Carbon taxes, to be fully effective, will have to be set fairly high — to the point that they will raise large sums of revenue. But generating new government dollars isn’t their purpose; indeed, distributing revenues from carbon taxes as carbon dividends, or using them to reduce or phase out existing (and onerous) taxes like payroll taxes in revenue-neutral “tax shifts or swaps,” is built into many carbon tax proposals, most of which the Carbon Tax Center strongly supports.
Rather, the intent of robustly taxing carbon emissions is to cut those emissions by decisively raising prices of fossil fuels relative to conservation, efficiency and renewable energy. 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. For example, in 2014, the wealthiest 20% of U.S. households spent just 2.7% of their after-tax income on gasoline; the percentage for the lowest quintile, 10.8%, was 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 — a more meaningful measure. In 2014, the top-echelon quintile spent an average of $3,789 on gasoline, or 3.3 times as much as the $1,160 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 31% of the total, while the lowest quintile contributed just 9%. (The middle quintile, true to its name, spent exactly 20% of total outlays.)
What’s true for gasoline applies to energy in general, as the Citizen’s Climate Lobby confirmed in a 2016 report analyzing the short-term financial impact of its fee and dividend idea set at a level of $15 per ton of carbon dioxide. The report painstakingly captures wide geographic variations in the carbon contents of fuels used to generate electricity, among other variables, giving it a finer grain than many previous analyses of carbon tax incidence. It found that households in the top quintile would pay an on average additional $319 per month, directly and indirectly, through higher fossil fuel prices associated with the carbon fee; that’s more than three times the additional $96 per month that households in the lowest quintile would pay. (The middle three quintiles would pay $116, $143, and $183, respectively.)
Although the lowest quintile would bear the greatest burden of the carbon fee as a percentage of household income, it would pay the least in absolute terms. This makes possible a “progressive” outcome through rebates such as CCL’s proposed dividends, or via appropriate tax-shifts. Significantly, the report found that 53% of households (58% of individuals) would receive more through monthly rebates than they would incur from the carbon tax. Even better, the majority of these benefits would be reaped by the most vulnerable, with nearly 90% of households below the poverty line benefiting in net terms from the carbon “fee and dividend” plan. Monthly dividends, in other words, could ensure an equitable and progressive carbon tax.
The bulk of carbon taxes will be paid by families of above-average means
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 and second quintiles’ shares of gasoline expenditures in the pie chart above, plus half of the middle quintile’s share, yielding a total of 66%; data are from the Bureau of Labor Statistics’ Consumer Expenditure Survey, 2014).
Using carbon tax revenues to cut corporate taxes is problematic
Conservatives who support, or at least are willing to consider, taxing carbon emissions (yes, there are some) fall into two camps on revenue treatment: backing the carbon dividend plan proposed by the Climate Leadership Council (which in turn draws on the fee-and-dividend approach espoused by the Citizens Climate Lobby); or urging that the carbon revenues be applied to reduce the U.S. corporate income tax.
Expert analysis published several years ago by Resources for the Future (which we summarize and link to on our Tax Shifting page) suggested that using carbon tax revenue to reduce corporate income tax rates would benefit middle- and upper-income households but not lower-income families, relatively few of whom own stocks whose share values would rise as corporate tax rates were reduced. Political deals (sometimes dubbed “grand bargains”) to win Republican support for carbon taxes, such as the proposal by Democratic Senators Sheldon Whitehouse (RI) and Brian Schatz (HA) therefore risk alienating labor, low-income advocates and economic-justice activists, many of whom are already tepid at best about carbon tax legislation that doesn’t directly invest considerable carbon revenues in a “just transition.”
Earlier analyses of carbon tax incidence
In 2010, four leading economists released a report detailing the impacts on different income groups of various cap-and-trade carbon pricing proposals. The following is an excerpt from 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:
[W]e find that carbon pricing by itself (ignoring the return of carbon revenues through allowance allocations) is proportional to modestly progressive. This striking result … stands in sharp contrast to previous work … 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.
As the authors suggest, their finding runs counter to conventional economic thinking that consumption taxes (including carbon taxes) are necessarily regressive when revenue treatment is ignored.
Last, a report published by Resources for the Future in October 2013, by Daniel F. Morris and Clayton Munnings, Designing a Fair Carbon Tax, provides a succinct guide to issues of fairness and efficiency in crafting a federal carbon tax.