Carbon taxes, to be effective, will raise large sums of revenue. But generating revenue for the government isn’t their main job. The purpose of “putting a price on carbon” is to cut carbon dioxide emissions by decisively raising prices of fossil fuels relative to conservation, efficiency and cleaner alternatives. We don’t need more tax revenue in order to cut CO2 emissions, we need to shift more of the total tax burden onto dirty energy, and to do so without harming low- and middle-income families..
Effects of Carbon Taxes Differ Across the Income Range
Most middle- and low-income households spend a larger percentage of their income on gasoline, other fuels and electricity than do higher-income households. The wealthiest 20% of U.S. households spend just 2.3% of their after-tax income on gasoline; the percentage for the lowest “quintile,” 9.1%, is four times as high. Clearly, imposing a gasoline tax or, by implication, a carbon tax, without tax-shifting or dividends, would have disproportionate impacts on lower-income families. But the picture is quite different when energy expenditures are viewed in absolute dollar terms — arguably a more meaningful measure. In 2005, the top-echelon quintile spent an average of $3,182 on gasoline, or 3.6 times as much as the $882 spent by the poorest 20% of households. Put differently, when all household outlays for gasoline are apportioned among quintiles, the highest-earning quintile accounted for 32% of the total, while the lowest quintile contributed just 9%. (The middle quintile, true to its name, spent exactly 20% of the total.)
What’s true for gasoline applies to energy in general, as the Congressional Budget Office confirmed in early 2007 in a report, Trade-Offs in Allocating Allowances for CO2 Emissions. Examining the price increases that would ripple through the economy from raising the price of carbon emissions sufficiently to reduce U.S. emissions by 15%, the CBO estimated that households in the highest quintile would average an additional $1,800 a year for fuel, electricity and goods — more than three times the additional $560 that households in the lowest quintile would pay. (The middle three quintiles would pay $730, $960 and $1,240, respectively.) Although the lowest quintile would bear the greatest cost as a percentage of household income, it would pay the least in absolute terms, thus making possible a “progressive” outcome through rebates or appropriate tax-shifts.
The upward skew in carbon use over the income range comes about because higher-income households don’t just drive more, they also fly more (burning jet fuel), they tend to own bigger (and sometimes multiple) houses to heat and cool, and they buy and use more products that require electricity or industrial fuels to manufacture, deliver and use. This means that the bulk of carbon taxes will be paid, directly or indirectly, by families of above-average means. For the gasoline part of carbon taxes, we estimate that around two-thirds will be paid by above-average-income households. (Calculated by summing: the first quintile’s share of gasoline expenditures, 31.6%, the second quintile’s share, 25.0%, and half of the middle quintile’s share, 19.8%, which yielded a total of 66.6%. Data are from the Bureau of Labor Statistics’ Consumer Expenditure Survey, 2005.)
Carbon Taxes May Not Be Inherently Regressive When Their Effects On Both Income and Spending are Considered
In June 2010, four leading economists released a report carefully examining the impacts on various income groups of different cap-and-trade carbon pricing proposals. The following is the abstract of Distributional Implications of Alternative U.S. Greenhouse Gas Control Measures by Sebastian Rausch, Gilbert E. Metcalf, John M. Reilly, and Sergey Paltsev, published by the MIT Joint Program on the Science and Policy of Climate Change (June 2010):
We analyze the distributional and efficiency impacts of different allowance allocation schemes for a national cap and trade system using the USREP model, a new recursive dynamic computable general equilibrium model of the U.S. economy. The USREP model tracks nine different income groups and twelve different geographic regions within the United States. Recently proposed legislation include the Waxman-Markey House bill, the similar Kerry-Boxer bill in the Senate that has been replaced by a Kerry-Lieberman draft bill, and the Cantwell-Collins Senate bill that takes a different approach to revenue allocation. We consider allocation schemes motivated by these recent proposals applied to a comprehensive national cap and trade system that limits cumulative greenhouse gas emissions over the control period to 203 billion metric tons. The policy target approximates national goals identified in pending legislation. We find that the allocation schemes in all proposals are progressive over the lower half of the income distribution and proportional in the upper half of the income distribution. Scenarios based on the Cantwell-Collins allocation proposal are less progressive in early years and have lower welfare costs due to smaller redistribution to low income households and consequently lower income-induced increases in energy demand and less savings and investment. Scenarios based on the three other allocation schemes tend to overcompensate some adversely affected income groups and regions in early years but this dissipates over time as the allowance allocation effect becomes weaker. Finally we find that carbon pricing by itself (ignoring the return of carbon revenues through allowance allocations) is proportional to modestly progressive. This striking result follows from the dominance of the sources over uses side impacts of the policy and stands in sharp contrast to previous work that has focused only on the uses side. The main reason is that lower income households derive a large fraction of income from government transfers and, reflecting the reality that these are generally indexed to inflation, we hold the transfers constant in real terms. As a result this source of income is unaffected by carbon pricing, while wage and capital income is affected. (Emphasis added.)
That’s a surprising finding that runs counter to conventional economic thinking that consumption taxes (including carbon taxes) are almost always regressive. This new finding may blunt the distributional argument for progressive revenue return of carbon revenue. But tax shifting also offers the potential for efficiency gains by reducing distortionary taxes in other areas. As Dr Metcalf testified to the Senate Energy and Natural Resources Committee:
Any allocation mechanism should address the regressivity of carbon pricing ideally in a way that does not forego the opportunity for gains in economic efficiency through the possibility of tax rate reduction.
Further, as the example below suggests, the political and “perception” advantages of tax shifting or direct distribution of carbon revenue can’t be overlooked. Revenue Return Drastically Affects Public Attitudes About Taxes and Fees By shifting revenue back to customers, the NY State Public Service Commission created incentives to limit costly directory assistance calls that had been driving up rates for all. Cornell economist Robert H. Frank recounted in the NY Times (5/16/07):
The commission argued that a 10-cent charge for directory assistance calls would give consumers an incentive to look up telephone numbers on their own whenever convenient, which would free up operators and equipment for more valuable tasks. Although the commission’s proposal promised net benefits for the average telephone subscriber, it was greeted by a firestorm of protest… Commission officials then introduced a simple amendment that saved it. In addition to charging 10 cents for each directory assistance call, they proposed a 30-cent credit on each consumer’s monthly phone bill, a reduction made possible by the additional revenue from the charge and the savings from reduced volumes of directory assistance calls. Because this amendment promised to reduce the monthly bill of customers willing to use their phone books, political opposition vanished overnight.
Interestingly, Frank was using the “411” telephone controversy to suggest the advantages of proposals to price traffic congestion, while here we are addressing CO2 emissions and the climate crisis. The common principle in all three situations is charging for services or activities that entail costs, and the political as well as moral imperative of returning revenue to protect vulnerable members of society from the impact of the higher charges and simply to build support.