What to Do With the Revenue From a Carbon Tax

(Bloomberg Opinion) -- If I wrote a list of the economists I most admire, it would look awfully similar to those who wrote a statement in the Wall Street Journal early this month calling for action on climate change.

Composed of four former Federal Reserve chairmen, two former Treasury secretaries, 15 former White House chief economists and 27 winners of the Nobel Memorial Prize in Economic Sciences, the group is a very impressive combination of political savvy, policy experience and leadership, and scholarly accomplishment.

The group recommends that a carbon tax be put in place and increased every year until goals for the reduction of emissions are met. A version of this proposal would begin with a $43 tax on every ton of carbon dioxide emissions. This translates to a tax of 38 cents per gallon of gasoline, and $18 for a barrel of crude oil, or about one-third of the 2017 average crude price in the U.S.

The tax would be set to increase every year at a rate faster than the growth in consumer prices. If implemented in 2021, the plan is estimated to result in emissions reductions of 32 percent in 2025, relative to their level in 2005. This would exceed the U.S. reduction called for by the Paris climate agreement.

The plan would change behavior by encouraging more efficient use of energy. The basic economic logic is as simple as it is powerful: If it costs more to drive, then people will drive less. And they will make other changes in how they use energy in their daily lives.

In addition, the tax will provide incentives for switching from coal to natural gas, and makes nuclear power and renewables relatively more attractive. It will also encourage clean-energy investment through relative price changes.

A key feature of the proposal is its promise to eliminate regulations that are no longer necessary once the tax is adopted, including many CO2 regulations enacted by the Barack Obama administration. “Substituting a price signal for cumbersome regulations,” the group of economists writes, “will promote economic growth and provide the regulatory certainty companies need for long-term investment in clean-energy alternatives.”

The proposal raises important questions. How can we be sure that the carbon-tax-for-regulations swap will actually take place? Will we end up with both a new tax and an increasing regulatory burden? Would this unilateral action by the U.S. meaningfully alter the global atmospheric concentration of greenhouse gases?

But the most interesting feature of the group’s proposal is also the most objectionable. Under this plan, the revenue from the carbon tax would be distributed to U.S. citizens in equal amounts. The advocates refer to this as a “carbon dividend.”

“The majority of American families, including the most vulnerable, will,” according to the statement, “benefit financially by receiving more in ‘carbon dividends’ than they pay in increased energy prices.”

Why use the revenue this way?

Though it isn’t being described as such, this proposal is equivalent to two proposals: a carbon tax and a universal basic income — a regular payment of an equal amount to every American that is made without regard to income, age, employment status, household composition or other factors. If you’re a citizen, you get the payment.

The problems with a universal basic income — UBI, for short — is worth another column. But one of them is its likely effect on employment: Fewer people will work if they are receiving a regular payment from the government.

Under this proposal, a family would receive around $2,000 in the first year, which would grow as the tax rate on CO2 emissions increases. A UBI of this amount is not a serious threat to overall employment. But this proposal would create a universal basic income, and once households begin receiving the payment it will be tempting for future politicians to increase its size. The genie would have been let out of the bottle.

One of the most attractive features of a carbon tax is based on the economic logic discussed above: If you tax something, you get less of it. So to the extent possible, taxes should be levied on things society wants less of.

It makes more sense to tax CO2 emissions than to tax income, because we don’t (or shouldn’t) want less income. Rather than handing the carbon-tax revenue back to households, it would be better to use it to reduce taxes collected on income. Doing so would increase incentives to work, save and invest, as well as to pollute less.

The best solution to climate change might be found in technological innovation, like safer nuclear power or ways to remove emissions and greenhouse gases. Why not use the revenue from the carbon tax to increase funding for the basic research necessary for scientific breakthroughs?

And, of course, there is the national debt, which is projected to grow substantially over the next 30 years. It is currently fashionable to minimize the importance of debt and deficits, but it remains the case that the trajectory of the U.S.’s long-term debt needs to change in order to avoid damage to the economy and the living standards of households. A new tax would help bring federal revenue closer to spending.

There is a fundamental question here: Why do we tax? Increasingly, some politicians want to tax to reduce inequality. Some argue that taxes should be used to equalize power throughout society and safeguard democracy.

I hold the old-fashioned view that the main reason we tax is to finance public spending that society deems necessary, and that such financing should be raised in the most efficient and fair way possible. That view can get me on board with a carbon tax.

But not if the revenue from the tax becomes a dividend payment.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Michael R. Strain is a Bloomberg Opinion columnist. He is director of economic policy studies and resident scholar at the American Enterprise Institute. He is the editor of “The U.S. Labor Market: Questions and Challenges for Public Policy.”

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