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A Green Employment Tax Swap: Using a Carbon Tax to Finance Payroll Tax Relief Gilbert E

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A Green Employment Tax Swap: Using a Carbon Tax to Finance Payroll Tax Relief Gilbert E TAX REFORM, ENERGY AND THE ENVIRONMENT POLICY BRIEF A GREEN EMPLOYMENT TAX SWAP: USING A CARBON TAX TO FINANCE PAYROLL TAX RELIEF GILBERT E. METCALF EXECUTIVE SUMMARY As the new Congress convenes, both Democratic and and presents an analysis of a Green Employment Tax Republican lawmakers are proposing limits on greenhouse Swap (GETS). Under this proposal, a national tax on car- gas emissions. Most of these proposals are for carbon cap bon emissions is paired with a reduction in the payroll tax. and trade systems similar to the European Union Emis- In particular, the brief assesses the impact of a tax of $15 sions Trading System. per metric ton of carbon dioxide (CO2), which is used to rebate the federal payroll tax on the fi rst $3,660 of earn- A carbon tax is another way to limit emissions. This policy ings per worker. This reform is both revenue-neutral and brief describes how a carbon tax could be implemented distributionally neutral. Congress is currently considering various legislative propos- activities result in pollution. The private cost of polluting ac- als to curb greenhouse gas emissions in the United States tivities falls short of the cost to society from the pollution. A and a number of bills to establish carbon cap and trade tax on pollution is a simple way to ensure that private fi rms schemes have been put forward.1 A carbon tax is an addi- use resources that take into account the full (social) cost of tional policy instrument that can be used to control carbon their behavior. emissions. To illustrate how a carbon tax could be imple- mented, this policy brief discusses a Green Employment Tax Support for pollution taxes, also known as Pigouvian taxes, Swap (GETS) in which a tax of $15 per metric ton of carbon cuts across the political spectrum. N. Gregory Mankiw, dioxide (CO2) is used to rebate the federal payroll tax on the professor of economics at Harvard and a former Chair of fi rst $3,660 of earnings per worker. 2 the Council of Economic Advisors under President George W. Bush, has argued in favor of higher gas taxes.3 He has I. A GREEN EMPLOYMENT TAX SWAP AS A established the Pigou Club, an “elite group of pundits and POLLUTION TAX policy wonks with the good sense to advocate higher Pigouv- Economists have long extolled the virtues of pollution taxes ian taxes.”4 Other supporters of pollution taxes include New to address the social damages arising from polluting activi- York Times columnists David Brooks and Thomas Friedman, ties. A central tenet of economics is that market prices do economist and columnist Paul Krugman, economists Martin not refl ect the social cost of resource use when economic Feldstein and Joe Stiglitz, and former Vice President Al Gore. The Brookings Institution World Resources Institute June 2007 1775 Massachusetts Ave., NW 10 G Street, NE, Suite 800 Printed on recycled paper Washington, DC 20036 Washington, DC 20002 Tel: 202-797-6000 Tel: 202-729-7600 www.brookings.edu www.wri.org A carbon tax is simply a pollution tax. Carbon emissions Share of Environmental Taxes in Total are a form of greenhouse gas emissions contributing to Table 1 Tax Revenue, 2003 global warming. The societal damages from global warm- ing have been extensively documented.5 Concerns about Country Share (percent) global warming led the United States to sign the Framework Canada 3.99 Convention on Greenhouse Gases in 1992. Many countries Denmark 10.27 have moved forward to address greenhouse gas emissions France 4.91 by signing the Kyoto Protocol. While the United States Germany 7.44 has not signed that protocol, it has recognized the dangers Japan 6.58 of global warming. Last year, for example, the U.S. Sen- Netherlands 8.93 ate passed a non-binding resolution calling for a “national Norway 6.86 program of mandatory market-based limits and incentives Sweden 5.84 on greenhouse gases.”6 In his most recent State of the Union United Kingdom 7.57 Address, President George Bush acknowledged the need “to confront the serious challenge of global climate change.”7 United States 3.46 Source: European Environment Agency. http://www2.oecd.org/ecoinst/ queries/index.htm accessed Jan. 25, 2007. Pollution taxes have an even stronger appeal because of the opportunities for using the tax revenues to lower other distorting taxes, as we propose in the GETS reform. This Finally, the United States is currently an outlier in its use of reform focuses on payroll taxes, which have become increas- environmental taxes relative to other high-income coun- ingly burdensome for working families. In fact, for nearly tries in Europe and elsewhere. Table 1 presents the share three-quarters of all households, payroll taxes are their of total tax revenues generated by environmental taxes for single largest tax to the federal government.8 Because the a sample of countries for 2003. The United States has the payroll tax is a fl at-rate tax up to a payroll limit of $90,000 lowest share of taxes on environmental activities among the (as of 2005), it is generally acknowledged to be a regressive 27 OECD countries reporting data for 2003. As an example, tax.9 Using the carbon tax to reduce the payroll tax bur- the tax on gasoline in the United States is roughly one- den would reduce the tax burden on working households, eighth the value of the average rate across all countries in especially for those households earning less than the median the OECD.10 income in the United States. II. IMPLEMENTING THE GREEN EMPLOYMENT In addition to possible improvements in the progressiv- TAX SWAP ity of the tax code, using a carbon tax to lower the tax rate A carbon tax could best be implemented in an upstream on wage income could improve the effi ciency of the U.S. system by taxing the carbon content of fuels at their source. tax code. Economists have long noted the benefi ts of this For coal, this would be the mine mouth for domestic coal second dividend from a tax on pollution. In general, taxes on and the border for imported coal.11 Natural gas would be labor supply discourage labor and create economic losses to taxed at the wellhead. Petroleum products would be taxed workers over and above any taxes collected. Workers forego at the refi nery on the various products produced from crude opportunities to work longer hours or engage in training that oil. Levying the carbon tax on refi nery outputs is prefer- increases their productivity and wages. Moreover, workers able because crude oil can have different emission factors may choose not to enter the labor force in response to taxes (carbon per barrel of crude) for different shipments; for on wage income. Tax reductions can encourage additional la- example, a single tanker could have batches of oil with dif- bor supply either on the intensive margin (hours worked) or ferent emission factors. the extensive margin (the decision to enter the labor force). The Green Employment Tax Swap encourages additional An upstream tax would require a few simple adjustments. labor supply on the extensive margin. First, electric power plants that sequester carbon should receive a rebate for carbon taxes previously paid on the 2 A GREEN EMPLOYMENT TAX SWAP sequestered carbon. In addition, non-energy carbon emis- sions should also be brought into the system. Such emissions Carbon Dioxide or Carbon? Carbon emissions can be reported in units of carbon or carbon diox- come from a variety of sources. For example, calcination of ide. By weight, 44 units of carbon dioxide contain 12 units of carbon. limestone to make clinker, an intermediate product in ce- To convert carbon dioxide to carbon, multiply the amount of carbon ment production, releases carbon. Applying the carbon tax dioxide by 12/44. To convert a tax rate per unit of carbon dioxide to to clinker production would address carbon emissions in the a rate per unit of carbon, multiply the former rate by 44/12. cement industry. would raise gasoline prices by approximately 13 cents per An upstream carbon tax would be relatively straightforward gallon, assuming the tax is fully passed forward into con- to administer with a small number of fi lers responsible for sumer prices. This represents a price increase of less than 7 remitting tax revenues to the government. Ease in adminis- percent using average gas prices for 2005. tration would help keep administrative and compliance costs down. The largest impact would be on the coal industry. Coal consumption would decline by nearly one-third. Success- III. ASSESSING A SWAP ful carbon capture and sequestration (CCS) will blunt the This brief considers a carbon tax set at a rate of $15 per met- impact on the coal industry. Pricing carbon is a necessary ric ton of carbon dioxide12 ($55 per metric ton of carbon). condition for a fi nancially viable CCS program. The impact Emissions of carbon dioxide in 2005 are estimated to be just on petroleum and natural gas output is very small. Emissions 13 over 6,000 million metric tons. Had a carbon tax of $15 per of CO2 would fall by over 700 million metric tons of CO2, ton of CO2 been in place in 2005, the tax would have raised a decline of 12.1 percent. Most of the decline results from $89.2 billion, assuming no behavioral response. Because de- decreased coal use. mand for carbon-intensive products will fall in response to a carbon tax, carbon emissions in the short run would fall by Allowing for these short-run demand adjustments, the car- an estimated 700 million metric tons of CO2 in response to bon tax would have collected $78.5 billion if it had been in the levy (12.1 percent based on price and quantity data from place in 2005.
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