter’s allies including the Chesapeake Climate Action Network.

b) Payroll tax rebate. Rep. John Larson’s “America’s Energy Security Trust Fund Act” pairs a carbon tax with rebates of payroll taxes on earnings. As articulated by Tufts University economist Gilbert Metcalf (now serving at the Treasury Department’s energy office), Larson’s proposal has the appeal of broad fairness. It would distribute revenue very evenly across both income and regions. Because Rep. Larson’s approach rebates payroll taxes via a credit on federal income taxes — it would rebate the payroll tax on the first $3600 of income in the first year, with that threshold and rising over time — it avoids tangling with the Social Security Trust fund.

Economist and former Undersecretary of Commerce Rob Shapiro supports the approach of a payroll tax rebate, arguing that cutting payroll taxes could spur job growth. Social entrepreneur Bill Drayton, founder of “Get America Working,” is also a strong advocate of using carbon revenue to cut payroll taxes in order to stimulate employment while reducing emissions. Al Gore captured the idea with the phrase, “tax what we burn, not what we earn.” Former Rep. Bob Inglis (R-SC) introduced the “raise wages, cut carbon” bill co-sponsored by Rep. Jeff Flake (R-Az). Conservative economists Greg Mankiw and Douglas Holtz-Eakin, both of whom have advised Republican presidents and candidates, have also supported shifting tax burdens from payrolls to carbon emitters. And the Progressive Democrats of America endorsed the Larson bill.

c) Deficit reduction. Brookings economists including Ted Gayer and Adele Morris have been pointing out the potential for climate policy to reduce deficits. While deficit reduction isn’t revenue return in the immediate sense that Dr. Hansen suggests, Morris points out that deficit reduction will benefit future taxpayers by paying down at least part of the nation’s debt, rather than letting it continue accumulating interest. In this way, she suggests, the impulse to help future generations via foresighted climate policy would have a natural fiscal correlative of reducing future tax burdens.

Supporters of applying carbon tax revenues to deficit reduction include MIT’s Michael Greenstone (chair of the Brookings Hamilton Project on climate and energy policy) and Alice Rivlin, founding director of the Congressional Budget Office, who co-chaired the Bipartisan Policy Institute’s alternative to the Obama deficit commission. Prof. Metcalf proposed a carbon tax to the commission, with revenue return as “transition assistance” in the early years, shifting to deficit reduction in later years. As Irwin Stelzer of the conservative Hudson Institute recently pointed out, when the options to close budget gaps sift down to unpopular alternatives such as a value added tax (regressive and annoying, as EU residents will attest) or curbing home mortgage deductions, a carbon tax may emerge with greater appeal. While Keynesians argue that the present weak economy militates against any net increase in taxes, a phased-in allocation of carbon tax revenues to deficit reduction such as Prof. Metcalf proposes may circumvent that objection.

d) Income tax cuts. Greg Mankiw has suggested cutting income taxes as an alternative to payroll tax cuts to return carbon tax revenues; those Form 1040’s could include a carbon rebate drawn from those revenues for every taxpayer. Revenue could be returned via a lump sum credit (which would be income-progressive) or by reducing income tax rates (arguably more stimulative of income-earning activity).

e) Corporate income tax (CIT) rate cut. At a recent AEI event “Whither the Carbon Tax,” AEI economist Kevin Hassett argued for a carbon tax paired with a reduction in the corporate income tax rate. The Wyden-Coates tax reform bill proposes to reduce top CIT rates and make up the revenue by closing numerous exemptions, indicating interest on the Hill. Adherents of CIT rate cuts point to IMF studies saying that U.S. CIT rates are among the world’s highest, asserting that these taxes are especially stifling of business activity and employment. Hassett and his AEI collegue Aparna Mathur argue that CIT’s are passed through as higher prices for consumers and passed back to the factors of production: labor (in the form of reduced wages) and capital (in the form of reduced corporate earnings). They estimate that using carbon tax revenue to cut the effective CIT rate would result in return of about 40% of revenue to wage-earners, which they assert would give the CIT to carbon tax shift a net progressive effect. Their conclusion may be a stretch, given that real wages have remained stagnant or fallen for decades while corporate profits are rising briskly, but a CIT cut has strong salience for conservatives and business leaders.

f) The sampler platter. The options listed above can be mixed and matched. In fact, British Columbia’s carbon tax (which started at $10/t CO2 in 2008 and rises $5/t each year — it notches up to $25 per metric ton on July 1) launched with a distribution of a $100 direct “dividend” to each taxpayer even before the carbon tax was levied, and is now returning revenue via cuts in payroll, income and corporate tax rates. Former BC Premier Gordon Campbell was re-elected to a third term in 2009 after enacting the carbon tax with this mix of revenue return measures, perhaps indicating that a diverse approach to revenue return can have broad and sustained appeal.

Each of the revenue options has important economic and political advantages as well as disadvantages. At the June 1 AEI event, Kevin Hassett decried Senator Cantwell’s direct “dividend” as “terrible policy” because it foregoes the efficiency advantage of using carbon tax revenue to reduce or possibly eliminate other taxes that dampen economic activity. In 2007 Hassett and his AEI colleague Ken Green published an essay aguing for a carbon tax shift as a “no regrets” policy for conservatives, because its tax reform benefits would make it worthwhile even without climate benefits. They pointed to the work of Stanford’s Lawrence Goulder who concludes that the benefit of reducing other distortionary taxes can be large enough to offset some or all of the dampening effect of adding a carbon tax, a phenomenon known as a “double dividend.”

Still, the potential political attractiveness of direct distribution of revenue can hardly be overstated. Dr. Hansen is no politician and doesn’t claim to be an economist, but he sticks to the “dividend” or “green check” while noting that because of its clear and briskly rising price, Rep. Larson’s approach is nevertheless the best climate option on the table. Rep. Van Hollen, outgoing chair of the Democratic Congressional Campaign Committee, certainly knows a thing or two about politics, and Senator Cantwell very effectively made the case for her “cap & dividend” approach last month at Brookings. But even she seems to be looking at other items on the revenue return menu. For the first time, she suggested appropriating some carbon revenue for deficit reduction, confirming that as high summer arrives in Washington, fiscal matters remain the topic for this Congress.

Photo: Flickr.

Comments

  1. David F Collins says

    An excellent summary! Congratulations… but more, thanks.

    More importantly, let us not become so enamored of any option that we lose track of the objective, the implementation of a Carbon Tax that can make a difference.

  2. says

    David,

    You’re welcome. And yes, revenue from a carbon tax is secondary to the climate benefits: predictable and rising returns on investment in renewables and efficiency.

    As a kid, I liked the “Pu Pu” platter at Chinese restaurants — a few bites of everything. That approach to carbon tax revenue seems to have done the trick in BC.

  3. Vanessa says

    I was glad to read that British Columbia has enacted a carbon tax. I’m from there but have since moved, but that news is great! It’s also encouraging to note that Premier Campbell was re-elected after enacting this bill.

    That’s good news for US politicians pushing for carbon taxes.

    It was great to learn about the different types of carbon taxes out there. Thanks for the information.

  4. Malcolm Childress says

    Very nice summary of options for carbon tax revenue and seems clear that the “climate” in DC for the time being is very focused on fiscal issues, so hopefully these ideas will get taken up in the fiscal discussion.

  5. says

    Thanks Vanessa & Malcolm,

    Yes, I sense an opportunity for deficit hawks to find common cause with climate hawks. Georgetown Public Policy Review quoted Alice Rivlin, “In the context of the Domenici-Rivlin committee, we had a lot of discussion about the carbon tax and a good deal of support for it.” Rivlin’s views carry weight. She was founding director of the Congressional Budget Office and participated in both the Simpson-Bowles and Domenici-Rivlin deficit commissions.

  6. says

    I was a frequent visitor to carbontax.org while conducting research for my book, “Let’s Make A Deal: A Hail Mary Pass to Get America Off the Bench and Back in the Game.” The book is a set of solutions and reforms, fashioned in the form of a trade designed to cater to Liberals, Conservatives, Democrats, Republicans, independents, apathetics, and even cynics. A key plank in that trade – a carbon tax – is modeled almost 100% on Dr. James Hansen’s carbon tax proposal and relies on its $600 billion revenue contribution to offset the elimination in taxes on production (the corporate income tax) and labor (the payroll tax).

    But “Let’s Make A Deal” (LMAD) is much, much bigger than just a carbon tax and includes other consumption taxes as well.

    So here are a couple of rhetorical questions:
    1) If the solution to too much CO2 in the air is to use less fossil fuels, why is NOT the solution to too much federal debt to use less government?
    2) If the optimal amount of CO2 in the atmosphere is 350 ppm (current=389 ppm) because that is the maximum concentration of CO2 in our atmosphere under which life as we know it can continue, why is 18% of GDP (current =25% GDP) NOT the optimal size of the federal government since that is the size that most likely yields maximum economic growth?

    Think about it. Progressives and Conservatives are actually making the same apocalyptic argument albeit on different issues. They both make good arguments for action. But the public is yawningly uninterested in AGW and unwilling to make the hard choices on America’s fiscal problems. Buying off the opposition is the American way so why not use the system we have to get the outcome you want. And that’s what Let’s Make A Deal—The Plan is all about: getting the outcome you want.

    It’s time for progressives concerned about rising temperatures and conservatives concerned about rising federal debt to realize the obvious: they need to BUY each other off in order to effectively address their pet ideological concerns-there is no other way. This means trading, among other things, a carbon tax for a balanced budget amendment and a more limited government. This plan is outlined at http://letsmakeadeal-thebook.com

    or Google LMADster for more…

  7. says

    Hi Jon (aka LMADster),

    I’ll be interested in your book. As Brookings economist Adele Morris has said, “A carbon tax is a two-fer” — emissions reductions and revenue.

  8. gillian jones says

    When China (for example) opens coal seam gas mines in our agricultural prime land and pristine forests, is the energy a part of Australia’s carbon output or China’s? And again, when we import products from China (for example) made from the resources mined here, is that their carbon footprint or ours?

  9. Herbert Handy says

    Any new TAX introduced on the excuse of “Carbon-Emission” or GST ( as with the Howard govt.) is simply a reflection of mismanaged Taxes by governments! A BUDGET every year outlines how best to spend the hard-earned taxes. Each household has to manage their own budget! How you spend the money — on fancy police cars, overseas travel for the ministerial portfolios, or on preventing emissions is what DETERMINES a trustworthy and RESPONSIBLE government. It’s high time TAXES were managed by the People who PAY THEM; we Determine how it should be spent; never more than 15-20% on maintaining the FAT politicians.

  10. Daniel Jones says

    Responding to Gillian Jones (Comment #8): Greenhouse gas inventories prepared in compliance with the United Nations Framework Convention on Climate Change attribute emissions occuring within a given country to that country. It follows that

    1. If a Chineese company engages in mining or gas extraction activity in Australia, the emissions from the mining and extraction activities are part of Australia’s carbon footprint. If the gas (or coal) were shipped to China and burned in China, then the emissions from that combustion would be part of China’s footprint.

    2. If iron ore were mined and made into steel in Australia and then shipped to China, where it is made into products, and then the products are shipped to Australia, the inventories would be as follows:
    a) emissions from mining and steel making would be Australia’s.
    b) emissions from making the final product would be China’s.
    c) emissions from international transport (i.e., from burning international bunker fuels would not be attributed to any country’s emission inventory. I think that’s right, but am not 100% certain).

    3. If Australia raises sheep (which are ruminants that, like cattle, produce and emit enteric methane) and sends the lamb chops to England, the methane emissions are attributed to Australia’s footprint.

    Some people do try to account for the emissions attributable to imported goods. David MacKay has tried to quantify this for Britain in his book “Sustainable Energy without the hot air”. (available for free at http://www.withouthotair.com). In Chapter 15 (entitled “Stuff”), he cites a study that estimated the carbon emissions attributable to material Britain imports to amount to about 10 tons of carbon dioxide per person per year. Officially, Britain’s carbon footprint is about 11 tons per capita per year. So, including emissions attributable to the imported stuff almost doubles Britain’s carbon footprint.

    If I recall correctly, about a third of China’s carbon footprint is attributable to producing exports.

  11. David says

    The Carbon Tax, I argue, is based on speculative science. A visit to joannenova.com.au will provide sufficient material for any open minded person to see the science is not settled.

    What concerns me most about the Carbon Tax is that it adds another cost to businesses which employ average Australians. As the cost of running a business increases, cost cutting may see these businesses move offshore.

  12. David F Collins says

    Thank you for posting the ECONOMIST article «British Columbia’s carbon tax woos sceptics, Jul 21st 2011». Also, as a warning, look at all the attention, it drew. All of 16 comments (10 PM CDT, 2011/07/25)! Overwhelmingly negative, although with a few interesting points scattered here and there by the anti’s.

    Anyhoo, The Carbon Tax Center is doing well! We now have an ever-inceasing number of anti’s blathering their drivel here; they are already getting scared! Keep up the good work!

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Last modified: June 10, 2011