A carbon tax is considered by most economists to be the most efficient and effective way to reduce carbon emissions. However, a long-standing political challenge to a carbon tax is the perception that it would disproportionately burden low- and middle-income households relative to high-income households. Many analysts and lawmakers have proposed using carbon tax revenues to either cut taxes or increase transfers to low- and middle-income households to mitigate any regressive effect. Perhaps the most prominent revenue recycling proposal would use carbon tax revenue to distribute carbon dividends — per-person lump sum payments.

A potential revenue swap similar to carbon dividends would use carbon tax revenue to finance an expansion of the child tax credit (CTC). In 2021 lawmakers temporarily expanded the CTC as part of the American Rescue Plan Act, and since then lawmakers and policy analysts on both sides of the aisle have been debating additional expansions. For example, President Biden has proposed temporarily expanding it in his latest budget, and Rep. Ashley Hinson, R-Iowa, and Sen. Marco Rubio, R-Fla., proposed a CTC expansion as part of a broader pro-family package.

Our new Tax Notes article explores a revenue recycling option — what we call a revenue swap — that would use carbon tax revenue to finance an expansion of the CTC. This revenue swap would enact a roughly $35-per-metric-ton carbon tax and use the revenue to finance one of four CTC expansion options. Using the American Enterprise Institute’s open-source “Tax-Calculator,” we model the effect of this potential revenue swap on the federal budget, the distribution of the tax burden, poverty, and labor supply.

This article was originally published on October 23, 2023 in Tax Notes.