A new report from MIT’s Joint Program on the Science and Policy of Global Change suggests that a tax on carbon emissions could help raise the money needed to reduce the US deficit, while improving the economy, lowering other taxes and reducing emissions.
In the report—Carbon Tax Revenue and the Budget Deficit: A Win-Win-Win Solution?—John Reilly, co-director of the Joint Program and co-author Sebastian Rausch, now at ETH Zurich University, calculated the impact a carbon tax starting at $20 per ton would have using a national economic model that details energy, taxes and household incomes. They found that the tax would raise $1.5 trillion in revenue, which could then be used to reduce personal or corporate income taxes, extend the payroll tax cut that expires this year, maintain spending on social programs—or some combination of these options—while reducing the deficit.
Bush-era tax cuts are scheduled to expire at the end of 2012, leading to interest in raising revenue through a carbon tax. This revenue could be used to either cut other taxes or to avoid cuts in Federal programs. There is a body of economic research suggesting that such an arrangement could be a win- win-win situation. The first win—Congress could reduce personal or corporate income tax rates, extend the payroll tax cut, maintain spending on social programs, or some combination of these options. The second win—these cuts in income taxes would spur the economy, encouraging more private spending and hence more employment and investment. The third win—carbon dioxide (CO2) pollution and oil imports would be reduced.—Rausch and Reilly (2012)
The analysis used the MIT US Regional Energy Policy (USREP) model to evaluate the effect of a carbon tax as part of a Federal budget deal. Reilly and Rausch compared a baseline scenario—in which temporary payroll cuts and the Bush tax cuts are allowed to expire—to several scenarios that include a carbon tax starting at $20 per ton in 2013 and rising at 4%.
They found that whether revenue is used to cut taxes or to maintain spending for social programs, the economy is better off with the carbon tax than if taxes remain high to maintain Federal revenue. They also found that, in addition to economic benefits, a carbon tax reduces carbon dioxide emissions to 14% below 2006 levels by 2020, and 20% below by 2050.
Oil imports remain at about today’s level, and compared to the case with no carbon tax, are 10 million barrels per day less in 2050. The carbon tax would shift the market toward renewables and other low carbon options, and make the purchase of more fuel-efficient vehicles more economically desirable.
In shifting the market through a tax on emissions rather than through tax credits for renewable sources, the nation would be raising revenue rather than spending it. This contributes to the win-win-win result we expected for the nation’s economy and environment.—John Reilly
Some have expressed concern over the impact a carbon tax could have on lower- and middle-income households. The study shows that this actually depends on how the revenue from the tax is used. If the revenue is used to maintain social programs, lower-income households, not surprisingly, benefit. In the short term, this also would benefit the economy, as these households have the greatest propensity to spend. Conversely, cutting income taxes would benefit wealthy households because they pay more in taxes. The analysis found that extending the payroll tax cut would be the most neutral option because there is an income limit, leveling out the affect across the spectrum.
There authors note a few caveats to the generally positive results around assumption in the model. The researchers also warn that while in principle it is possible to get very positive results from a carbon tax, in practice their study shows the result would depend entirely on the specific proposal—of which there are several. Earlier this month, Congressman Jim McDermott (D-Wash.) introduced one measure similar to a proposal by his Senate colleagues Maria Cantwell (D-Wash.) and Susan Collins (R-Maine). House Ways and Means Committee member Pete Stark has also introduced a bill that has 18 co-sponsors.
The level of congressional activity compliments growing bipartisan support off Capitol Hill. Former Republican Congressmen Sherwood Boehlert from New York and Wayne Gilchrest from Maryland joined Congressional Democrats Henry Waxman (Calif.) and Ed Markey (Mass.) in support of a carbon tax in a February opinion piece in The Washington Post. Meanwhile, former Republican Congressman Bob Inglis (SC) launched a think tank this summer to promote the tax and the conservative American Enterprise Institute held an informal forum on the subject in July.
The country faces difficult tradeoffs in getting the Federal budget deficit under control. In our analysis of a carbon tax, we find a win-win-win situation that requires no tradeoff at all. Carbon tax revenue allows (1) cuts in other taxes, (2) benefits the economy, and (3) reduces CO2 emissions and oil imports. The tradeoffs are mainly whether we want to choose a set of measures that produce higher consumption in the near term, or a path that sacrifices some current consumption for an investment tax credit that leads to greater benefit in later years. Given current economic conditions, changes that have more immediate benefit may be preferable, but we can hope for a compromise that yields a result that is also beneficial for the country in the longer term.—Rausch and Reilly (2012)
Rausch, S. and J.M. Reilly (2012) Carbon Tax Revenue and the Budget Deficit: A Win-Win-Win Solution? Report 228