Replacing income taxes with carbon taxes: how to leave the non-starter gate
There is increasing discussion among environmentalists, economists and fiscal conservatives about the benefits of replacing income taxes with carbon taxes. More income is a good thing–all else equal–but income taxes can discourage income and encourage inefficient expenditure, and many parts of the income tax code are believed to be unfair and inefficient.
More carbon emissions are a bad thing, on the other hand, and carbon taxes discourage carbon emissions. Ever increasing carbon emissions is just one of many good reasons to discourage fossil fuel consumption. There are national security and balance of trade issues: a more balanced energy portfolio that is less dependent on imports should be a matter of national security. Reduced consumption means that less fossil fuels have to be imported or more can be exported. Growth of domestic alternative energy and conservation industries would be a boost for the economy, and less consumption means that more finite fossil fuel resources are preserved.
Unless you are a global warming non-believer, or just someone who expects their carbon tax cost to exceed their income tax reduction, the simple appeal of the carbon-for-income tax proposal is undeniable. Still, carbon taxes have been characterized as a “non-starter.” After all, “no new taxes” is a mantra with justifiable public appeal. The coupling of a carbon tax with an income tax reduction provides a palatable platform to foster critical environmental, energy and tax efficiency goals.
Here are some suggestions to get the carbon-for-income tax proposal out of the starting gate:
• A mandatory dollar-for-dollar income tax reduction;
• Phase in over years;
• Consider how income tax reduction could be allocated to reduce inequitable tax burden
shifts;
• Consider impacts of the carbon tax on the poor
The first premise of the carbon-for-income tax, and perhaps its own mantra, must be a dollar for dollar replacement of the income tax. This might be accomplished by legislative language that requires annual re-setting of income tax rates according to the amount of carbon tax revenue raised. The important detail of whose income tax to reduce is discussed below.
A long phase-in of the carbon-for-income tax is simply good economics. With more time to adjust, energy-intensive industries and consumers can prepare in ways that will reduce carbon emissions and minimize long-run costs. A period of 5 to 10 years or even more might be advisable.
The distributional impacts of the carbon-for-income tax proposal contribute to its non-starter status. Many people could be hurt by the carbon tax more than they gain from income tax reduction. These people, primarily the fossil fuel industry and industries who emit relatively large amounts of carbon, will fight the carbon-for-income tax proposal. Their incentive to fight could be reduced by allocating the income tax reduction in consideration of their carbon tax burden. For example, energy-intensive industries could be provided with more income tax reduction. The purpose of the carbon tax is not to punish, it is to provide incentive, and the incentive to produce less carbon can be provided without so much inequity from shifts in the tax burden.
There are competing arguments about the types of income taxes to replace and whose income taxes should be reduced. Some argue that payroll taxes or corporate income taxes are most inefficient and therefore should be replaced first. Others argue that the poor should get income tax relief because their fossil fuel expenditures are for necessities such as commuting and home heating. Also, many older people are about done paying income taxes but they continue to buy fossil fuels. The poor and the retired can’t be provided an income tax break if they aren’t paying any. Should they get a carbon tax break?
There are numerous other issues to work out. A realistic carbon market based on the carbon tax rate could be added to obtain more carbon reduction at lower cost. A carbon tax could be coupled with cap and trade policies. However, counting of actual carbon emissions or savings for markets, or under cap and trade policies, turns out to be very complex. A carbon tax may be simpler, more transparent and more efficient than cap and trade policies, and even more efficient if coupled with income tax reform.
One argument against a carbon tax is that, as fossil fuel prices increase with the tax, people use less fossil fuels, so tax rates must be increased to maintain revenue, causing people to use even less fossil fuels, and so on. The idea of an endless cycle of carbon tax increases, however, is not valid. The demand for fossil fuels is generally inelastic (the percent reduction in use is much less than the percent increase in price), and well- documented. Therefore, it should be possible to establish a carbon tax that will provide a predictable amount of revenue without much fuss. Also, the mandatory dollar-for-dollar substitution means that, whatever the revenues turn out to be, they will be offset by income tax reduction.
Clearly, there are many details and issues that deserve further study. The first step must be to elevate the proposal through grassroots efforts, generate discussion at higher levels, and then, obtain genuine consideration in Congress. Congress should establish a commission to study the carbon-for-income tax proposal and provide a range of scenarios to be evaluated and debated in public. With the right mix of phasing and income tax breaks and reforms, we can achieve real carbon emissions reductions alongside a more efficient, growing and stable economy.
Roger Mann, PhD is a consulting resource economist. He can be contacted at rmecon@sbcglobal.net