NEW SOURCES OF REVENUE AND EFFICIENCY Proposal 11: The Many Benefits of a Carbon Tax Adele C. Morris The Brookings Institution Deficit Reduction (10-year): $199 billion Broader Benefits: Reduces the buildup of greenhouse gas emissions; replaces command-and- control regulations and expensive subsidies with transparent and powerful market-based incentives; promotes economic activity through reduced regulatory burden and lower marginal tax rates. Introduction The Challenge This paper proposes introducing a modest carbon tax to finance The United States confronts serious policy challenges from reforms to the U.S. tax system to promote economic growth, an unsustainable budget deficit, a tax and regulatory system reduce budget deficits, reduce redundant and inefficient that most experts agree is inefficient, and the long-term threat regulation, reduce unnecessary subsidies, and reduce the costs from climate disruption. A carbon tax offers a policy that associated with climate change. The revenues from the new can help address all three challenges by combating climate levy could fund permanent reductions in more distortionary change, curbing the rising debt level, and helping achieve taxes on capital income while also contributing to deficit efficient reforms to current policies. reduction. And by providing simple, transparent, but powerful market-based incentives to reduce damaging greenhouse gas Climate change poses serious risks to both the environment (GHG) emissions, this levy could supersede the array of costly and the economy. Scientists project that, depending on future regulatory command-and-control approaches and expensive GHG emissions, by 2100 average global temperatures will be subsidies aimed at reducing dependence on fossil fuels and 2°F to 11.5°F higher than now (National Academy of Sciences promoting clean energy. In addition to these benefits, of 2012). These higher temperatures will raise sea levels and course, is a contribution to stemming the global buildup of produce more-frequent, extreme, and damaging weather GHGs and improving the United States’ standing to foster events, such as wildfires, heat waves, storms, and droughts. the broader international action necessary to stabilize GHG These changes will disrupt ecosystems and crop production, concentrations and avoid catastrophic climate disruption. As increase heat-related deaths, require costly adaptation, this proposal shows, with a carbon tax these gains are possible and produce many other monetary and nonmonetary with less-adverse, potentially even positive, consequences consequences. While much remains to be learned about for economic activity, unlike other revenue raisers. Indeed, the potential impacts of climate change, the evidence within twenty years a modest carbon tax can reduce annual overwhelmingly suggests that lower GHG concentrations emissions by 12 percent from baseline levels, generate enough will produce lower climatic disruptions; for that reason, it is revenue to lower the corporate income tax rate by 7 percentage prudent to take steps today to curb emissions. points, and decrease the deficit by $815 billion, all while protecting the poorest households from undue burden. ACKNOWLEDGMENTS: The author would like to thank Dallas Burtraw, Donald Marron, Warwick McKibbin, Nathan Richardson, Eric Toder, Pete Wilcoxen, and numerous colleagues at the Brookings Institution for helpful comments, ideas, and conversations contributing to this paper. This paper reflects the views only of the author. The Hamilton Project • Brookings 1 NEW SOURCES OF REVENUE AND EFFICIENCY Proposal 11: The Many Benefits of a Carbon Tax The federal budget deficit is growing at an unsustainable of coal. This proposal also would repeal or modify inefficient rate. Rising costs of Medicare, Social Security, and defense and redundant environmental and energy regulations and spending are at the forefront of the budget deficit problem, eliminate approximately $6 billion of energy-related subsidies and politically feasible solutions remain elusive. A carbon tax each year. is one policy mechanism that has the potential not only to make a meaningful dent in the budget deficit, but also to raise In each year, the proposal would reserve 15 percent of the sufficient revenue to justify lowering other taxes. For instance, carbon tax revenue to benefit the poorest households, for the United States currently has the highest statutory corporate example by bolstering social safety net spending, to help income tax rate in the developed world. Using the revenue offset some of the regressivity of the tax. Over the first decade, from a carbon tax, the United States could significantly lower nearly all of the remaining revenue would be used to fund a the corporate tax rate while still reducing the budget deficit. permanent reduction in the top corporate income tax rate from 35 to 28 percent and reduce the deficit by about $199 Some climate-related regulations are in place, and more are billion. Over the subsequent decade, the proposal would pending under the Environmental Protection Agency’s (EPA’s) generate enough revenue and budget savings to reduce the Clean Air Act (CAA) authority. But the current approach to deficit by an additional $616 billion, for an undiscounted addressing climate change is inefficient and costly. Emissions total of $815 billion in deficit reduction over twenty years.1 standards, energy-efficiency standards, renewable electricity The individual components of this package are described in subsidies, and biofuel mandates are only a few examples of costly detail below. Table 11-1 summarizes the budget and emissions or ineffective policies. Indeed, current approaches can induce reduction estimates for the proposal. Lacking available out- costs of each ton of abated carbon that are substantially higher year projections, estimates in table 11-1 assume that the net than the U.S. government’s estimate of the benefits, leading to revenue lost from reducing corporate income tax rates and the negative net social benefits. A carbon tax could replace many potential budget savings from reduced subsidies are the same such inefficient environmental and energy policies. in the second decade as in the first. SET THE OPTIMAL TAX RATE AND BASE The Proposal This proposal recommends an initial tax rate per ton of CO2- equivalent of $16 (2012 dollars) beginning in 2014 and an annual This paper proposes a tax starting at $16 per ton of CO2- statutory increase in the tax of 4 percent over inflation. From equivalent and rising 4 percent over inflation per year to 2050. an economic perspective, policymakers should set the price The tax would be a simple excise tax on the carbon content of of carbon—that is, the tax—equal to the present value of the fossil fuels combusted in the United States and on select other environmental and social damages produced by each additional GHG sources. This amount, $16 per ton of CO2, translates ton of CO2 emissions (or the equivalent in other GHGs). This to about $0.16 per gallon of gasoline and $30 per short ton TaBle 11-1. Summary of Budgetary and Emissions Impact PROPOSAL: Implement a tax of $16 per ton of CO2 ; increase it by 4 percent plus inflation each year Total Budget effects (Undiscounted) Over 10 Years Over 20 Years Revenue $1.1 trillion $2.7 trillion Set-aside for low-income individuals ($161 billion) ($405 billion) Revenue loss from lowering the corporate tax rate from 35 percent to 28 percent ($800 billion) ($1.6 trillion) Savings from reduction in clean energy spending $60 billion $120 billion Net deficit reduction $199 billion $815 billion Monetized Benefit of CO2 reductions, valued at $16 per ton $52 billion $148 billion Note: Table 11-1 reports estimates for the tax on carbon in fossil fuels used in the energy sector, per McKibbin and colleagues (2012). These sources comprise about 79 percent of U.S. GHG emissions. The proposal’s actual tax revenue and emissions reductions could be a few percentage points higher than the values in table 11-1. Additional GHG sources, such as cement-related CO2 and methane emissions from landfills and coal mines, are in the proposal’s tax base, and the proposal includes border tariffs on select goods from countries without analogous carbon prices. However, federal government spending on its own energy consumption is likely to be higher, too. 2 15 Ways to Rethink the Federal Budget NEW SOURCES OF REVENUE AND EFFICIENCY Proposal 11: The Many Benefits of a Carbon Tax Adele C. Morris is called the social cost of carbon (SCC). Of course, measuring target and the process for adjusting the rate to achieve it, and the SCC is difficult because of the scientific and analytical it simplifies revenue forecasts. In lieu of a specific emissions challenges of predicting climate change impacts, monetizing target, Congress should request regular expert agency reviews them, discounting effects in the distant future, and assessing of the environmental and economic performance of the tax the costs of low-probability but catastrophic outcomes. and revisit tax rates when appropriate. However, useful benchmarks exist, and $16 falls within their Many economists recommend that the real rate of increase in range, as shown in table 11-2. The U.S. government uses a range the tax match the returns on relatively low-risk capital assets, of SCC estimates to calculate the benefits of rules that reduce or about 4 or 5 percentage points above inflation in typical GHG emissions.2 Sixteen dollars is within the bounds of the economic conditions.3