Legal & Regulatory

CBO Scopes Out Pros and Cons of a Carbon Tax

A federal carbon tax could raise large amounts of money for the government, while reducing emissions. But a carbon tax also would raise prices for many goods and services that “would have a negative effect on the economy,” says the Congressional Budget Office in a recent report.

The CBO report notes that taxing carbon dioxide emissions directly or by proxy, through a tax on fuels that release CO2, “would tend to increase the cost of producing goods and services – especially things, such as electricity or transportation, that involve relatively large amounts of CO 2 emissions.” These increased costs would create incentives to reduce CO2 emission and lead to higher consumer prices, encouraging “households to use less of them and more of other goods and services.”

The report prepared at the request of Rep. Henry Waxman (D-Calif.), the ranking Democratic member of the House Committee on Energy and Commerce, was released as lawmakers in Congress proposed bills that would directly tax carbon dioxide emissions from large sources. Though no federal estimates had been put forth as to how much revenue a carbon tax might produce, analyses of policies to cap and trade carbon dioxide emissions from most fossil fuel consumed in the U.S. suggest they could “generate a substantial amount of revenue.”

Without discussing how the federal government would use the new revenues, a carbon tax “would have a negative impact on the economy. The higher prices it caused would diminish the purchasing power of people’s earnings, effectively reducing their real (inflation-adjusted) wages.” Investment would also decline, said the CBO.

A carbon tax would hit lower-income families the hardest, said CBO, “because low-income households generally spend a larger percentage of their income on emission-intensive goods.” The tax would also take a toll on workers and investors in energy-intensive industries. Prices for electricity would go up most in regions where coal is the dominant source of power generation.

Lawmakers might choose to dedicate the revenues from a carbon tax in ways aimed at reducing the harmful economic effects. CBO analyzed three possibilities.

  • Using the carbon tax revenues to reduce deficits, says CBO, “would decrease the tax’s total costs to the economy.” Federal deficits, says the report, crowd out private-sector investment, resulting in lower economic output. So, in the long run, plowing carbon tax proceeds into deficit reduction would be a positive effect, “although they can have a negative effect in the short term when the economy is weak.”
  • Using the revenues to reduce marginal tax rates would also decrease total costs of a carbon tax. The carbon tax revenues could be used to reduce income tax or payroll tax rates—a tax swap. Personal taxes would go down as costs of living went up, offsetting the damage to the economy from a carbon tax.
  • Targeting the revenues “toward people who would be likely to bear a disproportionate burden,” such as aid to low-income households, “would not decrease total costs,” says the CBO analysis. Trying to target the revenues would face lawmakers “with a trade-off between the goals of helping those households most hurt by the tax and helping the economy in general.” The analysis concludes that “lump-sum payments to low-income households would not provide benefits to the broader economy under normal economic conditions, because those payments would not increase people’s incentives to work or invest and thus would not lead to greater economic productivity.”

How much revenue would a carbon tax raise? The CBO says neither it nor the Joint Committee on Taxation have come up with estimates, although the number would be large. A proxy might be the work CBO did in 2011 looking at what a cap-and-trade program might raise. That analysis found that a $20 price on a ton of CO 2, increasing by 5.6% annually, could raise “nearly $1.2 trillion during its first decade.” Total U.S. CO2 emissions would be 8% lower over the period than without the cap-and-trade program.

CBO said it was also unable to estimate what impact a U.S. carbon tax would have on the environment, in part because of the global nature of the problem. U.S. efforts to decrease emissions “would produce incremental benefits, in the form of incremental reductions in the expected damage from climate change.” But no one has come up with anything close to a definitive measure of the “social cost of carbon,” or SCC.

“Estimates of the SCC are highly uncertain,” says CBO, “and researchers have produced a wide range of values.” The report says, “Given the inherent uncertainty of predicting the effects of climate change, and the possibility that it could trigger catastrophic effects, lawmakers might view a carbon tax as a reflection of society’s willingness to pay to reduce the risk of potentially very expensive damage in the future.”

—Kennedy Maize is MANAGING POWER’s executive editor and Sonal Patel is a POWER magazine senior writer.

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