Americans for Tax Reform (ATR) recently published an article highlighting a carbon tax’s negative impact on the economy and low-income households. The piece only tells half the story—the regressivity of a carbon tax, without going into the various ways existing proposals are designed to improve a carbon tax’s distributional outcomes. A well-designed carbon tax that makes good use of the revenue it generates would offset increased energy costs to consumers and make the tax more progressive.
A carbon tax is aimed at pricing the negative externalities of burning fossil fuels and incentivizing consumers to switch to using clean energy. According to a Tax Foundation study, “in isolation and ignoring environmental effects, a carbon tax negatively impacts output and employment and makes the tax code less progressive.” However, the key factor determining the overall economic impact of a carbon tax in the long run is how its revenue is used. Recycling a carbon tax’s revenue can improve the tax’s distributional outcomes.
The ATR piece points out that Janet Yellen, Biden’s nominee for the Secretary of the Treasury, supports a carbon tax. Yellen, the Federal Reserve Board’s former chair, was a founding member of the Climate Leadership Council that promotes a carbon tax. The ATR piece summarizes the negative economic impact of a carbon tax by citing from a policy memo prepared for Hillary Clinton in 2015. However, the ATR piece did not mention any of the potential positive distributional outcomes from revenue rebating discussed in the same policy memo.
The internal Clinton policy memo modeled a carbon tax roughly at $42 a ton, with a majority of the tax revenue rebated to households on a lump-sum basis. According to the memo, a $42-per-ton carbon tax would indeed lead to increased household energy costs, but “the increase in energy costs would be more than offset by the pollution rebate for all households.” Non-energy products’ prices would slightly increase as well, but “the pollution rebate would offset the combined increase in energy and non-energy household costs for most Americans.”
These findings are in line with other studies that model the economic effects of recycling carbon tax revenue. An Earnst & Young study models a $55-per-ton carbon tax paired with three alternative revenue uses: permanently extending certain TCJA provisions, investing in public infrastructure, and household rebates. The E&Y study finds that a policy that replaces regulations with a carbon tax and uses the additional revenue for the three alternative revenue uses increases the level of long-run GDP by between 0.7% to 3.2%.
Treasury’s Office of Tax Analysis (OTA) modeled a $49-per-ton carbon tax and its distributional outcomes when paired with rebates or different tax swaps (lowering other existing taxes). The OTA study finds that “combining the per person rebate with the carbon tax results in a very progressive change in tax burden”, specifically, “the poorest decile would experience almost a 9 percent increase in average after-tax income” and “a 1 percent decrease in average after-tax income for the top income decile.” OTA also finds that pairing a carbon tax with a reduction in the OASDI (old age, survivors, and disability insurance) payroll tax rate would be more or less distributionally neutral. However, other modeled tax swap options such as reducing the corporate tax rate would lead to regressive changes in the tax burdens.
There are plenty of other studies that evaluate the various distributional outcomes and economic effects of different carbon tax revenue use options. These studies demonstrate ways to design a carbon tax with revenue recycling that makes the tax less regressive.
Economists like Janet Yellen recognize that, compared to alternatives such as regulations and mandates, a carbon tax is the most economically efficient policy to combat climate change. Using the regressivity of a carbon tax to criticize the policy without evaluating the revenue recycling options to offset it is misleading. A correct approach to evaluate the overall economic impact of a carbon tax must account for the effects of revenue recycling.