Carbon Tax Offers Super Powers to Super-Committee

09/11/2011 by James Handley

With a $1.5 trillion budget “canyon” to leap across, the new “super-committee” would be wise to summon the special elastic power of a gradually-rising carbon tax.

After prolonged high-wire suspense and partisan brinksmanship, President Obama and Congress agreed in early August to establish the twelve-member “Joint Select Committee on Deficit Reduction” to tackle the budget deficit and the national debt. The “super-committee,” as the JSC was instantly dubbed, comprises six Representatives and six Senators, three chosen by the leadership of each party in each chamber.

The JSC’s mission is to agree on $1.5 trillion in deficit reduction steps to be undertaken over the next decade. These spending cuts or revenue enhancements are to constitute a second installment beyond the $917 billion in cuts agreed to in the bargain to raise the debt ceiling. The JSC is to deliver its recommendations to Congress on Nov. 23, with the House and Senate required to vote the entire package “up or down” a month later. If the JSC cannot agree on deficit reduction steps of the required magnitude, or if Congress fails to adopt them, that will trigger $1.2 trillion of automatic cuts divided equally between domestic and military spending.

To be sure, Washington’s obsession with putting our faltering economy on an austerity diet is deeply troubling to Keynesians, including the Carbon Tax Center. Nevertheless, the fix is in, so let’s examine how a carbon tax could be made part of the debt and deficit solution.

The JSC’s options fall into three categories:

1) More budget cuts, which would contract the economy, compounding unemployment and speeding our descent into another recession,

2) Raising revenue by reforming the tax code, for instance by closing loopholes or reducing tax “expenditures” (i.e., tax exemptions that function as government grants), or

3) Finding new sources of tax revenue.

Given the Herculean dimensions of the super-committee’s task, the JSC may find itself pressing all three buttons. In the revenue category, there’s been some discussion of a “value added tax,” but less about a carbon tax or a Tobin (financial transactions) tax both of which have strong policy advantages.

Last year, William Galston of Brookings and Maya MacGuineas of the Committee for a Responsible Federal Budget included a carbon tax in their report, A Balanced Plan to Stabilize Public Debt and Promote Economic Growth. Also in 2010, Congressional Budget Office founder Alice Rivlin reportedly suggested a carbon tax to both the Simpson-Bowles commission, and the Rivlin-Domenici commission. Unfortunately, her recommendation didn’t make it into either final report, even though well-known economists Gilbert Metcalf and William Nordhaus conveyed the same recommendation to the Simpson-Bowles commission. Now the advent of the JSC with its $1.5 trillion mandate and short deadline has dialed up the pressure to look for revenue sources.

How much would a carbon tax reduce deficits? In May, the deficit-hawkish Peterson Institute hosted a fiscal summit in Washington, at which four out of six leading think tanks, including the conservative American Enterprise Institute, suggested pricing carbon as a way to raise government revenue. AEI recommended a carbon tax starting at $26 per ton and growing by 5.6 % per year after that. According Peterson, the proposal would raise $161 billion per year by 2020, enough to reduce the federal budget deficit by 22% that year. They point out that this is greater than the savings from raising the national retirement age to 70 and would reduce the deficit the same amount as eliminating all foreign aid and federal funding for education.

The Carbon Tax Center’s model shows that a more aggressive carbon tax proposed by Rep. John Larson, rising each year by an average of $12.50 per ton of CO2, would generate about $475 billion of new revenue by the tenth year. This would eliminate around 80% of that year’s CBO-projected deficit while reducing U.S. carbon emissions by 30%. Moreover, the mere expectation of a gradually-rising carbon price will reduce the risks and increase the returns to investors in low- and zero-carbon energy and energy efficiency, as former Federal Reserve economist Alan Blinder pointed out last winter in the Wall Street Journal. In other words, simply enacting a carbon tax – even one with a “grace period” prior to startup – would provide a stimulus to a key technology sector (not to mention one in which the U.S. is falling behind China and Germany).

Aside from the carbon tax rate, what other design criteria need to be weighed for a carbon tax to reduce both deficits and CO2 emissions? Economist Gilbert Metcalf recommends a tax covering not just CO2 but other greenhouse gases: methane, nitrous oxide, fluorinated gases and sulfur hexafluoride. Metcalf, a Tufts University economist now serving the Treasury Department, argues that this more broadly-based tax would achieve much greater emissions reduction, particularly in the early years, by inducing replacement of climate-damaging refrigerants and solvents with more benign substitutes – an easier task than rapidly phasing out fossil fuels.

What about the potentially regressive effects of carbon or GHG taxes on modest-income households? When Chad Stone, chief economist at the Center on Budget and Policy Priorities, analyzed the Waxman-Markey cap-and-trade bill in 2009, he concluded that only 15% of the permit revenues would be needed to compensate households in the bottom 20% of the income range for the price increases induced by carbon pricing. Presumably, this finding holds for a simple carbon tax as well. (The revenue could be distributed in a monthly or even weekly “lump sum” by electronic funds transfer). To build in this protection for the most vulnerable, we should reduce estimates of revenue available for deficit reduction by about 15% to provide funding for low income assistance.

If legislators choose to compensate a larger income range from the effects of a carbon tax, then of course, a greater share of revenue will be needed. But because of the strong upward skew in carbon use over the income range, the revenue needed to compensate lower and even modest income levels is substantially less than their proportion of the population, leaving a large portion available for deficit reduction.

Both the Domenici-Rivlin and the Simpson-Bowles deficit commissions considered a so-called “Value Added Tax.” A VAT is a sales tax applied at every level, which would particularly burden retailers and is likely to be even more regressive than a carbon tax. Europeans routinely refer to the EU’s VAT as a nuisance to business – it must be factored into virtually every business transaction – and punishment of the poor. Moreover, VAT’s have no climate or other social benefits, aside from being a source of revenue. When the energy and climate benefits of a carbon tax are compared to gumming up our economy with a VAT that “sticks” to everything, a carbon tax looks sleek, maybe even sexy.

A carbon tax should also be structured to protect energy-intensive industries in relation to overseas competitors. In their 2009 paper, “Design of a Carbon Tax,” Gilbert Metcalf and David Weisbach articulated a simple structure for harmonizing border tax adjustments that, consistent with the WTO’s prohibition on discriminatory taxes, would apply a carbon-equivalent import duty to energy-intensive commodities such as steel, aluminum, paper, chemicals and cement, along with finished products containing them. If a foreign manufacturer could show that its process is less carbon-intensive than production in the U.S., then its harmonizing carbon tax would be reduced.

Harmonizing taxes would incentivize our trading partners to enact their own carbon taxes – in effect, we would be taxing their carbon-intensive exports for them until they enacted their own carbon taxes. With a rising U.S. carbon price, the incentive for our trading partners to enact carbon taxes would rise as well.

In summary, a rising carbon tax offers the JSC an attractive revenue stream for deficit reduction, obviating the need for more onerous and regressive levies such as Value Added Taxes. Low income households could be protected from disproportionate regressive effects by setting aside 15% of carbon tax revenues. And with WTO-sanctioned border tax adjustments, a carbon tax will not disadvantage U.S. industry and will spur much-needed innovation, investment and job growth in low-carbon energy and efficiency in the U.S. It will also encourage establishment of a global carbon price with commensurate global emissions reductions.

The super-committee will need nothing short of super powers to leap across a $1.5 trillion chasm. A carbon tax can provide the extra “bounce” of a substantial and growing revenue stream along with the clear, predictable price incentives needed for sound climate policy and a healthy and growing clean energy sector.

Photo: Flickr — Chanchanchepon


6 Comments »

  1. How can I be of help to ensure a carbon tax gets established this fall?

    One thought: drop the income tax restoration issue for now (just let it lapse in 2012) in exchange for a carbon tax.

    Comment by Richard Dunn — September 12, 2011 @ 1:12 am

  2. Richard,

    Thanks for asking! I’d say call your Representative and Senators. Let them know about the special powers of a carbon tax to both reduce deficits and global warming. Ask them to pass the word to the leadership and the JSC. And remember, the JSC’s recommendations will be voted on by the full House and Senate.

    Comment by James Handley — September 12, 2011 @ 1:27 am

  3. Excellent article sir, I’m going to make time to chew through all the papers you referenced. That Stone paper is of particular interest to me; I’m from BC, and it’s always bothered me that the low income tax credit funded by our carbon tax doesn’t rise in lockstep with the rise of the carbon tax over time. Maybe there’s a reason for such a design choice that I don’t know.

    Comment by Cody — September 14, 2011 @ 10:06 am

  4. Mr Handley, here is my idea for a carbon tax,

    There are several ideas that could lead to economic growth using any future carbon tax. One idea put forth in the 2007 scientific American article is that that the carbon taxes subsidize a massive solar voltaic effort.

    Here I propose to off set the percentage of GDP of the national dept with a social security sovereign wealth fund fueled with a carbon tax invested in the market.

    A proposed SSI investment trust fund for all newborns starting in a year “zero.”

    It is an idea phased in over many decades. The carbon tax is placed starting at a start year into all newborns of that year. All newborns in subsequent years also receive this initial investment. The social security trust fund through an investment house invests the funds as any pension fund would in stocks and some bonds.

    This initial government investment will always be a government supervised one but the investment will be the personal property of the newborn future retiree. Interest on the funds must be payable for retirement and retirement health care but it may be possible for the individual or the individuals parents or relatives to contribute to this fund.

    Any future single payer health system that might include retirees could free Medicare money to the newborn future retiree’s pension. Monies contributed by the individual or the individual’s family through work or inheritance would entitle the individual a limited choice in investments.

    Naturalized Americans during the years the program goes into effect would get the initial investment but not necessarily the compounded interest back dated. However there should always be the SSI minimum benefit.

    The math:
    $ 200,000,000,000 divided by 4,000,000 live births = $50 000 for each new born

    200 billion Carbon Tax each year divided three ways, 1/3 goes each year to all newborns born that year. (1/3) of (US$ 200 billion) = 66.6666667 billion U.S. dollars (the devil’s number!)

    (1/3) of $50 000 = $16,666.6667
    1/3 goes to the children born the previous year and every previous year before that one for a number of years (19 years). lets say this 1/3 rule is used for 19 years, that would mean some one who is 19 in the year zero would 20 years from now receive a contribution to their SSI stock fund of $ 16,666 at the age of 39, it is these folks would need transition funds from the last 1/3 used for transition funding.
    1/3 would go into the existing SSI trust fund, but only in the form of stocks and bonds, not treasury’s.
    People who are twenty years of age on the date of enactment will always pay into the existing ISS system to pay existing retirees, those nineteen and younger at the time off enactment will have their SSI payroll taxes paid into their SSI investment accounts ,more math,
    $16,666 at 7% for 60 years yields $965,000 at age 60, however this child would never pay into the old SSI system but into his account, so the 15% payroll tax would be added to the original balance. So 35 working years of working wages of $30,000 per year x 10% SSI tax yields another $415,000; that’s a million and a half dollars in total.
    So for the 19 year old in the year of enactment, receives $16,666 at age 39 this is at age 60 yields $69,000, however 41 years of adding $3000 payroll tax yields another $ 664,000
    Since this 19 year old on the day of enactment is a part of the new SSI system at the time she reaches 60 ( the new retirement age!) the retirees and the over twenty year olds at the time of enactment(year zero) would be gone.

    Starting 20 years from now, who would be paying into the old SSI system for retirees? Some one who is twenty now would be 40 and still working and paying into the old SSI system, this is our transitional generation, some one who is 65 now would be 85 then, so here is my plan, in the 20 years after enactment the remaining 1/3 would also go into a trust fund that owns capital this come out to 66 billion x 20 years = $3,148,366,456,742 !, this is our contribution to shore up the existing SSI system and to provide a buffer or transition between the old and new SSI systems. I believe this 1/3 would be required for perhaps a decade or more, but after that the this 1/3 should be added to the 1/3 to the newborns of that year Would this be enough to pay the over 85 year olds in the old system at date of enactment + 20 years? Or is this way too much? If so when the last old ssi system recipient dies SSI should hand over the balance back into the new system to be spread out over the folks closer to the 20 year mark in the new SSI trust fund.

    Some additional thoughts,
    Upper middle class people and some others should have part of their child tax credit go into the Childs SSI retirement account, over 18 years plus another 41 years of compound interest…………… Year zero + 60 years should produce 300 million Americans X $ 1 million trust account each = $300 trillion.
    Year zero x $16,000 X 60 years at 7% interest
    Each year after year zero newborns receive $16,000 at birth in to their SSI trust fund
    Year zero + 18 years of a portion of the parent child tax credits into the Childs SSI trust fund x 60 years
    Dependent college age adults would have their parents tax credits funded into their SSI trust accounts
    Working year zero adults, 25 to 35 years 14% SSI tax into the SSI trust fund x 25 to 35 years at 7 %
    Working year zero adults 2.5 % of payroll Medicare deduction x 25 to 35 years at 7% ( SSI Medicare trust fund) Lump sum contribution at birth?
    Secondary 1/3rd funds each child born in the years before the year zero back 19 years with one time payments of $16,000 each to each year of children born back from year zero x 19 years
    • Tertiary 1/3rd equalizes the year 19 year old on the day of enactment who is now 39 years of age and the children younger who have received their $16,000 SSI trust fund investment but are lacking 19 years or less of compounded interest earnings. The tertiary 1/3rd also funds SSI transition expenses such as shoring up the existing SSI system and providing a invested fund to provide for SSI disability* and marriage credits* for the new SSI invested funds
    • * we do not know who might be born or become disabled or chose to marry or cohabitate and not work for a period of time, and there are the chronic unemployed or underemployed, and the poor, so after the twenty year transition funding to the zero + 19 year olds, so we must fund a invested capitalized contingency fund to answer known and unknown future societal problems

    SSI investment trust and national health insurance, Medicaid, state and local governments

    This government managed privatized SSI could from time to time accept voluntary payments from employers’ and state and local governments IE synchronized 401 K and 203 B with the carbon taxed fueled SSI fund. But perhaps these state and local government plans might keep a separate account for each employee tied to the SSI trust fund.

    Governance,
    The SSI administration would appoint an investment board of governance; the Federal Reserve would serve as members of this board of investment governance in equal numbers to the SSI appointed members. Citizens who own accounts would not be able to direct them except in an estate.

    States may join this board of governors with one representive if that state contributes with its employers’ and its citizens into a matching fund that is the personal property of that citizen but is controlled by the investment trust. This fund should include Medicare investments for the year zero children and beyond.
    With year zero children and beyond it might be possible for states who are partners to engage in a citizen owned SSI and Medicare governed trust fund.

    SSI invested trust fund as sovereign wealth fund and deficit reduction fund

    For a period of 7 to 8 decades the SSI trust fund would control an individuals invested retirement account and at death, some of the estate would by law accrue to the SSI trust fund account of close relatives or as by law to spouses. A portion of the estate could be controlled by the decedent’s wishes, but that portion under government supervision perhaps could be counted in part as a government asset against the deficit

    thanks for your time,
    Steven Rappolee

    Comment by Steven Rappolee — September 23, 2011 @ 11:03 am

  5. What about Republicans who voted against increases in taxes?

    The Citizen’s Climate Lobby has a fee and dividend approach that could be tailored to be revenue neutral (on introduction, anyway). It has garnered interest from some of those Republicans for that reason.

    Comment by Citizen's Climate Lobby — October 4, 2011 @ 4:01 pm

  6. If there is an opening for a carbon tax, it’s probably as part of the deficit reduction effort that will be ongoing for a long time. But I’d leave the revenue side to Congress. The point is that we need a gradually rising carbon tax. Call it a “fee” if you insist, but CBO and nearly all economists call it a tax as they do with cap-and-trade: a hidden, volatile and regressive tax. So really, I don’t go for “fee” which I consider a euphemism and I don’t think it’s helpful to insist on “dividend” either. But I am a fan of CCL.

    Oh, and by the way, who are those Republicans? Please show me a Republican member of Congress who supports a carbon tax and thinks we can balance the budget without any new revenue.

    Comment by James Handley — October 4, 2011 @ 10:47 pm

RSS feed for comments on this post. TrackBack URI

Leave a comment