Tax Shifts

A Carbon Tax Can Be Made Progressive With Appropriate Revenue Return

Tax Shifting

The upward distribution of carbon tax burdens creates an opportunity for progressive tax-shifting: transferring a portion of the tax burden from regressive taxes such as the payroll tax (at the federal level) or sales taxes (at the state level) onto carbon emissions instead. Advocating a carbon tax shift, Al Gore has long urged, “Tax what we burn, not what we earn.” This approach could have a net progressive effect, i.e., shifting taxes away from payroll and/or sales taxes and onto carbon pollution could raise, not lower, the after-tax incomes of a majority of below-median-income households.

In addition to this potential progressive effect of tax shifting, a number of economists, [including Gilbert Metcalf & David Weisbach, Alan Viard, Robert Shapiro… ] have suggested that use of revenue to reduce other taxes would improve the overall efficiency of the economy, for example, by removing burdens on work. In October 2007, the Brookings Institution published a A Proposal for a U.S. Carbon Tax Swap — An Equitable Tax Reform to Address Global Climate Change by Tufts University economics professor Gilbert E. Metcalf, describing a national carbon tax paired with an income tax credit for payroll taxes paid. Metcalf assessed the impact of a tax of $15 per metric ton of carbon dioxide and five major greenhouse gases. Revenues would be used to credit payroll tax paid on the first $3,660 of earnings per worker. Metcalf showed that such a tax swap would be 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, discussed on our blog.)

“Carbon Dividends” or “Green Checks”

Half or more of U.S. households’ carbon tax burden will be more than offset by their “green check,” so long as at least 70% of carbon tax revenues are returned to the public as dividends.

An alternative approach that is unquestionably income-progressive, and appealingly straightforward, is to return the carbon tax revenues equally to all U.S. residents. This  so-called “dividend” or “green check” 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. (We suggest that for a federal carbon tax, “dividend” checks be provided at least quarterly — or, better yet, monthly — to keep households ahead of the budget treadmill.)

Half or more of U.S. households’ carbon tax burden will be more than offset by their “green check,” so long as at least 70% of carbon tax revenues are returned to the public as dividends.[/caption]

With carbon tax revenues returned through equal (per capita) dividends, the vast majority of lower- and middle-income households would get back more in the dividends than they would pay in higher prices for carbon-intensive goods induced by the tax, as suggested in the graph at right — provided that most of the revenues are actually returned. (To view, and use, the spreadsheet supporting the graph, click here. Requires Excel 2003 or later.)

The 2008 “economic stimulus checks” authorized by Congress and the Bush Administration offer a preview of the simplicity and potential rapid implementation of a “carbon tax-and-dividend” approach.  Within months, the government rebated $168 billion in tax revenue via checks or equivalent direct deposits. Individuals received up to $600 and couples up to $1,200 with additional payments of $300 per child. A numerical illustration may help convey the progressive impact of returning carbon tax revenues equally to all U.S. residents:

  • We estimate that the revenues from Year 1 of our graduated “Starter Tax” of $37 per ton of carbon emitted (equivalent to $10 per ton of CO2) 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. [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 little over $100 in net 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 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 drive 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. While this analysis represents only a first approximation, the principles are clear: either carbon “dividends” or a tax shift can ameliorate the disproportionate impact of carbon taxing, to the point that below-median households become net beneficiaries. CTC advocates such an outcome, for both pragmatic and ethical reasons. Pragmatically, because a carbon tax will require broad, sustained support and ethically, because it’s not tenable to solve the climate crisis on the backs of those who can least afford it.

How Much Revenue to Return?

De-carbonization of our economy to the extent needed will take decades, and require broad, even increasing political support. Just as important as setting an effective climate goal is designing a policy that will ensure decades of continued political will to drive down emissions. We are aware of the many competing demands for carbon revenue illustrated by the long list of those seeking free allowances under the cap/trade/offset bills. But instead of handing out carbon revenue — even to worthy causes — we advocate return of all (or nearly all) carbon revenue so that roughly 2/3 of households will enjoy ongoing financial benefits from a carbon tax — an important pillar to ensure sustained public and political support.

Last updated: August 07, 2013