Carbon taxes, to be effective, will raise large amounts of money. That’s their job — to cut carbon dioxide emissions by decisively raising prices of fossil fuels. CTC is committed to making carbon taxation as “progressive” as possible, with the tax revenues used to protect low- and middle-income Americans.

It is true that most middle- and low-income households spend a larger percentage of their income on gasoline, other fuels and electricity than do wealthy households. The top 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 a disproportionate percentage impact on lower-income families.

But the picture is quite different when energy expenditures are viewed in absolute dollar terms — which we believe is a more meaningful measure. In 2005, the most recent year available, 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 pricing carbon emissions sufficiently to reduce U.S. emissions 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.

This comes about because wealthier households don’t just drive more, they also fly more (burning jet fuel), they have bigger (and sometimes multiple) houses to heat and cool (consuming heat and power), and they buy more stuff that requires electricity or industrial fuels to manufacture and use as well as diesel fuel to transport by truck. This means that most 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. (We calculated this by combining the first quintile’s share of gasoline expenditures, 31.6%, with the second quintile’s share, 25.0%, and half of the middle quintile’s share, 19.8%, which yielded 66.6%. Data are from the Bureau of Labor Statistics’ Consumer Expenditure Survey, 2005.)

This progressive distribution of carbon tax revenues creates a basis for progressive tax-shifting: transferring a portion of the tax burden from regressive taxes such as the payroll tax (at the federal level), as Al Gore is urging, and the sales tax (at the state level) onto carbon emissions instead. Although we at CTC haven’t finished running the numbers — allocating carbon tax payments by corporations and government adds a twist to the analysis — we believe it is possible that one or both of these approaches could have a net progressive effect, i.e., that tax-shifting from payroll and/or sales taxes to carbon taxes could be done so as to raise, not lower, the after-tax incomes of a majority of below-median-income households.

In August 2007, the World Resources Institute and the Brookings Institution jointly published a policy brief by Tufts Univ. economics professor Gilbert E. Metcalf, outlining a national carbon tax paired with a reduction in the payroll tax. The brief, available here, assesses the impact of a tax of $15 per metric ton of carbon dioxide (equivalent to approximately $60 per ton of carbon) which is used to rebate the federal payroll tax on the first $3,660 of earnings per worker. This tax swap is both revenue-neutral and distributionally neutral. (Harvard professor and former Bush Administration economist Gregory Mankiw mentioned the Metcalf paper in a Sept. 2007 New York Times op-ed, which we discuss on our blog.)

An alternative approach that is unquestionably progressive, as well as straightforward, is to return the carbon tax revenues equally to all U.S. residents. This would be a national version of the Alaska Permanent Fund, which once a year sends every resident of that state an identical check drawn from earnings on investments made with the state’s North Slope oil royalties. (For a federal carbon tax, the dividend checks should be provided at least quarterly to keep households ahead of the budget treadmill.) With carbon tax revenues returned through equal (per capita)  dividends, the vast majority of poorer households would get back more in the dividends than they would pay in the tax.

Congress and the Administration may have inadvertently paved the way for such a “carbon tax-and-dividend” approach with the economic stimulus package they enacted in February 2008. The plan provides $168 billion in tax rebates, with the first rebates sent electronically during the last week of April. The New York Times provided these details on April 30:

The Treasury Department plans to send electronic rebates to nearly 7.7 million people by the end of this week, said Andrew DeSouza, a spokesman for the department.

The government intends to begin mailing checks on May 9 and expects to send a total of about 130 million rebates. The bulk of those will be mailed by early July, Mr. DeSouza said.

People who chose direct deposit for their tax refunds or provided bank routing numbers to the Internal Revenue Service will receive their rebates electronically, said Eric Smith, an I.R.S. spokesman.

The plan provides rebates of up to $600 for individuals and up to $1,200 for couples filing jointly, with additional payments to families of $300 per child. Payments will be reduced for people with adjusted 2007 gross incomes above $75,000 and for couples with incomes above $150,000. Taxpayers whose incomes exceeded certain amounts — for example, an individual with no children who earned $87,000 — are not eligible, Mr. Smith said.

People who are not normally required to file a tax return are also eligible, provided they had at least $3,000 in qualifying income, which includes some payments from Social Security and the Department of Veterans Affairs, the I.R.S. said.

As for carbon taxes, a numerical illustration may help convey the progressive impact of returning carbon tax revenues equally to all U.S. residents. Here are the steps leading to this conclusion:

• We estimate that the revenues from Year 1 of our graduated “Starter Tax” of $37 per ton of carbon emitted would be approximately $55 billion a year. (The actual dollar amount isn’t critical for this example.)
• Assuming that this entire amount is returned equally to all 300 million U.S. residents, each annual dividend would be $183.
• From our earlier observation that the lowest-income quintile makes 9% of gasoline expenditures, $4.8 billion of the carbon tax payments would be made by the 60 million people comprising this quintile. (Yes, we are using gasoline as a “proxy” for carbon fuels, for the reasons given earlier.)
• Averaged over those 60 million, each individual in the lowest-income group would spend an average of $80 a year in carbon taxes.
• Netting this $80 per-person carbon tax from the $183 per capita dividend, we see that the average person in the bottom quintile would gain approximately $100 in the first year of our $37/ton carbon tax. Annual installments to ramp up the tax rate would only add to the gains of this lowest-income group.

Using the same methodology, we calculate that carbon tax payments for the top quintile would average $290 per person per year. Since each person in this group would also receive a $183 dividend, we see that the average person in the top quintile would pay a net of a little over $100 in carbon taxes during the first year. The same result of the more affluent paying a net tax and the less affluent receiving a net gain applies to the second and fourth quintiles as well, though the the impacts are of smaller magnitude. The middle group would average no net change in after-tax income.

We recognize that some individuals in the lower-income quintiles might be subject to higher than average carbon taxes because they have old fuel-guzzling cars, drive long distances to work, have old inefficient furnaces and/or live in poorly insulated homes. A portion of the carbon tax revenues could be used to help reduce the energy use of their cars and homes, or such assistance could be financed through general revenues.

These observations are preliminary, and much more analytical work remains to be done, particularly on the tax-shifting alternative. But the principles are clear: tax dividends or a tax shift can ameliorate the disproportionate impact of carbon taxing, perhaps to the point that below-median households become net beneficiaries. CTC is committed to advocating for such an outcome, for both pragmatic and ethical considerations. Pragmatically, because the politics of a carbon tax require support from economic justice advocates; and ethically, because it’s not tenable to solve the climate crisis on the backs of those who can least afford it.

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Addendum, May 16, 2007

Writing in the New York Times, Cornell economist Robert H. Frank invoked an all-but-forgotten rebate scheme that enabled the NY State Public Service Commission to begin charging for servicing directory assistance calls back in the 1970s. (Free “411″ calls handled by live operators were adding to system costs that were charged equally to all customers regardless of how many such calls they made.) Frank writes:

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. (A Sensible Solution to Thin Traffic, and One for Easing Concerns About Fairness, May 10, 2007)

Interestingly, Frank was writing about traffic congestion, whereas the “411″ controversy involved telephone rates and here we are addressing CO2 emissions and the climate crisis! What unites the three arenas is the principle of charging for services or activities that entail costs, and the political as well as moral imperative of protecting vulnerable members of society from the impact of the higher charges.

Addendum, May 29, 2007

There’s a quirkily fascinating piece, Carbon Tax & Trade, at a new (to us) blog called Interfluidity. While the hybrid tax-and-trade system outlined there is overly complicated for our taste, the piece is accurate and elegant in sketching the income implications of carbon taxing (regressive without tax-shifting or rebate distribution, but potentially progressive with). Here’s an excerpt:

Just as flattish taxes are regressive, flattish subsidies are progressive. So, when we enact the carbon tax, we grant citizens the right to a refund of the tax on a fixed quantity of carbon consumed. We distribute those refunds equally among all taxpaying US citizens annually… Light users of carbon end up receiving cash, from the excess permits they sell, while gas-guzzle-monsters pay up! That’s likely to mean that most poorer people earn cash from their allotment, paid for by the people whose Hummers they can’t see over.