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Hidden benefits and dangers of carbon tax

* E-mail: [email protected]

Affiliation Department of Sociology and Institute for Policy Research, Northwestern University, Chicago, IL, United States of America

• Monica Prasad

Published: July 7, 2022

• https://doi.org/10.1371/journal.pclm.0000052
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Many scholars argue that revenue from carbon taxes should be used to replace other taxes, such as taxes on capital or labor, in order to minimize economic damage or compensate for the regressive nature of carbon tax. Advocates of this approach argue that the carbon tax could produce a “double dividend,” reducing emissions while also increasing GDP by allowing other taxes to be lowered. This paper suggests caution before adopting this approach, for two reasons. First, the scholarly literature systematically understates the benefits of carbon taxes, and overstates their costs, by simply ignoring the possible environmental benefits of carbon taxes. The result is a one-sided scholarship that exaggerates the damage from carbon taxes and should be understood as providing a lower bound for the benefits of the tax, not a rigorous guide to policy. Second, carbon taxes, unlike other taxes, will produce less revenue as technologies improve and cleaner-burning fuels develop. Thus, if carbon taxes replace other taxes, over time the tax base of the state will wither, and the programs those taxes pay for will be threatened. This paper elaborates these claims and then discusses carbon tax policy designs that would take both points into consideration.

Citation: Prasad M (2022) Hidden benefits and dangers of carbon tax. PLOS Clim 1(7): e0000052. https://doi.org/10.1371/journal.pclm.0000052

Editor: Olivier Damette, Universite de Lorraine and Climate Economic Chair Paris Dauphine, FRANCE

Copyright: © 2022 Monica Prasad. This is an open access article distributed under the terms of the Creative Commons Attribution License , which permits unrestricted use, distribution, and reproduction in any medium, provided the original author and source are credited.

Funding: The author(s) received no specific funding for this work.

Competing interests: The authors have declared that no competing interests exist.

Carbon taxes, like all taxes, raise two sets of design questions. The first set of questions is on how to levy the tax: what the rate should be, on whom it should be levied, and whether there should be any exceptions. The second set of questions is how to spend the revenue, such as whether it should become part of general revenue or should be reserved for dedicated purposes, and if dedicated, then whether it should be dedicated to environmental purposes or other purposes.

There is disagreement on all these questions. On how to levy the tax, the World Bank’s Carbon Pricing Leadership Coalition’s Report of the High-Level Commission on Carbon Prices concluded that achieving the Paris climate targets would require a price on carbon of US $50–100 per ton of CO2 emissions by 2030 [ 1 ]. In 2014 William Nordhaus calculated that a price of $7.40 per ton of CO2 would be optimal in terms of balancing costs and benefits of carbon tax [ 2 ]. A few years later, however, and in the face of several more years of inaction on carbon tax around the world, Nordhaus concluded that the social costs of carbon are over $30/ton of CO2 [ 3 ]. Many studies suggest starting with a lower rate in order to give households and firms time to adjust to the tax and make longer-term changes, and incrementally increasing the rate over time. The theoretical literature is clear that the optimal tax would be a flat tax on carbon that is levied equally on all sectors, but in practice, it is common for existing carbon taxes to exempt politically influential sectors and/or sectors vulnerable to international competition, even in the most environmentally ambitious countries. Finland and the Netherlands have had a carbon tax since 1990, Sweden and Norway since 1991, and Denmark since 1992. In all of these countries some sectors are hit by the tax and some are exempt, and the affected sectors have changed over time [ 4 ]. For example, in Sweden, much higher tax rates in transportation have led to emissions reductions in transportation, but lower rates are levied on oil and natural gas and have thus not led to lower emissions in those sectors [ 5 ]; in Norway only about 60% of emissions are taxed, with exemptions being given to the most energy-intensive industries [ 6 , 7 ].

If there is disagreement on the specific rate and exemptions, there is much more disagreement on how to spend the revenue, and several different approaches have been proposed: merging the revenue with tax revenue from other sources, returning the revenue to households in a lump sum, using the revenue to cut other existing taxes, using the revenue to lessen the regressivity of the carbon tax, using the revenue to subsidize environmentally beneficial technologies or policies, or using the revenue to reduce debt [ 8 ].

The problem is that these different uses of the revenue respond to different—and potentially conflicting—concerns. Different design features have different consequences for three goals, all of which may be seen as relevant to carbon taxes: economic growth, distributional consequences, and the environment. If the goal is to minimize economic costs , many scholars argue the revenue from carbon tax should be used to lower other taxes. For example, [ 9 ] argue that because any tax introduces distortion and economic cost, adding a carbon tax on top of existing taxes magnifies the economic cost: “As firms pass CO2 taxes forward into higher energy prices, this drives up product prices in general, thereby depressing the real return to work effort and savings…Reducing the buying power (real returns) to capital and labor depresses labor supply and capital accumulation.” Therefore, as many scholars argue, the goal should be to minimize the economic damages of carbon tax by cutting other taxes. The most substantial recent study in this vein is [ 10 ], which examines several different revenue scenarios, including using the revenue to reduce the deficit or cut taxes on labor or capital, and finds that if the carbon tax is used to cut capital tax rates, it can actually increase GDP (see also [ 11 – 14 ]). Minimizing economic costs and using the revenue to cut capital taxes is also useful politically, to bring on board political actors who might not otherwise be convinced of the need for a carbon tax, because the broader public debate revolves around the perceived economic costs of these policies. British Columbia uses revenue from its carbon tax to fund a reduction in the corporate tax rate and taxes on small businesses, among other uses [ 15 ]. Although there are certainly criticisms of the argument that tax cuts for capital lead to significant benefits for the economy (e.g. [ 16 ]), a recent review found that “almost all studies agree that recycling the revenue through capital or corporate tax cuts is preferable, from an efficiency perspective, in the long term” [ 17 ].

On the other hand, a different goal may be distributional . A carbon tax is generally held to be regressive, because lower-income households spend much larger shares of their income on energy costs ([ 18 , 19 ]. It is not fair for lower-income households to bear a disproportionate share of the burden of climate change mitigation, and therefore—some argue—the revenue from the carbon tax should be returned to low-income households ([ 20 , 18 ]. The Carbon Pricing Leadership Coalition report is clear that lessening the regressivity of the tax may be necessary to generate political coalitions in its favor. However, some scholars argue that this goal conflicts with the goal to minimize the economic damage from the tax. For example, [ 18 ] conclude that a lump sum rebate is the policy that most improves the fortunes of the bottom three quintiles, while “recycling revenue to reduce capital taxes is the most efficient policy, but we caution that it makes carbon pricing, which is already regressive, even more so.” They suggest as a middle option using carbon tax revenues to reduce labor taxes. They worry that “if the rebate policy is viewed as an attempt to reduce inequality, this might introduce a controversial policy sub-plot to an already polarized debate.” Moreover, recycling revenue to lower income households could be a selling point for carbon taxes in some circumstances but could be politically unpopular in other cases. The ultimate political consequences are unclear. The Australian carbon tax reserved a significant share of its revenue to be returned as dividends to lower and middle-income households, but this was not enough to overcome the political opposition that eventually saw the tax repealed [ 15 ]. Other authors dispute the equity-efficiency tradeoff of carbon tax entirely, finding that economic efficiency and distributional concerns need not always be in conflict [ 21 , 22 ].

Cost-and-no-benefit analysis

If the goals of economic efficiency and distributional justice are potentially in conflict, at least the literature is aware of these two goals, examines the extent to which they are in conflict, and tries explicitly to reconcile them. But on the question of environmental benefits , the literature is surprisingly silent. Because environmental consequences are hard to measure, the peer-reviewed econometric literature assessing the consequences of carbon taxes generally ignores environmental consequences. A World Bank report examined 30 years of scholarship on carbon taxes in peer-reviewed journals and found only a handful that examine their effects on the environment. Even fewer studies attempt to include the environmental benefits in an overarching assessment of the costs and benefits of carbon tax [ 23 ].

This is because of the inherent difficulty of modeling climate harms and benefits. Marron and Toder note:

Carbon dioxide emissions stay in the atmosphere for decades. Their environmental and economic impacts depend nonlinearly on the stock of greenhouse gases, which will depend on future economic developments, domestic climate policies, and policies elsewhere in the world. Estimating the marginal social cost of carbon thus requires complex modeling and assumptions about the trajectory of carbon emissions, climate sensitivity, and the impacts of any climate changes, all of which are uncertain. The cost may depend critically on controversial assumptions, such as what value to place on low-probability, catastrophic outcomes and what discount rate to apply in valuing damages far in the future [ 19 ]

As a result, the estimates of environmental costs are wildly different, with a mean of $196 per metric ton of carbon but a standard deviation of $322. Examining the social costs of carbon has become more common in governmental cost-benefit analyses in the U.S. over the last decade, because a court case in 2008 concluded that governmental analysts could not assume that carbon emissions reductions have no value [ 24 , 25 ]. Nevertheless, this literature generally ends with a wide range of measurements and an acknowledgment of uncertainty, since there are parameters that will forever remain outside the bounds of any attempt at calculation, such as the actions of future governments, and parameters that do not generate any consensus, such as the discount rate. Tol, in a metareview of these studies, concludes that “estimates of the social cost of carbon or the Pigouvian tax are highly uncertain and are very sensitive to the researcher’s assumptions about people’s attitudes toward the distant future, faraway lands, and remote probabilities” [ 26 ]. Governmental calculations have seen drastic revisions, ranging from $-10 to over $100, and changing from one year to the next the conclusion of the benefits of particular policies ([ 24 , 27 ]. Pindyck argues that the conclusions of these models are almost entirely a function of an arbitrarily chosen discount rate, and that these exercises “create a perception of knowledge and precision that is illusory, and can fool policy-makers into thinking that the forecasts the models generate have some kind of scientific legitimacy” [ 26 ].

Because of this uncertainty, rather than attempt to model the environmental benefits of carbon tax, most cost-benefit analyses of carbon tax take the approach of beginning with a specific emissions reduction target and determining only what is the most cost-effective way of reaching it, a goal which demands less information and therefore affords more certainty [ 19 ]. While this approach is sensible given the uncertainties and political controversies surrounding the measurement of environmental harm, it leaves the literature disproportionately oriented to economic costs, and silent on the possible environmental benefits of carbon tax: “Since existing empirical studies on carbon tax do not account for the benefits of mitigating climate change, the common findings are carbon taxes cause the economy to shrink … While the magnitude of carbon tax varies significantly [depending on] how the carbon tax revenue is recycled to the economy, the direction of impact is always negative, with few exceptions” [ 23 ].

For example, one study argues “Substituting carbon taxes for other sources of revenue or using the proceeds to reduce deficits or finance expenditures are the keys to integration of carbon taxes with proposals for fiscal reform” [ 11 ]. But the authors do not assess whether using the revenue to facilitate the development of alternative energy would result in more or less abatement of carbon emissions, examining only how cuts in tax rates or returning the revenue in a lump sum would affect abatement. And they do not include the environmental benefits in their conclusion: “We focus on the market consequences of the carbon tax and recycling policies. We do not consider the avoided damages and climate benefits that would accompany such policies”. Similarly, another study argues for using carbon tax revenues to reduce capital taxation [ 10 ]. The authors find that the carbon tax reduces CO2 emissions, but they do not include the benefits of this reduction in assessing the costs and benefits of the tax, and they do not assess whether using the revenue for environmental purposes could lead to greater reductions in CO2 emissions. Because the environmental benefits are out of the equation, these authors ignore the question of whether using carbon tax revenue for environmental purposes would lead to even greater emissions abatement and thus to even greater overall benefit.

As Nemet, Holloway, and Meier write, because these benefits are not considered in economic studies “the focus on cost minimization—rather than comparison of benefits and costs—diminishes the role of benefits in general”[ 28 ]. They note that targets for abatement levels are specified exogenously and treated as given in many carbon tax studies, and thus “the marginal damages of climate change do not influence choices among policy options” and “The resulting marginalization of climatic benefits has had the effect of excluding quantitative representation of benefits in general.”

Perhaps most striking is that the focus on quantifiable costs leads these scholars to criticize the policies that may be precisely the ones to have the most environmental benefits. For example, the success of carbon tax in the Nordic countries has been attributed to their use of carbon tax revenue to subsidize research and development into clear energy technologies. One study cites “compelling technological contingences or breakthroughs…a continued phase out of nuclear power; a rapid ramping up of onshore and offshore wind energy; a spectacular diffusion of electric vehicles; a massive increase in bioenergy production; and the commercialization of industrial scale carbon capture and storage” as the relevant factors in explaining the energy transition in the Nordic countries [ 29 ]. Other authors emphasize the development of substitute fuels as a primary factor in the reduction of climate emissions [ 4 , 30 ]. Using carbon tax revenue to subsidize research and development into clean energy technologies could thus be a means of accelerating technological innovation that gives firms the ability to reduce carbon emissions [ 31 ]. As Liscow and Karpilow argue, because innovations are non-linear and can build over time in a “snowballing” fashion, “To address social harms like climate change, government policy should encourage innovation in targeted areas” [ 32 ], giving clean energy technologies a “big push” that would fundamentally alter the trajectory of innovation.

But Timilsina [ 23 ] notes that when carbon tax revenues are used to subsidize renewable electricity and efficiency improvements, the existing models, which are not equipped to consider the environmental benefits, show only economic costs, because the policy is only “recycling the revenue from one distortionary policy (i.e., carbon tax) to finance another distortionary policy (i.e., clean technology subsidy).” The policies most likely to lead to the development and adoption of substitute cleaner-burning fuels are precisely the ones that are deemed too distortionary by the existing models, because their benefits—particularly the nonlinear benefits of rapid technology improvement—are not visible in the models.

The motivations behind decisions to leave out environmental benefits are understandable given the impossibility of calculating them, but the result is a scholarship that thoroughly explores the costs of carbon taxes to economic growth but is unable to consider the possible benefits to the environment. This leads to policy suggestions that may not be the most effective in reducing carbon emissions.

The new starve the beast

If the literature on carbon tax misses hidden benefits of carbon tax, it also misses a hidden danger: the carbon tax generates revenue only if individuals or firms are paying the tax, that is, if they are emitting carbon. To the extent that they are able to bypass the tax by substituting to lower-carbon substitutes—or to the extent that lower-carbon emitting firms drive out higher carbon-emitting firms—revenues from the tax fall. If those revenues have been used to substitute for other taxes, when revenues fall the programs funded with those revenues come under threat.

One study, for example, in analyzing the effect of carbon taxes in Canadian provinces, assumes fixed elasticities of response of fuel use to carbon taxes [ 33 ]. But given the immense research and development infrastructure that has been generated around environmental technologies, this assumption of fixed elasticities is questionable, and it may be necessary to model also the elasticity of the elasticity—that is, it may become much easier to improve energy efficiency or substitute renewable fuels than it is now. For example, the price per watt of solar photovoltaic cells has dropped from over $70 in 1977, to under 70 cents today. That kind of non-linear development in technology is common in the rapidly developing green technology sector, but it is not incorporated in the current models. Indeed, the most ambitious countries have aimed to become 100% free of fossil fuel, and in the Nordic countries 63% of electricity already comes from renewable energy [ 34 ; see also 30 ].

Consider McKibbin et al.’s argument for using carbon tax revenues to reduce capital taxation: “In that case, investment rises, employment and wages rise, and overall GDP is significantly above its baseline through year 25” [ 10 ]. But what happens when one introduces non-linear technological development, of the kind seen in the development of solar energy, into the model? The environmental benefits would of course be dramatic, but the revenues from the carbon tax would fall, because these newer technologies emit less carbon and thus generate less tax revenue. If capital taxes or other taxes have been cut, then the programs that were supported by the carbon tax revenue can only be financed through deficits, through new taxes, or through cuts in spending, none of which are included in the optimistic model about economic benefits. These developments may reduce some of those economic benefits. Stern and Stiglitz [ 1 ] argue that this would only happen over the very long run, but it is hard to be confident of this prediction given the rapid development of clean energy technologies.

In a sense, using carbon tax revenue to replace other tax revenue pits the goal of reducing environmental emissions against the goal of preserving revenue for government programs, because efforts to reduce carbon emissions will starve the government of funds. Of course, taxes could always be raised in the future if and when this problem arises, and Gillis [ 35 ] suggests tax cuts are often reversed or undone in subtle ways. However, in the American context, cutting taxes has become an important electoral tool, and politicians therefore have an incentive to spotlight and campaign against tax increases, making maintenance of tax revenue more difficult than in other countries [ 36 ]. Carbon taxes could thus become a new means of reducing the size of government by changing the default situation to one of declining tax revenues.

One strategy to mitigate this problem would be to incrementally raise the price of carbon emissions to keep government revenue fixed. For example, one study notes that the Swiss carbon tax “establishes a clear link between the rate and pre-defined quantitative reduction targets of CO2 emissions. In case reduction targets are not achieved an increase in the CO2 levy rate is triggered” [ 30 ]. Similar policies could be adopted to preserve government revenue, although these would make the carbon tax tougher to implement politically. Some scholars worry that policymakers will in fact privilege the preservation of revenue over the reduction of carbon emissions, keeping carbon emissions high in order to keep revenue high ([ 37 , 28 ]). A strategy to avoid this would be to avoid using the revenue for general government purposes altogether.

Policy implications

In Cents and Sensibility , Morton Schapiro tells the story of a World Bank report that evaluated a World Health Organization program to counteract river blindness in Africa. The WHO considered the program highly successful, as there was progress in stamping out the disease in 90% of the areas covered by the program, without going over budget. But when the World Bank tried to analyze the success of the program using traditional economic principles of cost-benefit analysis, the result was inconclusive. Schapiro writes: “If you count value in economic terms—changes in earnings discounted back to the present—the answer is, alas, not all that much [value generated] in areas with high unemployment and low educational achievement” [ 38 ]. Because the beneficiaries could not be expected to be particularly productive in economic terms, the economic benefits were not as large as they would be for those in contexts where the beneficiaries could be expected to earn more. The authors of the report noted “there are humanitarian benefits associated with reducing the blindness and suffering” but “these benefits are inherently unmeasurable, and we will not account for them here.” The benefits of curing blindness for large numbers of people simply do not enter the cost-benefit analysis.

In a way, this hesitation to tread where one’s methods do not go can be seen as admirable modesty. If the mandate is to measure the calculable benefits of a program, then clearly things that are not calculable are outside of one’s remit, and one should not try to force them into calculability. These calculations are best thought of as exercises, designed to shed light on some issues but not to provide a wholesale judgment on programs.

The problem arises when policymakers make decisions based on these partial analyses as if they were complete analyses. This behavior, too, is understandable: policymakers who care about evidence and analysis and rigor (which does not constitute the entirety of the population of policymakers) will gravitate toward studies that claim to provide it and may let themselves be guided by such studies. But if scholars are unwilling to consider incalculable benefits, policymakers who pay attention to scholars will be making decisions based on overestimations of costs and underestimations of benefits.

This phenomenon seems to be occurring today with the study of carbon tax. Decision-makers should be wary of relying on the economic scholarship for this reason.

Simply pointing out the insufficiency of these approaches, however, does not give us alternative principles for policy analysis and selection. Thus, rather than completely ignoring cost-benefit calculations, a better principle is that we should always examine cost-benefit calculations with an eye toward whether the unmeasurable factors are symmetrical or asymmetrical. If both costs and benefits have equal degrees of difficulty of measurement, cost-benefit analysis cannot be a guide to action. However, where, as in this case, there is a strong tendency for unmeasurable factors to be in one direction—the calculation of benefits—cost-benefit analysis can be a guide to action if it is taken as providing a lower bound. Despite the difficulties of measurement, the implications for policy in this case are clear: carbon tax is a more promising policy than cost-benefit calculations would lead us to believe. More precise measurement is not necessary to reach that conclusion.

But if there are unmeasurable benefits to carbon tax, there is also a hidden danger. If carbon taxes are substituted for other taxes, then the tax base of the state becomes dependent on the revenue from carbon taxes continuing. If that revenue declines—as it surely must, given the rapid development of alternative energy and energy efficiency technologies, which will make it easier for firms and individuals to reduce carbon emissions and therefore no longer need to pay the tax—then the tax base of the state declines.

Of course, there will be many who would celebrate the decline of the tax base and the pressure it puts on government to reduce spending. However, voters who are concerned about climate change and would be willing to support a carbon tax tend to be on the progressive part of the political spectrum. It cannot be assumed that they will be sanguine about a shrinking tax base. If carbon tax is to avoid losing support among such voters, a general principle is that it should not lead to an unintentional weakening of state capacity in future.

In the absence of the ability to measure and take into account environmental benefits, policy proposals cannot be made by drawing on precise measurements, but rather by drawing on general principles. The general principle to avoid unintentionally weakening state capacity gives us one way to evaluate various policy proposals for the use of carbon tax revenue.

• (1) Using the revenue to cut other existing taxes The discussion in the paper argues against this approach, because revenues from carbon tax are destined to—indeed, intended to—decline. In fact, this is the main approach that should not be adopted according to the principles suggested in this paper. For example, a popular suggestion is to reduce taxes on labor to lessen the regressivity of carbon tax. However, taxes on labor such as payroll taxes fund highly popular programs, including Social Security and Medicare in the U.S., and other welfare programs in other countries. Pinning these programs on a revenue base that is destined to shrink is a stealth politics of shrinking the welfare state.
• (2) Merging the revenue with tax revenue from other sources Similarly, if the revenue from carbon tax has been merged into general revenue, general revenues will eventually decline. While they would be declining from a higher base given the addition of the carbon tax revenue, and asymptotically to the same level as before, the danger is that necessary programs will come to depend on carbon tax revenue and will eventually be threatened as revenues decline. If carbon tax revenues are not clearly distinguished from other revenue sources, there will be no structural ability for policymakers to protect necessary programs from what is in fact a temporary tax base.
• (3) Using the revenue to reduce debt Using carbon tax revenue to reduce debt is a plausible use of the revenue. In an ideal scenario, by the time carbon tax revenues start to decline, significant headway will have been made in eliminating or substantially reducing debt, leading to benefits for the economy. The temporary nature of carbon tax revenues is not a disadvantage in this case because they will have contributed to reduction in the stock of debt. They can be seen as transitional revenues with a temporally limited purpose, lowering levels of debt. This may not be the best use of carbon tax revenue, however, if interest rates remain low. This approach also seems to be unpopular with the American public [ 39 ].
• (4) Using the revenue to lessen the regressivity of the carbon tax Carbon tax revenue could be used to carve out exemptions to the carbon tax for lower-income households. This does not violate the principle of preserving state capacity, and because the decline of carbon tax revenue implies that the costs the tax inflicts are declining, the exemptions become less necessary as revenue declines. However, this approach lowers incentives for emissions reductions among households who have been given exemptions.
• (5) Returning the revenue to households in a lump sum For that reason, it may be better to collect the revenue without exemptions, and then return it to lower-income households, or to all households, as “carbon dividends.” Returning it to lower income households would lessen regressivity, while returning it to all households would increase the proposal’s popularity. As carbon tax revenue declines, these dividends would decline, but no other aspect of state capacity would be threatened. Many have argued that this approach would be the one most likely to generate broad political support among the public [ 17 ], and [ 40 ] show that even a universal dividend not targeted to the poor would disproportionately benefit the poor, because the wealthy produce more carbon emissions and would pay more of the tax.
• (6) Using the revenue to subsidize environmentally beneficial technologies or policies Finally, one strategy would be to implement carbon tax but use the revenues to promote the growth of energy efficiency and alternative energy technologies. In Denmark, which boasts perhaps the most successful carbon tax, 40% of tax revenue was used in ways that led to the promotion of clean energy technology [ 31 ]. Polls find this use of carbon tax revenue to be the most popular among the American public, even generating majority support among Republicans [ 39 , 41 ]. There are several concerns to consider in designing such a policy: if not designed carefully, policies to promote green technology can end up benefiting the wealthy [ 42 ]; not all governments have been as successful as Denmark in using carbon revenue for productive clean energy purposes [ 35 ]; and clean energy technologies can be funded through measures other than carbon tax. Nevertheless, if designed carefully such a policy could help to reach climate goals that cannot be reached directly through carbon tax. For example, there are some areas where individuals or businesses may be unable to reduce carbon emissions because cleaner-burning fuels are not available; carbon tax revenue could be used for research and development in such areas [ 8 ]. Industries exposed to trade may also require government assistance to reduce emissions [ 43 ].

This paper thus argues for ways that policymaking can be informed by evidence but not led astray by the false precision of cost-benefit estimates. As this discussion shows, even without precise measurements, we can develop principles that can lead us to favor carbon taxes, but to reject the option of using carbon tax revenues to reduce other taxes, and to be wary of merging carbon tax revenue into general revenue, the first two of the six options above. While options three and four respect the principle of integrity of the tax base, they have other disadvantages.

The last two options combined—carbon dividends plus funding for green technology—could produce an emissions reduction policy that generates public support, follows the advice of economists, takes into account the hidden as well as visible benefits of carbon tax, and also responds to the basic principle suggested here: don’t use a temporary source of revenue to make permanent changes in the tax code.

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Carbon taxes could make significant dent in climate change, study finds

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Putting a price on carbon, in the form of a fee or tax on the use of fossil fuels, coupled with returning the generated revenue to the public in one form or another, can be an effective way to curb emissions of greenhouse gases. That’s one of the conclusions of an extensive analysis of several versions of such proposals, carried out by researchers at MIT and the National Renewable Energy Laboratory (NREL).

What’s more, depending on the exact mechanism chosen, such a tax can also be fair and not hurt low-income households, the researchers report.

The analysis was part of a multigroup effort to apply sophisticated modeling tools to assess the impacts of various proposed carbon-pricing schemes. Eleven research teams at different institutions carried out the research using a common set of starting assumptions and policies. While significant details differed, all the studies agreed that carbon taxes can be effective and, if properly designed, need not be regressive.

An overview report on the 11 studies appears today in the journal Climate Change Economics, along with reports on the individual team results. The MIT and NREL team included former MIT postdoc Justin Caron, MIT Joint Program on the Science and Policy of Global Change Co-Director John Reilly, and Stuart Cohen and Maxwell Brown of NREL.

Reilly, who is a senior lecturer at MIT’s Sloan School of Management, says the groups looked at several options for a carbon tax and use of the resulting revenue. They considered two different starting values ($25 and $50 per ton of carbon emissions produced), and two different rates of increase (1 percent or 5 percent per year), as well as three different approaches to dispensing the revenue: an equal rebate to every household, a tax break for individuals, or a corporate tax break.

Of the different levels of fees, the team found, not surprisingly, that the highest starting value and the highest rate of increase produced the greatest emissions reductions. But the study showed that even the lowest taxation rates could in themselves lead to reductions sufficient to meet the U.S. near-term commitmtent under the 2015 Paris Agreement on climate change, Reilly says.

However, the most efficient way of achieving those reductions, in terms of overall impact on the economy, is to use the revenue to reduce taxes on capital — corporate profits or investment income. Given the relatively high capital taxes in the U.S. (at the time this study was completed) such cuts spur economic growth more than cuts in other taxes or direct rebates to households. However, that option is also the most regressive, with its impact disproportionally falling on lower-income households.

At the other extreme, the option of sending equal payments to everyone was found to be the least efficient for the overall economy, but also the least regressive. Individual tax breaks came in somewhere in between on both criteria.

But the researchers say another scenario, combining the basic strategy of providing tax breaks to corporations but adding a rebate to the low-income families most affected by the tax, could virtually eliminate the regressive aspects of the tax at very little cost in overall efficiency, and thus might be the most appealing option. It could have appeal both for conservatives concerned about the costs of such a program, and for liberals concerned about its possible impacts on those at the lower end of the economic spectrum.

“It’s sort of an obvious solution,” Reilly says, “to take some chunk of the money and use it to focus on the poorest households, and use the rest to cut taxes. It doesn’t seem like a hard thing.” He continued: “It is important to realize that this study was completed before the tax reform that took effect in January that slashed corporate income tax rates. Given that these tax rates have now been cut, and that those cuts will contribute to a growing deficit, we might better consider the revenue as a contribution to closing the deficit.”

Reilly’s team used an economic model developed at MIT to assess the impacts of different policies on the world’s likely climate trajectory, and combined that with a model of the nation’s electrical system, developed at NREL. This combination allowed the team to do a much more detailed assessment of the way different policies would affect decisions by the power producers and distributors — a key point, since the electricity sector has the most immediate potential for changes that could reduce emissions, and is the biggest contributor to emissions overall.

While some versions of the carbon-pricing plan were found to be more efficient overall in terms of their impact on the economy, the study found that those impacts are actually quite modest — even without taking into account potential advantages such as better health due to lowered pollution levels. The least-efficient policies still achieved significant emissions reductions, with an overall impact of just four-tenths of a percent on economic growth. For the more efficient options, the same reductions could be achieved at zero cost, or even a net gain to the economy, the researchers found.

Their analysis indicates that starting with a $50 per ton carbon tax and increasing it by 5 percent per year would lead to a 63 percent reduction in total U.S. greenhouse gas emissions by 2050, Reilly says. “So that’s in line with what people are talking about, which is needing a 50 percent reduction by 2050, globally,” he says, “and getting to net zero beyond that.”

Caron, the paper’s lead author, who was an MIT postdoc during most of this research but is now a professor at HEC business school in Montreal, says that all of the different research teams largely found similar results, though there were differences in the details. “Qualitatively, we all agree on many of the main conclusions.” That includes the fact that carbon taxes can indeed be an effective way to curb emissions.

“By taxing carbon,” Caron says, “we will collect a lot of money that can be used to supplant other taxes that we like less. Why tax something that we like?” And, he adds, by using just a small portion of that revenue — less than 10 percent — it’s possible “to compensate the lower-income people and neutralize the regressivity.”

The actual Paris agreements involved a range of different targets by different nations, but overall, Reilly said, the carbon-pricing scheme is predicted to exceed the targets for emissions reductions for 2030 and 2050, “so that’s a healthy reduction.” But even at the lowest end of the policies they studied, with a $25-per-ton initial tax,” that “would be adequate to meet the U.S. pledge in Paris” for 2030. But the rate of increase is important, the study says: “Five percent a year is sufficient. One percent a year is not.”

Reilly says “all these tax scenarios at worst meet U.S. commitments for 2030, and the $50 tax is well exceeding it.” Many experts say the Paris Agreement alone will not be sufficient to curb catastrophic consequences of global climate change, but this single measure would go a long way toward reducing that impact, Reilly says.

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• Journal of Economic Literature
• December 2022

Carbon Taxes

• Govinda R. Timilsina
• Article Information

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JEL Classification

• Q58 Environmental Economics: Government Policy

The Macroeconomic Effects of a Carbon Tax to Meet the U.S. Paris Agreement Target

We explore the quantitative impact of a carbon tax that reduces emissions by 35 percent—a target consistent with the Biden Administration’s new commitment under the Paris Agreement— on labor market and macroeconomic outcomes in a model with equilibrium unemployment and pollution externalities. In contrast to existing quantitative studies, our framework incorporates two key margins of adjustment to carbon taxation: firm entry and green technology adoption. Under a scheme where carbon-tax revenue is transferred lump-sum to households, we show that the tax bolsters labor income, consumption, output, and labor force participation, with marginal adverse unemployment effects. In addition, the carbon tax does not require short-term output or consumption costs as the economy adjusts to the higher carbon tax. Our findings highlight the importance of considering endogenous technology adoption in assessments of the aggregate effects of a carbon tax.

The potential adverse effects of taxing carbon emissions on firms, job creation, employment, and aggregate economic activity are a central theme in current discussions of environmental policy. This topic has taken on greater importance with the Biden Administration’s April 2021 Paris Agreement commitment to reduce greenhouse gas pollution by roughly 50% from 2005 levels by 2030 – an ambitious target.

We analyze the effects of a carbon tax in a general equilibrium framework with labor search frictions, an endogenous production structure, and pollution externalities.  We extend existing  analyses by introducing pollution externalities and a focus on how firms’ decisions over entry and technology adoption are influenced by the carbon tax. Our model incorporates two margins of adjustment that have been jointly absent in existing quantitative analyses of carbon taxes: (1) firm entry and (2) firms’ choices over (polluting vs. green) production technologies.

These margins are important for a comprehensive assessment of the aggregate impact of carbon taxation for at least two reasons. First, the regulatory costs associated with the environmental policy not only affect the labor and capital decisions of existing firms—an intensive margin of adjustment to a carbon tax—but also the incentive of potential firms to enter the market in the first place. In turn, firm entry and exit has direct implications for job creation and aggregate economic activity. Second, a carbon tax shapes firms’ relative costs of production and, in doing so, influences the relative merits of adopting green technologies – an extensive margin of adjustment to this tax.

Our model uses a carbon tax scheme designed to reduce long-run emissions by 35 percent and rebate carbon-tax revenue lump-sum to households. We find that this policy can generate mild, positive, long-run effects on consumption, output, employment, and labor force participation; negligible long-run adverse effects on unemployment; and a long-run increase in both the number and the share of firms that adopt green technologies. In our simulations, the 35% reduction is achieved in five years, making the Biden Administration’s 2030 target feasible. Moreover, the transition path to an economy with lower emissions need not entail short-term reductions in consumption, output, or labor force participation. Since some of the output increase is used for fixed costs of adopting green technologies, increases in consumption or output does not necessarily imply welfare increases.

The absence of significant adverse aggregate effects from a carbon tax are at odds with those documented in existing quantitative studies on the macroeconomic effects of carbon taxes in literature. Indeed, these studies, which abstract from firms’ ability to adopt different technologies in response to policy, find that for similar carbon tax-induced reductions in emissions, a carbon tax has non-trivial negative effects on labor, labor income, consumption, and output. Our analysis differs by stressing the role of firm entry and green technology adoption decisions in shaping the net positive effects of a carbon tax on aggregate outcomes and the limited adverse effects on unemployment. Specifically, firms’ ability to choose green production technologies leads to policy-induced endogenous changes in the economy’s technological (regular vs. green) composition of aggregate production—an effect that is absent in models that abstract from green technology adoption. This technological composition effect is the central mechanism behind the positive effects of a carbon tax on consumption and output.

In our model with endogenous technology adoption decisions, along with firm entry and exit, a carbon tax triggers endogenous changes in both the market structure and in the economy’s technological composition of production—that is, the prevalence of polluting versus green production technologies in the aggregate production process. These policy-induced endogenous changes improve the economy’s average firm productivity and cost profile and, in doing so, lead to improved labor market and macroeconomic outcomes. The heart of our model, and a key finding of our analysis, is that endogenous changes in the economy’s dirty-clean technological composition of production that arise as an indirect result of taxing emissions, can play a decisive role in shaping labor-market and macroeconomic outcomes in response to a carbon tax. These changes can potentially generate positive (albeit small) macroeconomic and welfare effects.

Finkelstein-Shapiro, A. and G. Metcalf (2022), “The Macroeconomic Effects of a Carbon Tax to Meet the U.S. Paris Agreement Target: The Role of Firm Creation and Technology Adoption,” MIT CEEPR Working Paper 2022-013, September 2022.

Further Reading:  CEEPR WP 2022-013

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Impact of Environmental Protection Tax on carbon intensity in China

• Research Article
• Published: 08 April 2024

Cite this article

• Shen Zhong 1 ,
• Zhicheng Zhou 1 &
• Daizhi Jin   ORCID: orcid.org/0009-0002-5540-8583 2  

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In the context of increasingly severe global climate change, finding effective carbon emission reduction strategies has become key to mitigating climate change. Environmental Protection Tax (EPT), as a widely recognized method, effectively promotes climate change mitigation by encouraging emission reduction behaviors and promoting the application of clean technologies. Based on data from 282 cities in China, this paper takes the official implementation of the EPT in 2018 as the policy impact and the cities with increased tax rates for air taxable pollutants as the treatment group and uses DID model to systematically demonstrate the relationship between the implementation of the EPT and carbon intensity (CI) and further explores the possible pollutant emissions and green innovation mediating effects. The findings show that (1) the implementation of EPT can effectively reduce CI by about 4.75%, and this conclusion still holds after considering the robustness of variable selection bias, elimination of other normal effects, policy setting time bias, and self-selection bias. (2) The implementation of EPT can reduce CI by reducing pollutant emissions and improving the level of green innovation. (3) There is obvious regional heterogeneity in the carbon reduction effect of EPT, and the implementation of EPT has a more significant effect on CI in medium-tax areas, low environmental concern areas, general cities, and eastern regions. This paper not only provides a new analytical perspective for systematically understanding the carbon emission reduction effect of EPT but also provides policy insights for promoting regional green transformation and advancing carbon peak carbon neutralization.

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Data Availability

All data used in this study are available from the corresponding author upon request. Readers interested in the data presented in this article or seeking further information are encouraged to contact the corresponding author directly for data support. We commit to providing the necessary data as much as possible, according to research needs and subject to adherence to relevant data protection regulations.

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Abbreviations

• Environmental Protection Tax
• Carbon intensity
• Green innovation

Pollutant emissions

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This study appreciates support for a fund: 2023 Ministry of Education Humanities and Social Sciences Planning Fund Project “Research on the Dilemma of Labor Rights and Interests Protection for Employees in New Businesses and Governance” (Project Approval No. 23YJA840007).

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The distributional effects of a carbon tax: The role of income inequality

The fact that a carbon tax is an environmentally and economically efficient instrument for reducing emissions is often highlighted, but the equity story is also of importance: who bears the burden of the tax? This paper addresses the question of the distributional burden of a carbon tax.

The authors show that it is not only the income measure that matters for the incidence of the tax, but also the underlying distribution of income across a society. They look at the Swedish carbon tax on transport fuel and its impacts on different income groups over the period 1999–2012. The overall trend is towards an increase as time goes on in the burden borne by lower income groups – i.e. in regressivity – which is highly correlated with the increase in income inequality that has occurred in Sweden in recent years.

The authors find evidence to support their hypothesis that for expenditure on necessities, rising income inequality increases the regressivity of a tax on consumption. To mitigate climate change, a carbon tax should be applied to goods that are typically characterised as necessities: transport fuel, food, heating and electricity. Carbon taxation is thus likely to be regressive in high-income countries, and increasingly so, the more unequal the distribution of income.

Given the importance of carbon taxation for reducing emissions globally, policymakers therefore need to design carbon tax policy that includes revenue-recycling mechanisms, reductions of distortionary taxes, or other means to offset the regressive effect.

Key points for decision-makers

• This is the first empirical study of carbon and fuel tax incidence that looks at a longer time period than just one specific year.
• The authors examine if there is empirical evidence to support the common assertion that carbon taxes are regressive, and what are the most important determinants of carbon tax incidence – i.e. the factors in where the burden will fall.
• They study the Swedish carbon tax on transport fuel, using data from 1999–2012 on carbon tax expenditure from a large annual household expenditure survey: the tax mainly affects the transport sector and so the analysis focuses only on the carbon tax part of households’ expenditure on gasoline/petrol and diesel.
• Carbon tax burden is measured as the percentage of a household’s income that is spent on the tax. The authors use measures of annual income, measured as disposable income in any given year; and lifetime income, where total expenditure in a year is used as a proxy.
• The differences in size of the carbon tax budget share across income groups determines the distributional effect. If the budget share decreases with a move up the income distribution, the tax will be regressive, and the incidence will be progressive if the budget share increases with income.
• Measured against annual income the tax had regressive impacts; progressive impacts were recorded when using a measure of lifetime income.
• The authors find that the most important variable explaining variations in regressivity over time in Sweden is changes to income inequality, measured by the Gini coefficient – where 0 equates to complete equality and 100 to complete inequality. They show that at a Gini below 22 the Swedish carbon tax is progressive, and that above a Gini of around 30 the tax is regressive. Income inequality has grown in Sweden since the tax’s implementation in 1991 (to 26.9 in 2012), leading to a more regressive outcome from the tax over time.
• In analysing previous studies of gasoline tax incidence across OECD countries the authors find a similar strong correlation between regressivity and income inequality: for those countries, below a Gini of 24 a gasoline tax will be progressive and above 29 it will be regressive, using both annual and lifetime income.

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• Published: 24 January 2022

Limited impacts of carbon tax rebate programmes on public support for carbon pricing

• Matto Mildenberger   ORCID: orcid.org/0000-0001-5784-435X 1 ,
• Erick Lachapelle   ORCID: orcid.org/0000-0002-0808-0688 2 ,
• Kathryn Harrison 3 &
• Isabelle Stadelmann-Steffen   ORCID: orcid.org/0000-0003-3441-4757 4  

Nature Climate Change volume  12 ,  pages 141–147 ( 2022 ) Cite this article

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Revenue recycling through lump-sum dividends may help mitigate public opposition to carbon taxes, yet evidence from real-world policies is lacking. Here we use survey data from Canada and Switzerland, the only countries with climate rebate programmes, to show low public awareness and substantial underestimation of climate rebate amounts in both countries. Information was obtained using a five-wave panel survey that tracked public attitudes before, during and after implementation of Canada’s 2019 carbon tax and dividend policy and a large-scale survey of Swiss residents. Experimental provision of individualized information about true rebate amounts had modest impacts on public support in Switzerland but potentially deleterious effects on support in Canada, especially among Conservative voters. In both countries, we find that perceptions of climate rebates are structured less by informed assessments of economic interest than by partisan identities. These results suggest limited effects of existing rebate programmes, to date, in reshaping the politics of carbon taxation.

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In recent years, over 3,500 US economists, including 27 Nobel prize winners 1 , and 1,600 European economists 2 have signed public statements advocating carbon taxation. As a policy tool, carbon taxes offer theoretical cost effectiveness, price stability and administrative simplicity. However, these potential economic advantages can come with a steep political price. Carbon taxes have been rejected in referenda and elections 3 , 4 , 5 , 6 , 7 , been reversed after political backlash 8 , 9 , been opposed by a substantial proportion of the public 10 , 11 , 12 and generated political controversy whenever debated across advanced democracies 9 , 11 , 13 , 14 , 15 , 16 . Scholars have identified diverse barriers to public acceptance of carbon taxes, including perceptions that the policy will not reduce emissions, that it is too costly, that it is regressive and that it might undermine economic prosperity 10 , 11 , 17 , 18 , 19 , 20 .

In response to this opposition, interest has grown in deploying carbon tax revenues to boost public support. Carbon tax revenues can be directed towards environmental spending 4 , 6 , 7 , 17 , 21 , 22 , 23 , 24 , 25 , 26 , 27 , 28 , 29 , 30 or can be paired with tax cuts, although this latter approach may be less effective than green spending at reducing public opposition 23 , 24 , 28 , 30 , 31 or only effective for some voters 22 , 32 , 33 . However, earmarking through either spending or tax cuts may lack high visibility 6 , 34 , and voters may distrust that governments will deliver or maintain these benefits 23 , 33 , 35 , 36 . Instead, it has been suggested that highly visible lump-sum rebates or ‘dividends’ could be more effective in winning public support and reinforcing that support over time as beneficiaries become accustomed to regular dividends 37 . The hypothetical potential of climate rebates to increase public carbon pricing support has been shown in the United States 4 , 17 , 20 , 21 , 29 , Canada 38 , Norway 35 , Switzerland 39 , the United Kingdom 4 , 30 , Australia 4 , Germany 17 , Turkey 27 , France 40 and India 4 . These studies offer strong reasons to expect that bundling carbon taxes with lump-sum rebates could increase public acceptance.

However, other studies offer more sobering assessment. Surveys measuring public support for hypothetical policies may overestimate voters’ support when confronted with real-world costs. For example, polling overestimated voter support for failed carbon tax referenda in Washington state 5 and Switzerland 39 . Voters’ perceptions of rebate costs and benefits may also be shaped by competing partisan and interest-group narratives 5 , 40 , 41 . More broadly, voters are often unaware they receive even high-profile government benefits 42 .

In light of these competing perspectives, the political impact of climate rebates requires testing in the context of real-world policies, as they are implemented. Two such policies currently exist, in Canada and Switzerland. In Canada, the federal government imposed a carbon tax and rebate scheme for households as part of its national strategy for pricing carbon in 2019, which currently applies in four of the country’s ten provinces (covering over half of the Canadian population). The tax was initially set at 20 Canadian dollars (Can$20) per tonne, rising to Can$50 per tonne by 2022. In December 2020, the government announced a revised schedule increasing to Can$170 per tonne by 2030. The associated rebate, called the Climate Action Incentive Payment, is based on the number of adults and children in each household, with a 10% increase for rural households. It is delivered through an income tax credit to one adult per household. All tax revenues are returned to the province of origin. Because provincial emissions per capita vary widely, rebate sizes also vary by province. For example, the average dividend in Saskatchewan is almost double that in Ontario. The policy is highly progressive, with 80% of households receiving more in dividends than they pay in carbon taxes 43 . Supplementary Section 1 details Canadian federal and provincial carbon pricing.

By contrast, Switzerland established its climate rebate programme in 2008 as part of an escalating carbon tax that reached 96 Swiss francs (CHF96) per tonne by 2018. In Switzerland, roughly two-thirds of revenue is redistributed to businesses and the public. Public rebates are given on a per capita basis, with every person (including children) receiving an equal amount. Citizens receive their rebates as a discount on their health insurance premiums, with annual notifications about this monthly benefit through health insurance forms. In a June 2021 referendum, Swiss voters narrowly rejected a climate law that would have increased the carbon tax level and associated rebate amounts. Supplementary Section 2 details the Swiss policy context.

We evaluate the effect of real-world dividends on public support for carbon taxes in both countries. In Canada, we report an original five-wave panel survey of Canadians from February 2019 to May 2020. Our sample included residents from five provinces, two subject to the federal carbon tax (Saskatchewan and Ontario), one with provincial emissions trading (Quebec) and two with provincial carbon taxes (British Columbia and Alberta). Alberta repealed its provincial tax midway through our study, prompting introduction of a federal-tax and rebate scheme in 2020. We surveyed the same respondents after the federal carbon tax was announced but before it was implemented (February 2019), soon after implementation (April 2019), after residents of federal-tax provinces received their rebates (July 2019), after a federal election in which carbon pricing was a prominent issue (November 2019) and one year after policy implementation (May 2020). In wave 4, we embedded a survey experiment exposing respondents to individualized information about their actual rebates. In Switzerland, we fielded a survey of 1,050 Swiss residents in December 2019, which also included an embedded survey experiment where respondents were exposed to information on their actual policy rebates. We provide full details on Canadian and Swiss surveys in Methods .

We begin with data from our longitudinal Canadian survey, visualizing public support for carbon pricing by province over time (Fig. 1 ). Canadian carbon tax support remained relatively stable across our panel. In the rebate province of Ontario, public support by wave 5 was within two percentage points of wave 1. However, between waves 1 and 4, carbon pricing support did increase in the rebate province of Saskatchewan, before declining through wave 5 for a net gain of five percentage points to 32%. The final wave followed the onset of the COVID-19 pandemic, although COVID incidence in rebate provinces was still low; for example, in Saskatchewan, there had been a total of only 176 cases and 2 COVID-related deaths in advance of wave 5 (ref. 44 ). Federal COVID-related financial assistance was already available to respondents by this time. Trends in carbon pricing opposition are similar (Extended Data Fig. 1 and Supplementary Section 4 ). We also conduct exploratory statistical analysis comparing trends in rebate versus non-rebate provinces (Supplementary Section 5 ).

The dotted line indicates when the federal carbon tax policy came into effect. The solid line indicates the approximate period during which households received their climate rebates. The dashed line indicates the timing of a federal election in which the carbon tax was highly salient. Respondents in Saskatchewan and Ontario received climate rebates. Data from respondents who completed all five waves ( n  = 899). Error bars depict 95% confidence intervals. Supplementary Section 3 reproduces this figure for the first four waves only ( n  = 1,190), finding identical trends across this expanded sample.

These provincial averages mask strong partisan differences in carbon pricing support (Fig. 2 ). Policy support was concentrated among Liberal Party of Canada supporters (the party that implemented the policy) versus Conservative Party of Canada supporters (the opposition party that strongly opposed it) and remained stable through time. Conservative opposition persisted in both federal-tax (rebate) and provincial pricing (non-rebate) provinces. By wave 5, 75% and 81% of Liberal Party supporters in Ontario and Saskatchewan, respectively, supported carbon pricing, compared with 32% and 13% of Conservative Party supporters in these same provinces. Partisan splits across rebate and non-rebate provinces show similar trends (Extended Data Fig. 2 and Supplementary Section 6 ). These partisan differences persist even after conditioning on respondents’ individual cost exposure (Extended Data Fig. 3 and Supplementary Section 7 ).

The dotted line indicates when the policy came into effect. The solid line indicates the approximate period during which households received their climate rebates. The dashed line indicates the timing of a federal election in which the carbon tax was highly salient. Voters are classified according to their wave 1 (pre-policy implementation) party preferences. Albertan respondents are excluded because Alberta switched from being a non-rebate province to being a rebate province between waves 1 and 5. Error bars depict 95% confidence intervals.

For rebate policies to offer political benefits to incumbent governments, the public must perceive those benefits 42 , 45 . We test public knowledge about existing rebate programmes in both Canada and Switzerland. We first test Canadian respondents’ specific knowledge about their rebates. In wave 3, immediately after residents of Ontario and Saskatchewan received their rebates, we asked respondents whether they had received a climate-related benefit as part of their federal income tax returns (Supplementary Section 8 ). Many Canadians did not know, including 17% in rebate provinces and between 33% and 36% in non-rebate provinces. In Ontario, only 55% of residents correctly believed they had received a rebate, while Saskatchewan residents were more aware (75%). By contrast, about 11% and 13% of individuals in the non-rebate provinces of Alberta and British Columbia incorrectly reported rebate receipt.

We then asked respondents to estimate the size of any rebate they believed their household had received (Table 1 ). We compare perceived amounts to the true average rebate for our survey respondents (see Methods for details). Residents in non-rebate provinces nonetheless estimated a positive average rebate amount, a misperception that continued after the fall 2019 election (Supplementary Section 9 ). In rebate provinces, our survey averages reflect a 40% underestimation in Saskatchewan and 32% underestimation in Ontario of true rebate amounts. Limiting our analysis to respondents who correctly believed they had received a rebate, the Ontario average estimate was CDN$198 (standard error (s.e.) $13), only a 9% underestimation, and the Saskatchewan average estimate was CDN$315 (s.e. $13), a 29% underestimation. Still, only 24% of Ontario respondents and 19% of Saskatchewan respondents estimated a rebate amount falling within CDN$100 of their true rebate (Extended Data Fig. 4 and Supplementary Section 10 ). These misperceptions are associated with party preference. In both provinces, respondents who consistently indicated they would vote for the anti-carbon tax Conservative Party systematically estimated lower rebate amounts (Supplementary Section 10 ). We also find persistent confusion among respondents as to whether the provincial or federal government is responsible for carbon pricing in their province, with some learning across the panel (Supplementary Section 11 ).

We conduct a similar analysis in Switzerland. Consistent with previous surveys 7 , 46 , we find limited knowledge of the Swiss rebate policy. Although the policy has been in place for over ten years, only 12% of respondents knew tax revenues were redistributed to the public, and 85% did not know they received a health bill discount associated with the country’s carbon tax (Fig. 3 ). Every Swiss resident receives CHF5.35 per month (in 2019) as their rebate, but only 13% of respondents knew (or correctly guessed) the monthly rebate was between CHF3 and CHF10.

a – d , Responses to survey questions: belief that Switzerland has a carbon tax on fossil fuels ( a ), belief regarding what most carbon tax revenue is directed towards (b), belief regarding what tax revenue is redistributed to reduce (c), perceived monthly rebate size (d). Correct choices are highlighted in green.

Low public awareness of rebates in Canada and Switzerland may stem from the indirect mechanisms through which governments in both countries redistribute their climate dividends. Using two survey experiments, we assess whether increasing rebate awareness through individualized rebate information increases support for existing and future carbon taxes. Here, low existing public knowledge allows us to randomize information about government benefits that respondents already receive, providing a second-best approximation for experimental manipulation of rebate receipt itself. However, our experiments ultimately identify the effect of information about rebates on public support, not the direct effect of rebates themselves. These experiments also focus on testing information about policy benefits, rather than policy costs.

In Canada, half of wave 4 survey respondents from Ontario and Saskatchewan ( n  = 605) were randomly assigned a custom mock-up of their own tax return with their true climate dividend prominently displayed (Supplementary Section 12 describes treatment; Methods describes calculation details; Supplementary Section 13 shows experimental balance.) Receiving treatment led respondents to increase perceptions of their household’s rebate size, suggesting at least partial updating in the treatment group (Supplementary Section 14 ). However, treatment did not change carbon pricing support (Fig. 4a : Difference-in-Means (DIM) = –0.0342, s.e. = 0.106, P  = 0.747). Instead, information about their true benefit decreased respondents’ belief that the rebates were sufficient to cover their tax exposure (Fig. 4b : DIM = –0.136, s.e. = 0.0662, P  = 0.0398). As such, Canadians who learned the true value of their rebates were significantly more likely to perceive themselves as net losers even though most Canadians are net beneficiaries. This shift was concentrated among Conservative Party of Canada supporters (DIM = –0.213, s.e. = 0.102, P  = 0.0391).

a , b , Exposure to individualized information about a respondent’s true climate rebate amount in Canada did not shape carbon pricing support ( a ) but instead generated a backlash by making respondents believe they paid more in tax than they received as their rebate ( b ). Full sample is in black, with subgroups defined by wave 4 party preference. Error bars depict 95% confidence intervals. NDP, New Democratic Party.

In our December 2019 Switzerland survey, half of respondents were randomly assigned an encouragement treatment to leave their computers mid-survey and retrieve their health insurance forms; respondents were then asked to report the size of their benefit. All treated respondents were then shown a sample health form with benefit size highlighted (Supplementary Section 15 provides example), irrespective of whether they reported having found their personal form (Supplementary Section 16 shows experimental balance). Unlike in Canada, we find personal rebate information increased support for the current scheme on a four-point scale by around one-fifth of a standard deviation (DIM = 0.18885, s.e. = 0.06155, P  < 0.01; Fig. 5a ). These results hold on both the right and left sides of the political spectrum but not for centre-party supporters. However, treatment had no effect on support for either small (equivalent to CHF0.03 per litre increase in heating oil costs; DIM = 0.06213, s.e. = 0.09744, P  = 0.524) or large (equivalent to CHF0.15 per litre increase in heating oil costs; DIM = 0.11182, s.e. = 0.09396, P  = 0.235) increases in the Swiss carbon tax rate.

a – c , Exposure to individualized information about a respondent’s true climate rebate amount in Switzerland increased support for the existing policy ( a ) but not support for either small ( b ) or large ( c ) future carbon tax increases. Full sample in black, with subgroups based on ideological position of preferred political party (Supplementary Section 17 provides classification details). Error bars depict 95% confidence intervals.

Beyond low visibility, we also consider alternative reasons for the weak effects of rebates on public opinion. In Canada, carbon pricing preferences might have remained relatively stable despite rebates because the political benefits of revenue recycling came with policy announcement (before our wave 1), not during implementation (our panel period). Two pieces of evidence suggest this as unlikely. First, we find little baseline knowledge about the rebate in wave 1, which we would expect if anticipation of future rebates had already increased support (Supplementary Section 11 ). Second, the announcement of a federal rebate policy for Alberta occurred between waves 2 and 3, after a newly elected provincial government repealed the provincial tax, which did not provide universal rebates. This prompted the federal government to step in to announce it would impose a tax and rebate policy over the objection of the provincial government (as in Saskatchewan and Ontario.) However, we find no announcement effect in Alberta, where carbon pricing support trends roughly in parallel with other provinces after policy announcement (Fig. 1 ).

Another possibility is that policy preferences remain conditioned primarily by partisanship. We find that Conservative Party supporters are more likely than Liberal Party supporters to acknowledge having seen negative ads about carbon pricing and to report that these ads made them less supportive of this policy (Supplementary Section 18 ). Similarly, respondents who report having voted for the Conservative Party in the Fall 2019 election were more likely to underestimate their rebates, even when exposed to information about their true rebate amount in our survey experiment (Supplementary Section 19 ). More broadly, in the two federal-tax provinces, supporters of the Liberal Party of Canada were three to eight times more likely to support the carbon tax than were Conservative Party supporters. Similarly, in Switzerland, left-leaning voters were 48% more likely to support rebates relative to right-leaning voters. In short, partisanship does structure both carbon tax preferences and patterns of rebate responsiveness.

Finally, our Canadian results might be a function of survey design effects. However, we find no such effects using independent samples of provincial respondents across the survey’s first four waves (Supplementary Section 20 ). Accordingly, response consistency in panel surveys is unlikely to account for weak rebate effects 47 .

Overall, our results speak to growing interest in recycling carbon tax revenues in the form of lump-sum rebates to mitigate persistent public opposition to carbon taxes. We explore existing policies, as implemented, in Canada and Switzerland using a new longitudinal opinion panel as well as two survey experiments. We find only limited evidence that these existing policies have reshaped the politics of carbon pricing to date. Members of the public in both countries remain ill-informed about the rebates they are already receiving and systematically underestimate their size. These low levels of awareness may stem from rebates delivered via a credit against a (tax or insurance) bill rather than a more-visible check in the mail and, in the case of Canada, a highly politicized communication environment. Still, experimental provision about individual rebate size only modestly increased support for the current policy in Switzerland and did not increase support for even a small tax increase. In Canada, information about rebate size did not increase policy support, but instead led Conservative Party respondents to believe the policy imposed net costs on their household.

These findings imply that one-time information does not substantially affect policy support. While results from non-climate domains may not extrapolate to carbon taxation 19 , previous studies suggest learning over time built public support for congestion taxes 48 , 49 , 50 and solid-waste charges 51 . Yet public ignorance of dividends has persisted for more than a decade in Switzerland, and our Canadian panel covered a period in which the carbon tax was highly salient by virtue of the policy’s implementation, court challenges, federal–provincial conflict and partisan debate during a federal election, a most likely case for public learning about the rebate scheme.

Altogether, results from these studies paint a more complex picture of the benefits of lump-sum carbon tax rebates than did previous surveys and laboratory experiments using hypothetical policies. While the climate-dividend policies in Switzerland and Canada diverge from policy ideals, trading off public transparency for administrative efficiency, we note that these are the only two extant examples of carbon tax and dividend globally. Both were implemented in the context of partisan and interest-group debates, including widespread dissemination of selective or misleading information. As always, both policy design and attitudinal change may still occur. The government of Canada has announced that future rebates, which will steadily increase in value, will be delivered to households directly. However, in Switzerland, voters rejected an increase in the country’s carbon tax rate, alongside increased rebates, in June 2021 when faced with intense politicization of policy costs by opponents. The evolution and impact of new rebate designs, increasing tax rates and benefit sizes, and potential shifts in partisan positions remain for future research.

Our paper draws from four new data sources. First, we report a new survey dataset, the Canadian Climate Opinion Panel (CCOP). Second, we report a survey experiment embedded in the fourth wave of the CCOP. Third, we report a large- n survey of Swiss residents conducted in December 2019. Fourth, we report a survey experiment embedded in this Swiss survey. We discuss each dataset and the methods used to analyse it, in turn.

The CCOP was a custom five-wave public opinion panel survey administered online to a sample drawn from the Leger 360 platform. This platform is a web-based pool of over 400,000 Canadians, 60% of which were recruited randomly via random-digit dialling. From this pool, an initial sample of 3,313 panellists was generated for five Canadian provinces: Alberta ( n  = 663), British Columbia ( n  = 661), Ontario ( n  = 660), Québec ( n  = 661) and Saskatchewan ( n  = 668). These provinces were selected to ensure representation of provinces subject to the federal carbon tax and dividend as well as provinces exempt from the federal carbon tax because of provincial policies deemed equivalent to the federal carbon price. Respondents were remunerated by Leger at a rate of CDN$1 to CDN$3 per wave depending on survey length.

Panellists were invited to participate in the study and answered the first questionnaire between 21 February and 5 March 2019. During this wave, we obtained 3,313 completes and a combined American Association of Public Opinion Research (AAPOR) RR3 response rate of 18%. AAPOR RR3 rates incorporate an estimate of eligibility among respondents of unknown eligibility into the response-rate denominator, offering a conservative response-rate estimate 52 . Panellists were subsequently recontacted between 10 and 28 April 2019, after the federal carbon tax policy came into effect on 1 April. During this second wave, responses were received from 2,189 returning panellists from Alberta ( n  = 437), British Columbia ( n  = 434), Ontario ( n  = 440), Québec ( n  = 439) and Saskatchewan ( n  = 439). An additional 252 respondents (50 from each province except Saskatchewan, where 52 completed) were added to this wave as a check against panel experience, resulting in a total sample of 2,441. The combined AAPOR RR3 response rate for this portion of the fieldwork was 50%. A third invitation went out to panellists between 27 June and 19 July 2019, after the majority (over 96%) had completed their income tax returns and thus would have received their rebate if eligible. In this wave, we secured completes from 1,509 panellists from Alberta ( n  = 303), British Columbia ( n  = 301), Ontario ( n  = 301), Québec ( n  = 300) and Saskatchewan ( n  = 304). Another 251 respondents (50 from each province except Quebec, where 51 completed) were added as a check against panel experience, for a total of 1,760 completes. The AAPOR RR3 response rate for this third wave was 49%. We then secured 1,440 completes in the fourth wave following the October 2019 federal election, of which 1,190 were returning panellists. The remaining 250 over sample were equally distributed across the five provinces. The fieldwork for this portion of the study was conducted between 22 November and 16 December 2019. The AAPOR RR3 response rate for this portion of the fieldwork was 56%. Finally, a total of 899 panellists completed a fifth wave of our survey administered between 13 and 28 May 2020. This included 200 from British Columbia, 176 from Alberta, 161 from Saskatchewan, 193 from Ontario and 169 from Québec. The AAPOR RR3 response rate for returning panellists in wave 5 was 76%. Our overall sample was broadly representative of population characteristics of each province, including age, gender, education and income (Supplementary Section 21 ). The survey received a human subjects review from the Université de Montréal’s Comité d’éthique de la recherche en arts et humanités (certificate CERAH-2019-016-D). All survey respondents provided informed consent before beginning the survey. We find no evidence of systematic attrition of respondents in our later waves on the basis of observed demographic characteristics (Supplementary Section 22 ).

A concern in any public opinion panel is that respondents are repeatedly exposed to a topic, shaping their beliefs and opinions as a function of panel participation. Panel design effects of this sort can compromise the representativeness of a panel over time. In the context of the present study, panel design effects are of even greater potential concern. Climate dividends, as implemented by the Canadian federal government, are integrated into a complex federal income tax system, which would tend to dampen respondents’ awareness and understanding of the policy. Further, contentious political debates have created a confusing messaging environment for Canadians about the structure, value and presence of carbon pricing policies in various provinces. If panel respondents, by virtue of their participation in our study, became more informed about and engaged with climate dividends, then preference shifts within the panel could be a misleading indicator of the dividend’s effects on the general public’s preferences. To measure potential design effects, we collected a random sample of new respondents during waves 2, 3 and 4 ( n  = 252 in wave 2, n  = 251 in wave 3 and n  = 250 in wave 4). These respondents were randomly sampled across the five survey provinces in equal proportion, equivalent to our sampling procedure in the broader panel survey (Supplementary Section 20 ).

Canada survey experiment

Before deploying wave 4, we estimated the objective rebate received by each survey respondent from Ontario and Saskatchewan, using their province of residence, reported marital status (including common law), number of children residing with them as reported in wave 3 and whether their residence is rural (for example, outside a census metropolitan area (CMA)) and thus eligible for an additional rebate. These factors completely determine dividend levels within the current Canadian policy, which we calculated using Revenue Canada income tax worksheets. Note that dividend levels are not a function of income in Canada. For CMA measurements, we determine the respondent’s place of residence using the Postal Code Conversion File provided by Statistics Canada, which gives us a range of geographic identifying variables (such as residence in a CMA and electoral district) for each of the self-reported postal codes collected in our survey. We summarize the rebate calculation process for 2019 in Supplementary Section 23 . As part of an embedded survey experiment in wave 4, we randomly assigned half the respondents to receive a filled-out tax form that showed them their own household rebate amount (Supplementary Section 12 ).

Details about question wording in our survey instrument are presented in Supplementary Section 24 . All respondents were given the option of responding in either English ( n  = 752) or French ( n  = 147).

Swiss public opinion survey

We fielded an online survey of 1,050 Swiss residents, quota sampled on age, gender and language, in December 2019. The survey was provided in German and French but not Italian, which is the official language in the canton of Ticino as well as some municipalities in Graubünden. Nevertheless, the survey covers respondents from all Swiss cantons. Overall, the sample quite closely matches the Swiss population; however, as typical for such surveys, the groups of the lower educated (secondary education I) as well as the oldest age groups are somewhat underrepresented (Supplementary Section 26 ). A copy of the Swiss survey instrument is also provided in Supplementary Section 26 . The survey received a human subjects review from the University of California Santa Barbara’s Office of Research Human Subjects Committee (protocol number 21-19-0801). All survey respondents provided informed consent before beginning the survey.

Swiss survey experiment

As part of this December 2019 Swiss survey, half of respondents were randomly assigned to an encouragement treatment, where we asked respondents to pause their survey and retrieve their most recent health insurance form. Respondents were then asked to let us know what the size of their rebate benefit was. Because all Swiss residents receive the same amount, we then displayed a sample document (in their language of survey response) to all respondents in the treated group, whether they reported finding their bill or not (Supplementary Section 15 for example). We then measured respondent support for the existing Swiss policy and their potential support for either a small (from CHF0.25 to CHF0.28 per l heating oil) or large (to CHF0.40 per l heating oil) tax increase (respondents were randomly asked for their preferences on either of these two cost settings). A summary of all variables used as well as descriptive statistics for the Swiss data can be found in Supplementary Section 27 .

Reporting Summary

Further information on research design is available in the Nature Research Reporting Summary linked to this article.

Data availability

All supporting data are available through a Harvard Dataverse replication archive at https://doi.org/10.7910/DVN/3WBCH9 .

Code availability

All supporting code is available through a Harvard Dataverse replication archive at https://doi.org/10.7910/DVN/3WBCH9 .

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Acknowledgements

This research was supported by grants (initials of grant principal investigators in parentheses) from a Social Sciences and Humanities Research Council (SSHRC) Partnership Granthad (M.M., E.L. and K.H.), theSmart Prosperity Institute at the University of Ottawa (M.M., E.L. and K.H.), the Economics and Environmental Policy Research Network of Canada (M.M., E.L. and K.H.) and the Centre for International Governance Innovation (#5597, K.H.), the Social Sciences and Humanities Research Council of Canada (#435-2017-1388, E.L.), the Institute for Social, Economic and Behavioral Research at UC Santa Barbara (M.M.) and the Hellman Fellows Fund (M.M.). We thank participants at the UC Santa Barbara Environmental Politics Workshop, Swiss Political Science Association annual meeting, Environmental Politics and Governance conference, L. Fesenfeld, P. Bergquist, C. Fischer, P. Quirk, G. de Roche and C. Hazlett for comments on earlier drafts of this manuscript.

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Matto Mildenberger

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Erick Lachapelle

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M.M., E.L. and K.H. designed, collected and analysed the Canadian data presented here. M.M. and I.S.-S. designed, collected and analysed the Swiss data presented here. All authors contributed to the writing of the paper.

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Extended data

Extended data fig. 1 opposition to carbon pricing by province across waves..

Wave 1 was conducted in February 2019 and wave 5 in April 2020. The dotted line indicates when the federal carbon tax policy came into effect. The solid line indicates the approximate period during which households received their climate rebates. The dashed line indicates the timing of a federal election in which climate policy, including the carbon tax, was highly salient. Respondents in Saskatchewan and Ontario received a federal climate rebate associated with Canada’s 2019 carbon tax. Other respondents were subject to provincial carbon pricing policies that had few, if any rebate, components. Error bars give 95% confidence intervals.

Extended Data Fig. 2 Support for carbon pricing among Liberal and Conservative voters, by rebate vs. non-rebate province.

The dotted line indicates when the policy came into effect. The solid line indicates the approximate period during which households received their climate rebates. The dashed line indicates the timing of a federal election in which climate policy, including the carbon tax, was highly salient. Voters are classified according to their wave 1 (pre-policy implementation) party preferences. Since Alberta only became subject to the federal tax, and thus eligible for the federal dividend, between wave 4 and 5 (and Albertan respondents had not received a rebate as of wave 5), we bundle Albertan data with the non-rebate provinces. Error bars give 95% confidence intervals.

Extended Data Fig. 3 Support for carbon pricing among Liberal and Conservative voters, by cost exposure.

Cost exposure measured by whether respondents report driving alone to work, or whether they report a different means of getting to work (transit, walk, cycle, carpool, work/study from home). Individuals who chose the survey option ‘This question doesn’t apply to me’ when asked how they get to work are excluded from the figure. The dotted line indicates when the policy came into effect. The solid line indicates the approximate period during which households received their climate rebates. The dashed line indicates the timing of a federal election in which climate policy, including the carbon tax, was highly salient. Voters are sorted according to their wave 1 (pre-policy implementation) party preferences and self-reported means of getting to work. Error bars give 95% confidence intervals.

Extended Data Fig. 4 Distribution of perceived household rebate sizes for Canadian panel.

Responses from respondents who remained in the panel as of wave 3 and resided in the rebate provinces of Ontario and Saskatchewan. The correct answer for each set of respondents is highlighted in green.

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Mildenberger, M., Lachapelle, E., Harrison, K. et al. Limited impacts of carbon tax rebate programmes on public support for carbon pricing. Nat. Clim. Chang. 12 , 141–147 (2022). https://doi.org/10.1038/s41558-021-01268-3

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DOI : https://doi.org/10.1038/s41558-021-01268-3

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US Carbon Tax Design: Options and Implications

Reports by Jason Bordoff & John Larsen • January 16, 2018

While there seem to be no immediate prospects for a national carbon tax in the United States, there is growing interest among some policymakers and thought leaders across the political spectrum. If and when a legislative opening emerges in the coming years, policymakers will need to grapple with a range of important design issues that will determine the effectiveness of a carbon tax in reducing carbon emissions.

The Center on Global Energy Policy (CGEP) at the School of International and Public Affairs (SIPA) of Columbia University has initiated a major research initiative to answer key questions related to the development of a carbon tax. In considering development of a tax, policymakers and stakeholders will need to understand, among other issues:

• The design options available (e.g., a carbon tax coupled with tax reductions elsewhere; with revenue spent on R&D or other clean energy programs; with revenue rebated to households; a sector specific tax [such as electricity or transportation] versus an economy-wide tax; or some other mechanism) and
• Their respective environmental, energy market, and economic impacts, including how a carbon tax would interact with existing energy, environmental, and tax policies at the state and national levels.

CGEP plans to address these key questions through a series of reports, public events, and meetings and briefings. CGEP’s initiative will bring a unique, academic, and nonpartisan voice to the issue. Research will be presented using language that is clear for all stakeholders.

This scoping paper, the first in the initiative, outlines the key design options that policymakers will need to address in the design of a carbon tax. Additional papers in this series will include:

• Interaction between a carbon tax and existing policies
• Energy market and environmental impacts of a carbon tax
• Macroeconomic effects of a carbon tax
• Distributional effects of a carbon tax
• How a carbon tax might affect international competitiveness
• Transition assistance for communities affected by a carbon tax
• Synthesis report

Papers addressing the effects of a tax on the energy sector and the environment, and a tax’s macroeconomic and distributional effects, will report the results of modeling undertaken by external quantitative research teams who are examining the effects of different tax scenarios. Other papers will be authored by members of the Columbia University community in collaboration with outside experts.

CGEP is not making specific recommendations about the enactment of a tax or its design and is not advocating for any particular policy. CGEP strongly believes in the importance of bringing together unique perspectives to address the most pressing energy issues. The purpose of academic research is to promote the competition and comparison of ideas, as well as foster debate and disagreement. We hope this initiative, including this series of papers, helps inform public discussion about implementation of a carbon tax and the trade-offs that exist in its pursuit.

Executive Summary

How does a society pay for the environmental and social costs of industrial and commercial activity? This question is front and center as nations work to address climate change across the globe. Economists broadly agree about the cost effectiveness of a market-based approach to reducing the emissions associated with climate change, with a carbon tax being one of the most popular of systems under consideration.

In the United States, opposition to any system that would address the costs of climate change—even one based on market principles—remains significant. Yet there has been a recent uptick in interest in a carbon tax, including from prominent members of both parties. The possibility of greater future legislative interest in a carbon tax means that a number of important policy design questions may need to be considered, and there has been considerable exploration of these questions to date by various research institutes and universities.

Building on this work, the Center on Global Energy Policy at Columbia University’s School of International and Public Affairs is undertaking a research effort in collaboration with external partners to explore the range of issues that policymakers will need to understand, model the effects of different scenarios that policymakers may choose to consider, and produce insights that will inform the policymaking process. This Carbon Tax Design research initiative will serve as a resource for both stakeholders and policymakers through a series of papers, public events, workshops, and policymaker briefings about the key design choices and the implications of those choices in the implementation of a carbon tax.

This initial scoping paper lays out the set of issues to be addressed by identifying the key design choices to be made in implementing a carbon tax:

• Scope and Emissions Coverage: Determining which sectors and which gases are taxed and what amount of total US greenhouse gas (GHG) emissions would be covered by a tax is critical. The broader the scope, the more efficient and environmentally effective the tax, as it increases the number of GHG abatement opportunities.

• Point of Taxation: Carbon emissions can be taxed upstream, at the point of fuel production, downstream at the point of fuel consumption, or at points in between. An upstream approach taxes emissions from end-use sectors without having to track emissions and tax payments from millions of downstream emitters such as vehicles, factories, and buildings. A downstream approach taxes tons of CO2 that enter the atmosphere at the point where they are emitted. Policymakers must weigh the desired scope of the tax, existing emissions and/or fuel reporting infrastructure, administrative efficiency, and politics in determining where to tax.

• Tax Rate: The combination of the tax rate and the total coverage of the program (as determined by the scope and point of taxation) is what ultimately determines revenue collection, environmental effectiveness, and energy market outcomes. However, there is no guarantee that a carbon tax set at a particular price will guarantee the achievement of a particular emission reduction goal.

• Revenue Allocation Options: Large new sources of federal government revenue are not found frequently, and if a carbon tax is seriously considered, there will be an endless number of stakeholders arguing in favor of their preferred approach. This paper discusses six options for what to do with revenues achieved through a carbon tax, although more than one approach could be chosen. The limiting factor is ultimately the net revenue derived from the tax.

• Interaction between Carbon Taxes and Other Energy/Environmental Policies: Any carbon tax, especially one with an economy-wide scope, will interact with a range of existing energy and environmental policies. Federal regulations, federal research and development on energy technologies, federal subsidies for clean energy, federal royalty, bonus, lease, and tax revenue from fossil fuel production, state regulations and carbon pricing systems, and state revenue from carbon pricing systems should be taken into account in the design of any tax.

• International Trade Effects and Distributional Considerations: A carbon tax would affect US trade as well as the companies that engage in trade. Policymakers need to discuss how to reduce the risks to US exports that would be subject to a tax when competing against foreign firms not subject to a tax. Work is also needed to understand how a carbon tax would affect households at different income levels, affect different sectors of the economy, and different parts of the country.

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Expert Commentary

Carbon pricing: What the research says

Carbon pricing schemes are widely portrayed in the economic literature as an effective way to reduce carbon emissions and curb rising global temperatures.

Republish this article

This work is licensed under a Creative Commons Attribution-NoDerivatives 4.0 International License .

by Clark Merrefield, The Journalist's Resource January 17, 2020

This <a target="_blank" href="https://journalistsresource.org/environment/carbon-pricing-research/">article</a> first appeared on <a target="_blank" href="https://journalistsresource.org">The Journalist's Resource</a> and is republished here under a Creative Commons license.<img src="https://journalistsresource.org/wp-content/uploads/2020/11/cropped-jr-favicon-150x150.png" style="width:1em;height:1em;margin-left:10px;">

In the lead-up to the 2020 elections, the  Journalist’s Resource team is combing through the Democratic presidential candidates’ platforms and reporting what the research says about their policy proposals. We want to encourage deep coverage of these proposals — and do our part to help deter  horse race journalism , which research suggests can lead to inaccurate reporting and an uninformed electorate. We’re focusing on proposals that have a reasonable chance of becoming policy. For us, that means at least 3 of the 5 top-polling candidates say they intend to tackle the issue. Here’s what the research says about carbon pricing.

Candidates favoring carbon pricing

Joe Biden , Michael Bloomberg *, Pete Buttigieg *, John Delaney *, Amy Klobuchar *, Tom Steyer *, Andrew Yang *

What the research says

Carbon pricing schemes put a financial price on carbon emission. They are widely portrayed in the economic literature as an effective way to reduce carbon emissions from high-carbon emitting industries, such as certain types of energy production. Academics and politicians often frame carbon pricing not as a cure-all, but rather as one part of a broader strategy to slow or reverse rising global temperatures.

Key context

Rising temperatures caused by climate change could cost the U.S. economy many billions of dollars. A 2017 paper in Science projects that for every 1.8 degree Fahrenheit average temperature increase in the U.S., gross domestic product will fall by 1.2% yearly — equal to roughly $233 billion at today’s GDP.

Poorer areas of the country could be hit hardest, according to the paper. By the end of this century, “under business-as-usual emissions,” the poorest third of U.S. counties are likely to lose between 2% and 20% of current income that residents earn, the authors write. The richest third of counties could lose up to 6.8% of income, according to the authors’ estimates — or gain 1.2%.

The Science paper offers one estimate of the effect of climate change on U.S. economic output, or productivity, as measured by GDP. Another paper by two Environmental Protection Agency staffers, published April 2019 in Nature Climate Change , looks at costs related to infrastructure, health, agriculture and other sectors across two scenarios.

The first scenario — where the average global temperature is trending toward 5 degrees Fahrenheit higher in 2100 compared with pre- Industrial Revolution levels — would come with about $170 billion in annual costs by 2050 across the 22 sectors the authors analyzed.

The second scenario — heading toward an average global temperature in 2100 that’s 8 degrees Fahrenheit higher than pre-industrial levels — would come with about $206 billion in annual costs across those sectors by 2050. The estimates don’t include potential cost savings from adaptation measures , such as creating dunes to protect beaches or building levees to divert floodwater, which can reduce infrastructure damages.

Aside from estimating the costs of rising global temperatures, economists have also come up with two big market-based ideas to address climate change and put a price on carbon emissions: Carbon taxes and cap-and-trade .

Carbon taxes put an initial financial burden on entities that emit carbon as part of their regular business. Think a coal-fired electricity plant. Under carbon tax schemes, governments set the price of pollution while markets determine the amount of pollution — companies can pollute and pay the tax or reduce emissions to avoid it.

There are carbon taxes in other countries but not in the U.S. Some academics have argued that there is already a kind of carbon “tax” borne by people, not companies — in the sense that some parts of the U.S. experience substantial economic losses from climate change, like from more severe storms that cause billions of dollars in property damage.

In practice, businesses could pass along the cost of a carbon tax to consumers. If a refinery that produces heating oil pays a tax for emitting carbon, customers might end up paying higher prices for home heating oil.

To some economists, this is not a bug but a feature: higher prices would lower demand for carbon-intensive fuels. In some countries, revenues from carbon pricing programs are disbursed to households to help pay higher fuel prices, according to an October 2019 paper in Climate Change and Renewable Energy .

Cap-and-trade puts a cap on overall carbon emissions levels. Unlike carbon taxes, where governments set the price and markets determine the amount of pollution, under cap-and-trade governments set an amount of allowable pollution while markets set the price.

The emissions cap is divided into credits and governments then sell those credits to companies that pollute. Companies that pollute under the cap can sell their credits to entities that pollute more. Part of the appeal is that as the cap lowers over time, so does the number of credits, incentivizing companies to pollute less.

A national carbon tax is a popular idea among some economists and policymakers in the U.S. More than 3,500 economists from across the political spectrum, including 27 Nobel laureates, support a carbon tax plan that would give dividends directly to Americans. But so far, jurisdictions in the U.S. have gone with cap-and-trade strategies over carbon taxes.

Michael Bennet*, Deval Patrick* and Elizabeth Warren* have indicated to The Washington Post they might pursue carbon pricing as president, but none have released firm policy statements in support of carbon pricing schemes. Bernie Sanders and Tulsi Gabbard would not pursue carbon pricing as president, according to the Post .

Formative findings

In June 1990, Colorado State University economist Jo Burges Barbier wrote in a paper in Energy Policy that “further policy instruments and considerations” beyond carbon pricing alone were needed to curtail carbon emissions from the energy sector.

The EPA’s Acid Rain Program in 1995 became the first national cap-and-trade effort. It seeks to reduce airborne sulfur dioxide and nitrogen oxides coming from power plants.

Acid rain happens when those pollutants get into the atmosphere, then fall to the ground through precipitation like rain or snow, contaminating waterways and crops. Since the program’s introduction, acid deposits have decreased 30% across the Midwest and Northeast and the program prevents an estimated 20,000 to 50,000 premature deaths each year, according to the EPA .

Another national cap-and-trade program was the NOx Budget Trading Program, which operated during the 2000s and sought to reduce nitrogen oxides from power plants during the summer.

But a national cap-and-trade program failed in 2010, in part because opponents rebranded it “ cap-and-tax ,” making the idea politically unpalatable. No national cap-and-trade program has come close to passing Congress since.

Recent research

Though now defunct, the NOx Budget Trading Program prevented nearly 2,000 summertime deaths each year in participating states, most of them along the east coast, according to a 2017 analysis in the American Economic Review .

Harvard University economist Robert Stavins assesses the state of carbon pricing in a May 2019 National Bureau of Economic Research working paper . He writes that economists have reached consensus that pricing systems such as carbon taxes and cap-and-trade will be key to reducing carbon dioxide emissions:

“There is widespread agreement among economists — and a diverse set of other policy analysts — that at least in the long run, an economy-wide carbon pricing system will be an essential element of any national policy that can achieve meaningful reductions of [carbon dioxide] emissions cost-effectively in the United States.”

States have taken up the cap-and-trade baton in the last decade or so. The Regional Greenhouse Gas Initiative covers nine New England and Mid-Atlantic states and set its first carbon cap for the power sector in 2009. Since then, greenhouse gases have fallen 40% in those states, and they’re aiming for another 30% reduction by 2030. The initiative has raised $2.7 billion, which has been invested into wind and solar power generation, and to help low-income people pay their energy bills.

Power plants across those nine states generate about 112,000 megawatts less each month than plants in other states, and they emit 286 fewer tons of sulfur dioxide and 131 fewer tons of nitrogen oxides per month, according to a May 2019 paper in Energy Economics . However, that analysis finds the Regional Greenhouse Gas Initiative had a causal effect only on reductions of sulfur dioxide emissions, not nitrogen oxides.

California’s cap-and-trade program began in 2006 and the legislature extended it in 2017 . It has an emissions cap affecting 80% of greenhouse gases coming from about 450 of the state’s biggest polluters.

That program “has demonstrated the feasibility and effectiveness of an economy-wide approach, compared with sectoral systems,” write economists Richard Schmalensee of the Massachusetts Institute of Technology and Stavins of Harvard in the Oxford Review of Economic Policy.

California reports it is on track to beat its initial target of reducing greenhouse gas emissions to 1990 levels by 2020, and is aiming for emissions levels 40% under 1990 levels by 2030.

But the California cap-and-trade program may be distributing benefits, like cleaner air, unequally. Companies that emit greenhouse gases there tend to be located in areas where more people live in poverty, but the program hasn’t led to environmental benefits in those neighborhoods, according to a July 2018 analysis in PLOS Medicine .

In fact, greenhouse gas emissions in neighborhoods near polluters actually increased from 2013 to 2015, compared with 2011 to 2012, the authors find. They peg overall greenhouse gas reductions to the state importing less electricity from coal-fired plants.

Emissions reductions also vary widely by industry, the authors find. Seventy percent of certain power plants reduced emissions over the period studied, while 75% of cement plants increased emissions. A glut of credits on the market may keep lower-income California communities from enjoying the environmental benefits of cap-and-trade.

Some experts also caution that California is markedly dissimilar from most states. California has a strong, mostly popular, single-party majority in its legislature, so it’s an easier lift politically to experiment with market-based emissions reduction strategies.

Utilities in the state are also largely on board with addressing climate change, even through regulation. The state doesn’t rely much on coal to produce energy, while many other states do.

“Because California is a unique case in several respects, it is unlikely that other states in the U.S. will be able to adopt similar systems,” Guri Bang , research director at the Center for International Climate Research in Oslo, and her co-authors write in a 2017 article in Global Environmental Politics .

Finally, on the global scale, there is the free-rider problem.

Right now there’s no prospect of an enforceable, international cap-and-trade system that could put a meaningful dent in global carbon emissions. There are too many hurdles to mention, but one of them is that countries would probably want higher emissions ceilings for themselves, but lower emissions ceilings for the rest of the world, as the late Harvard economist Martin Weitzman explained in a June 2019 article in Environmental and Resource Economics .

In other words, countries want to reap the environmental benefits of carbon reduction without paying the price — they want a free ride.

Still, people in countries with carbon pricing programs can reap monetary benefits.

A 2016 paper in Energy Policy analyzed real-world carbon tax and cap-and-trade programs and found that policymakers earmark 70% of revenues from cap-and-trade to climate-friendly efforts, while 72% of revenues from carbon tax systems — there are several in Europe — are refunded to people or put into government general funds.

Further reading

Policy perspective: Building political support for carbon pricing — Lessons from cap-and-trade policies

Leigh Raymond. Energy Policy , November 2019.

The gist: “This review of long running cap-and-trade programs suggests that a new idea in carbon pricing — the idea of a carbon ‘dividend’ in the form of an equal per capita payment to all citizens —  is consistent with the successful public benefits strategy discussed here.”

Perceived fairness and public acceptability of carbon pricing: A review of the literature

Sara Maestre-Andrés, Stefan Drews, Jeroen van den Bergh. Climate Policy , July 2019.

The gist: “Somewhat surprisingly, most studies do not indicate clear public preferences for using revenues to ensure fairer policy outcomes, notably by reducing its regressive effects. Instead, many people prefer using revenues for ‘environmental projects’ of various kinds.”

Carbon pricing and energy efficiency: Pathways to deep decarbonization of the US electric sector

Marilyn A. Brown, Yufei Li. Energy Efficiency , February 2019

The gist: “Our modeling results suggest that carbon taxes coupled with strong energy-efficiency policies would produce synergistic effects that could meet deep decarbonization goals.”

Subject experts

Marilyn Brown , professor of sustainable systems, Georgia Institute of Technology.

Jo Burgess Barbier , assistant professor of economics, Colorado State University.

Noah Kaufman , research scholar, Center on Global Energy Policy at Columbia University.

Gilbert Metcalf , professor of economics, Tufts University.

Leigh S. Raymond , professor of political science, Purdue University.

Robert Stavins , professor of energy and economic development, Harvard University.

*Dropped out of race since publication date.

About The Author

Clark Merrefield

Carbon Taxes as Part of the Fiscal Solution

Subscribe to the economic studies bulletin, william g. gale , william g. gale the arjay and frances fearing miller chair in federal economic policy, senior fellow - economic studies , co-director - urban-brookings tax policy center @williamgale2 samuel brown , and sb samuel brown research associate, economic studies fernando saltiel fs fernando saltiel.

March 12, 2013

• 35 min read

I. Introduction

The United States faces large federal fiscal deficits in the immediate future, the next 10 years, and the longer term. Although the current and recent deficits are thought to be helping the economic recovery, the deficits in the medium-term and long-term are more troubling because of their potential impact on national saving, economic growth, and financial markets. Addressing these medium- and long-term challenges will likely require a combination of spending cuts and revenue increases. None of the relevant options (some of which will need to be implemented sooner or later) are particularly attractive from a political perspective.

In this chapter, we consider the fiscal outlook, how new taxes on carbon could not only help address the fiscal problem but also bring about benefits on economic and environmental grounds, and how these taxes compare with some other revenue options. Section II discusses issues related to the fiscal outlook. In section III, we highlight the revenue, efficiency, and equity effects of taxes on carbon emissions and/or a higher tax on gasoline. Section VI provides a brief comparison of a carbon tax to other revenue options — including a VAT and income tax expenditure reform. Section V offers a short conclusion.

II. Fiscal Outlook and Implications

This section summarizes the fiscal outlook, discusses why both revenue increases and spending cuts will need to be considered as part of the solution, and examines the long-term impact of tax-financed deficit reduction policies.

A. Fiscal Outlook

Figure 1 shows historical budget deficits and deficits projected under different future policy scenarios. Under the current-law baseline produced by the Congressional Budget Office (CBO) assumptions the deficit falls from 5.3 percent of GDP in 2013 to 2.9 percent in 2018, before rising to 3.8 percent by 2023.

Auerbach and Gale (2013), however, show that under a current policy baseline (reflective of more realistic policies), the federal deficit under current policies will hover around 3.5 percent of GDP between 2015 and 2019, before rising to 5.0 percent by 2023 (Figure 1). The policy differences between current law and current policy baseline are shown in Table 1.

Moreover, after 2022, projected deficits are poised to rise further under both scenarios (Figure 1), reaching 10 percent of GDP by 2036 under the current policy baseline and continuing to rise thereafter.

As for the debt-to-GDP ratio, after averaging 37 percent of GDP in the 50 years prior to the Great Recession that started in 2007 and attaining a value of 36.3 percent of GDP in 2007, the ratio is now projected to pass its 1946 high of 108.6 percent in 2035 under current policy baseline (Figure 2). Unlike the aftermath of World War II, however, the debt-to-GDP ratio will continue to rise after surpassing the previous peak. Expenditures are expected to rise significantly as the aging of the populace and excess cost growth of health care cause Medicare and Medicaid outlays to grow rapidly. Current estimates place the fiscal gap—the immediate and permanent increase in taxes or reduction in spending that would keep the long-term debt-to-GDP ratio at its 2012 level – or 72.5 percent of GDP – at 3-5 percent of GDP through 2089 and 5-7 percent on a permanent basis (Auerbach and Gale 2013).

In contrast to the U.S projected fiscal trajectory, many organizations place the desired debt/GDP ratio between 40 percent and 60 percent. [1] It is not entirely clear how an optimal debt/GDP ratio can be derived from theoretical first principles. What is clear, however, is the current trajectory for U.S. debt is not sustainable.

Although delayed implementation of deficit-reducing policies may be preferable given the current state of the economy, the longer it takes to put in place deficit-reducing policies, the larger will be the required spending cuts or tax increases in order to address the long-term fiscal gap. For example, if the adjustments are delayed until 2018, when the CBO projects the economy will reach potential GDP, the fiscal gap increases by up to 0.3 percentage points of GDP.

Budget projections (especially for the long-term) embody considerable uncertainty, and deficit projections are particularly uncertain as relatively small percentage changes in outlays and revenues can lead to relatively large percentage changes in deficits. In the current environment, economic projections also may be more uncertain than usual, given uncertainty about the effects of the recent recession on the long-term growth rate. The other major uncertainty is the rate of growth of health care spending, which can have enormous impacts on the projected budget outlook. Despite this uncertainty, it is hard to paint an optimistic picture of the fiscal outlook. Indeed, the projections above are based on a series of economic and political assumptions that could be viewed as optimistic.

B. The need for spending cuts and revenue increases

Since projected spending is slated to rise faster than GDP for the indefinite future, it is clear that spending cuts must be part of the solution, in particular for government health care programs, which have been rising as a share of GDP for several decades and are projected to continue to rise.

There are several reasons to consider tax increases (beyond those already included in the January 2013 budget deal), however, as well as spending cuts, as part of the fiscal solution. First, the sheer magnitude of the fiscal gap suggests that a spending-only solution would need to impose very substantial reductions on spending that might not be seen as equitable. At 5-7 percent of GDP, the fiscal gap is several times larger than the savings that were generated in budget deals in the past. The 1983 Social Security Reform reduced deficits by about 1 percent of GDP in the four years after passage while the 1990 and 1993 budget deals reduced deficits by about 1.4 percent of GDP and 1.2 percent of GDP, respectively, over the 5 years after passage. [2] The recently enacted tax bill only raised 0.3 percent of GDP in revenue over the next decade. In addition, Americans seem particularly reluctant to cut government spending on Social Security and Medicare, two of the key drivers of long-term spending, than on other forms of spending. For instance, a 2011 Gallup poll showed that over 60 percent of Americans were unwilling to cut social security and/or Medicare, and this was true across the political spectrum.

Second, as a political equilibrium, it seems likely that a sustainable budget deal would draw from both sides of the ledger. Indeed, in the past, major deals have included both tax increases and spending cuts. With the 1983 Social Security reforms, the 1990 bipartisan budget deal, and 1993 budget deals, Congress both slashed spending and raised taxes. For example, in the 1990 budget deal, 49 percent of the reductions came from higher tax receipts, 34 percent from reduced defense spending, and 17 percent from other cuts in spending (Steuerle 2004).

Third, as a matter of equity, the only way that high-income households will share significantly in the burden of fixing the deficit is through revenue increases since spending cuts typically do not have a large impact on high-income households.

Fourth, spending appears to be controlled more effectively by requiring that it be paid for with current taxes, rather than allowing deficits to grow. In contrast, the “starve the beast” hypothesis argues that keeping revenues down is an effective approach to curtailing spending. However, the hypothesis does not appear to be consistent with recent experience. [3] And evidence in Romer and Romer (2009), for example, suggests that tax cuts designed to spur long-run growth do not in fact lead to lower government spending; if anything, they find that tax cuts lead to higher spending. This finding is consistent with Gale and Orszag (2004a), who argue that the experience of the last 30 years is more consistent with a “coordinated fiscal discipline” view, in which tax cuts were coupled with increased spending (as in the 1980s and 2000s) and tax increases were coupled with contemporaneous spending reductions (as in the 1990s).

C. Long-Term Growth Effects of Tax-Financed Deficit Reductions

An increase in taxes will not necessarily slow long-term economic growth. Tax changes have two broad sets of long-term effects on the economy. [4] The first set operates through direct changes in relative prices, incentives, and after-tax income. These changes affect the degree to which households are willing to work, save, invest in education and training, etc. and to which firms invest and hire; these effects are known as income and substitution effects. Thus, for example, increases in marginal tax rates, holding other factors constant, can reduce the size of the economy and reduce economic growth.

However, other factors are not constant. The second broad effect is on national saving. A reduction in the deficit tends to raise public saving, which typically results in higher national saving (national saving is the sum of household, corporate, and government saving). This effect is often ignored in discussions of tax policy and economic growth, but it can be quite important.

Containing deficits matters for several reasons.

Sustained deficits may enhance the risk of a financial crisis. Even in the absence of precipitating a financial crisis, however, sustained deficits have deleterious long-term effects, as they translate into lower national savings, higher interest rates, and increased indebtedness to foreign investors, all of which reduce future national income. In addition to the growth impacts, sustained deficits may impose unfair burdens on future generations and may constrain U.S. foreign policy or defense positions, especially as they relate to creditor nations.

Gale and Orszag (2004b) estimate that a 1 percent of GDP increase in the deficit will raise interest rates by 25 to 35 basis points in the United States and reduce national saving by 0.5 to 0.8 percentage points. Engen and Hubbard (2004) obtain similar results with respect to interest rates. Thus, relative to a balanced budget, this study suggests a deficit equal to 6 percent of GDP would raise interest rates by at least 150 basis points and reduce the national saving rate by at least 3 percent of GDP. The IMF (2010) estimates that, in advanced economies, an increase of 10 percentage points in the initial debt/GDP ratio reduces future GDP growth rates by 0.15 percentage points. Hence (if this result is extrapolated linearly, and we do so with caution, since it would be easy to think of reasons that would make a larger debt change have more-than-proportional or less-than-proportional effects), the increase in the debt-to-GDP ratio from about 40 percent earlier in the decade to 85 percent by 2022 (Auerbach and Gale 2012) would be expected to reduce the growth rate by a whopping 0.675 percentage points. Thus a deficit reduction plan that included tax increases (at least on that did not primarily rely on raising taxes on savings and investment) could, on balance, help spur economic growth in contrast to continuing policy as normal.

The net long-term effect of a tax change is the result of the two effects outlined above, which are sometimes offsetting and sometimes mutually reinforcing. Stokey and Rebelo (1995), for example, show that even the very large tax increases associated with World War II—on the order of 10 percent of GDP—apparently had no discernible impact on the long-term economic growth rate. Likewise, the 1981 tax cuts, which cut the top rate from 70 percent to 50 percent, accounted for only a very small share of the growth of the economy between 1981 and 1986, according to Feldstein and Elmendorf (1989). Auerbach and Slemrod (1997) also document tepid economic growth responses to the 1986 tax act. Gale and Potter (2002) find that the impact of the 2001 tax cuts on the deficit and national saving outweighed its impact on incentives, so that the net effect on growth was negative. This suggests that raising taxes by undoing the 2001 tax cuts would raise long-term economic growth (due to the beneficial effect of lower deficits).

III. Carbon Taxes

The discovery and exploitation of natural resources by humans gave rise to the advanced civilization in which we live today. Coal, petroleum, and natural gas fueled industrialization, raising living standards and life expectancy for most. Energy use continues to fuel economic growth and development today. But along with the benefits of energy consumption come substantial societal costs – including those associated with air and water pollution, road congestion, and climate change. Many of these costs are not directly borne by the businesses and individuals that use fossil fuels and thus are ignored when energy production and consumption choices are made. As a result, there is too much consumption and production of fossil fuels.

Economists have long recommended specific taxes on fossil-fuel energy sources as a way to address these problems. That recommendation has gained additional urgency in recent years in light of the fiscal situation outlined above. New revenue from energy taxes could be used to reduce the debt or finance reform or reductions in other taxes.

Throughout this paper we use the phrase “carbon tax” to refer to a tax on carbon dioxide. Although a carbon tax would be a new policy for the federal government, the tax has been implemented in several other countries (though—as discussed in the introduction to this volume— not always in a way that conforms to the design principles advocated by economists). Finland, Norway, Sweden, and Denmark instituted carbon taxes in the early 1990s, followed by the Netherlands and Germany in the latter part of the 1990s. The United Kingdom followed suit in 2001. Australia introduced a carbon tax in 2011. North American jurisdictions have also implemented carbon taxes. The town of Boulder, Colorado, adopted a carbon tax in 2006, and Montgomery County, Maryland, did so in 2010. The Canadian provinces of Alberta and Quebec adopted carbon taxes in 2007, followed by British Columbia in 2008.

Carbon taxes can raise significant amounts of revenue. For instance, in 2007 the tax raised revenue equivalent to about 0.3 percent of GDP in Finland and Denmark, and 0.8 percent in Sweden. A well-designed tax in the United States could raise similar amounts. As shown in Table 2, a number of studies have estimated the net revenue effects of carbon taxes—accounting for the reduction in revenues from broader taxes that would occur—with estimates (for the year 2015) ranging from 0.5 percent of GDP for a $15 per ton tax (McKibbin, Morris and Wilcoxen 2012) to 0.8 percent of GDP for a $31 per ton tax (Metcalf 2010) with intermediate estimates including CBO (2011) and Rausch and Reilly (2012). [5]

Based on analysis in Dinan (2012) discussed below, we assume 38 percent of net carbon tax revenues would need to be used to offset distributional effects—as noted later, this might be viewed as a generous estimate if a carbon tax is part of a broader package of measures to reduce the deficit, and other measures are progressive (i.e., they impose a disproportionately larger burden on higher income households). Our assumption leaves the net revenue yield after distributional compensations, at between 0.32 percent and 0.49 percent of GDP. In terms of gauging how large these taxes are in practical terms, a tax of $25 per ton of carbon dioxide would raise gasoline prices by 25cents a gallon (Bauman 2010)

B. Efficiency

In principle, carbon taxation receives high marks on efficiency criteria. Indeed, the basic rationale for a carbon tax is that it makes good economic sense: unlike most taxes, carbon taxation can improve the efficient allocation of resources by accounting for externalities in the market price. Externalities can be severe. Stavins (2007) notes that the efficiency benefits of a carbon tax are often understated since the largest efficiency gains come in the form of internationally-shared reduced greenhouse gas emissions. While the United States is the largest per capita emitter of carbon dioxide, China is the largest overall emitter, and the European Union makes a significant contribution as well. Therefore, enacting a program that would lead to better cooperation with other countries, and reduce emissions across the world, would be better suited to deal with the well-known problems brought about by global warming, such as rising sea levels, more frequency in extreme temperatures, among others.

Taxes on energy can address these externalities. Not surprisingly, most analyses find that a carbon tax could significantly reduce emissions. Metcalf (2008) estimates that a $15 per ton tax on CO 2 emissions that rises over time would reduce greenhouse gas emissions by 14.0 percent, while Sumner, Bird, and Smith (2009) estimate that the European countries’ carbon taxes have had a significant effect on emissions reductions, attributing reductions of up to 15 percent to the carbon tax. Furthermore, the University of Ottawa (2012) found that the carbon tax implemented in British Columbia led to a 9.9% reduction in greenhouse gas emissions in the province, compared to just 4.6% for the rest of Canada, where comprehensive carbon taxes were not applied.

In addition to reducing emissions, a carbon tax could improve other economic incentives by reducing other tax rates or paying down the deficit (Parry and Williams 2011). A carbon tax could have other benefits too. It would reduce the U.S. economy’s dependence on foreign sources of energy, and would create better market incentives for energy conservation, the use of renewable energy sources, and the production of energy-efficient goods. The permanent change in price signals from enacting a carbon tax would stimulate new private sector research and innovation in developing new ways of harnessing renewable energy and energy-saving technologies. The implementation of a carbon also offers opportunities to reform and simplify other climate-related policies affecting transportation sector.

C. Distribution

The net effects of a carbon tax will depend, of course, not only on the magnitude of the tax and the behavioral response by consumers and firms, as the studies above consider, but on how the funding is used. To be clear, all uses of carbon tax revenues (or of other revenues for that matter) involve some form of giving the money back to taxpayers. What varies is which taxpayers receive the funds, during what time period, and under what conditions. Providing a rebate to consumers obviously returns the revenue to citizens. But so do all other uses of the funds. For instance, paying down the deficit implicitly gives the money to future citizens by reducing the extent to which they have to pay higher taxes or bear the burden of spending cuts. Likewise, using the funds to provide corporate tax cuts reduces burdens for whichever individuals ultimately bear the burden of corporate taxation.

In many instances to date, carbon tax revenues have not been used for deficit reduction. Norway and Sweden do include carbon tax revenue as part of general government receipts, which suggests a possible effect on deficit reduction. But carbon tax revenue in Denmark is returned to industry and directed towards environmental subsidies. Several nations have used carbon tax revenue to reduce other taxes (Sumner, Bird, and Smith 2009). Australia coupled its carbon tax with a substantial increase in the tax-free level of income (and other tax changes). [6] The Netherlands and Sweden have exempted a large portion of the industrial sector from the tax, as well as helping low-income households offset the burden of the tax (the latter measure was also implemented by Germany) (Johansson 2001). Quebec deposits carbon tax revenues into a fund devoted to public transportation and environmental initiatives, while British Columbia makes its carbon tax revenue-neutral by reducing corporate and personal income tax rates and providing an annual credit of $100 per adult and $30 per child to lower-income citizens (British Columbia Finance Ministry 2008).

Distributional concerns over carbon taxes stem from the observation that low-income households devote a higher proportion of their income to consumption and will thus bear a higher burden of the tax relative to high-income households. The distributional effects of carbon taxation have been well-studied (Bull, Hassett, and Metcalf 1994, Hassett, Mathur, and Metcalf 2009, Metcalf 1999, Metcalf 2007).     The regressivity finding is consistent across studies, but varies in magnitude. Metcalf (2008) analyzes the distributional effects of a carbon tax and finds that it would reduce the after-tax income of taxpayers in the first decile by 3.7 percent, compared to just an 0.8 percent reduction for the wealthiest decile. Findings are dependent on whether incidence is measured on a current income versus lifetime basis, with the tax being more regressive when measured on a current income basis relative to lifetime income basis. For example, Hassett, Mathur, and Metcalf (2009) find that the indirect component of a carbon tax (i.e., higher prices due to higher costs of production) is significantly more progressive, whereas the direct component, which focuses on the changes in the cost of gas and electricity, is regressive. Lastly, the incidence varies with timing: the carbon tax can either fall forward in the form of higher consumer prices or backwards in the form of lower returns to factor inputs. Bovenberg and Goulder (2001) and Paltsev et al. (2007) find that the short- and medium-term incidence falls primarily on consumer prices.

Importantly, the regressive impact of a carbon tax could be offset in any of a number of ways, similar to offsets for distributional effects of the VAT, as will be discussed in the next section. Most prominent among these options would be refundable income tax credits (Dinan 2012) or payroll tax refunds (Metcalf 2007). Dinan (2012) notes that CBO analysis suggests that fully offsetting the effects of carbon taxes for households in the lowest quintile would require about 12 percent of gross revenues, while fully offsetting the effects for households in the second quintile would require 27 percent of gross revenues. These figures do not account for added government costs (of indexing transfers or higher payments for inputs, for example). Nor do they account for the reduction revenues from other taxes noted above. As a rough approximation, for now we assume that 38 percent of net carbon tax revenues would have to be used for offset purposes. This is not inconsistent with Dinan’s estimates and is similar to the calculations derived by Toder and Rosenberg (2010) for a VAT. Thus, while the regressivity of a carbon tax is clearly a concern, it should not be considered an obstacle to the implementation of carbon taxes.

D. Motor Fuel Taxes

Raising taxes on gasoline and (motor) diesel is another option. While modest excise taxes on these fuels already exist in the United States, they are substantially lower than in other industrialized nations.

For example, in the U.S., federal excise taxes on gasoline amount to 18.4 cents per gallon, with local tax rates typically taxing gasoline at additional 20-30 cents per gallon in 2010. The OECD average for gasoline excise taxes is approximately $3.39 per gallon, about 7 times the rate of the U.S. tax. [7] OECD taxation of gasoline ranged from $0.34 per gallon (Mexico) to $5.14 per gallon (Turkey); the U.S. has the second-lowest rate of gasoline taxation among OECD countries (OECD 2011). In addition, per-mile fuel taxes in the U.S. are low by historical standards, falling by 40 percent in real terms since 1960 (Parry, Walls, and Harrington 2007). Moreover, fuel taxes at least three times as high as current levels (and perhaps higher still) appear to be justified by the adverse side effects of motor vehicles—pollution, congestion, and so on (Parry, Walls and Harrington 2007).

Higher excise taxes on motor fuels could raise significant amounts of revenue. For example, Parry (2011) estimates that raising gasoline and diesel fuel taxes to their corrective levels would increase revenue by around 0.8 percent of GDP, while CBO (2009) estimates that a 50 cent increase in the gasoline excise tax alone would raise about 0.3 percent of GDP. Raising the gas tax by 25 cents per year for 10 years would raise substantially more in revenues, but would still leave U.S. gas tax rates well below those of European countries.

Although higher fuel taxes would have some impact on reducing carbon emissions, they are much less effective than a carbon tax at reducing carbon emissions, since the former covers a much narrower range of externality-producing goods. [8] Davis and Killian find (2009) find that a 10 cent per gallon increase in the U.S. gasoline excise tax would reduce total carbon emissions by 0.5 percent overall and by 1.5 percent from vehicles. Like carbon taxes, gasoline taxes will fall disproportionately on low-income households, especially in the short-run when households have difficulty adjusting their behavior to avoid the tax (Poterba 1989 and 1991).

IV. Other revenue options

A carbon tax can be compared to other tax options – not necessarily because the ultimate choice will be one of those options versus another, as the country will probably need several ways to raise revenue, but rather to discuss the relative revenue-generating potential, efficiency and equity effects of the different taxes. A full-scale comparison is beyond the scope of this paper (see Gale and Brown 2012 for a more comprehensive discussion of the options). We do briefly describe options relating to the value-added tax (VAT) and to income tax expenditure reform however, to provide some sense of the trade-offs, and possible complementarities, between carbon taxes and broader fiscal options.

A. Value Added Tax

Under a VAT, businesses would pay taxes on the difference between their revenues from total sales to other businesses and households and their purchases of inputs from other businesses. That difference represents the value-added by the firm to the product or service in question. [9] The sum of value added at each stage of production (including extraction of the raw materials) is the retail sales price, so the VAT simply replicates the tax patterns created by a retail sales tax and is like other taxes on aggregate consumption. The key distinction is that VATs are collected at each stage of production, whereas retail sales taxes are collected only at point of final sale. Furthermore, the VAT is easier to enforce and is widely regarded as having a superior administrative structure to a retail sales tax. Although it would be new to the United States, the VAT is in place in about 150 countries worldwide and in every OECD country other than the United States. Experience suggests that the VAT can raise substantial revenue, is administrable, and minimally harmful to economic growth. Toder and Rosenberg (2010) show that a 5 percent VAT with a relatively broad base could raise revenue equal to 1 percent of GDP in the United States, even after accounting for distributional issues via rebates and adjusting for revenue losses from other taxes (Table 3).

The distributional burden of the VAT is regressive relative to current income (though not relative to current consumption). Concerns about the regressivity of the VAT are valid, but they should not obstruct the creation of a VAT for two reasons. First, while we accept the validity of distributional considerations, what matters is the progressivity of the overall tax and transfer system, not the distribution of any individual component of that system. Clearly, the VAT can be one component of a progressive system. Second, it is straightforward to introduce policies that can offset the impact of the VAT on low-income households. The most efficient way to do this is simply to provide households either refundable income tax credits, adjustments to cash-transfer benefits, or outright payments. [10] In contrast, many OECD governments and U.S. state governments offer preferential or zero rates on certain items like health care or food to increase progressivity. This approach is largely ineffective because the products in question are consumed in greater quantities by middle-income and wealthy taxpayers than they are by low-income households. [11]

B. Tax Expenditure Reform [12]

A third alternative is reform of income tax expenditures. In formal terms, tax expenditures are “revenue losses attributable to provisions of the Federal tax laws which allow a special exclusion, exemption, or deduction from gross income or which allow a special credit, preferential rate of tax or a deferral of liability” (The Congressional Budget Act of 1974 (P.L. 93-344)). The canonical focus for income tax reform is to create a system with a broad base that taxes all sources and uses of income at the same rate so as to generate lower statutory rates. Tax expenditure reform would be essential to achieving these goals. Broadening the base entails restricting the use of exclusions and deductions. Taxing all sources and uses of income, at the same effective rate, entails restricting the use of preferential rates, credits, and deferrals. This would reduce distortions between the taxation of different sources and uses of income and therefore could be efficiency improving.

Many major tax expenditures act essentially as government spending programs that happen to be embedded in the tax code rather than in outlays (Batchelder and Toder 2010; Marron 2012; Marron and Toder 2012). Tax expenditure reform in many cases can be thought of as reducing effective government spending.

The value of most tax expenditures, other than credits, rises with the marginal tax rate. A deduction or exclusion of $1000 would reduce tax liability by $150 for an individual in the 15 percent bracket but $330 to one in the 33 percent bracket.

Although different types of tax expenditures are distributed differently, the aggregate distribution of tax expenditures tends to be tilted toward high-income households because they itemize their deductions, receive a substantial share of the income in the form of returns to investment, which is often subject to preferential rates, they have more tax to offset, and they receive a higher benefit per dollar of deduction or exclusion due to higher marginal tax rates.

Tax expenditure reform can raise significant amounts of revenue. Although precise estimates are difficult to compute, illustrative calculations indicate the potential for revenue-raising. The FY2013 Budget lists 173 individual and business tax expenditures, the total value of which would approach 7.5 percent of GDP in the 2015 fiscal year (relative to current law) and about 80 percent coming from individual income receipts (Office of Management and Budget 2012, Marron 2012). Interaction effects increase the revenue loss: Toder and Baneman (2012) estimated that interaction effects increased lost revenue from non-business individual income tax expenditures by 9.6 percent in 2011.

Yet potential revenue raised from a realistic tax expenditure reform would be much less for administrative and political reasons. Some expenditures are difficult to eliminate for various administrative reasons. Many of the largest tax expenditures (e.g. mortgage interest deduction, employer sponsored health insurance) are broadly popular because they benefit middle-income, as well as high-income, taxpayers. Recent proposals have focused on capping overall tax expenditures for a tax filer rather than eliminating individual policies to ease the political constraints to tax expenditure reform. Such proposals still can raise revenue and increase the progressivity of the tax system.

One recent proposal would cap itemized deductions at $50,000. The Tax Policy Center estimates that, relative to current policy, a $50,000 cap would raise 0.33 percent of GDP in 2015 (Table 3). The policy will have a small effect on households in the bottom 90 percent of the income distribution. Households in the 90th to 99 th percentiles would see their after tax income decrease by between 0.3 and 0.5 percent. After-tax income would decrease by 3 percent in the the top one percent of the income distribution.

Feldstein, Feenberg, and MacGuineas (2011) propose a cap on the tax value of certain tax expenditures to 2 percent of the earner’s AGI. [13] Baneman et al. (2011) applied the cap to earners making more than $250,000 (married) or $200,000 (single) and estimated that it could raise 0.26 percent of GDP relative to current policy (Table 3). The cap would not affect taxpayers below the 95 th income percentile. It would decrease the after-tax income by 0.9 percent of income for filers between the 95 th to 99 th percentiles and by 3 percent for filers in the top 1 percent (Baneman et al. 2011).

V. Conclusion

The United States faces substantial and unsustainable medium- and long-term budget deficits, which will require a combination of tax increases and spending cuts to resolve. On the tax side, one relatively attraction option for raising revenue would be to impose a carbon tax. Besides its impact on revenues, the tax would improve environmental outcomes, increase economic efficiency, and allow the elimination of selected other tax subsidies and spending programs. The distributional effects would be regressive but could be offset by other policy changes. As policy makers search for solutions to the fiscal problem and for ways to improve the tax system, carbon taxation could play a positive role in addressing each situation.

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Auerbach, Alan J. and William G. Gale. 2012. “The Federal Budget Outlook: No News Is Bad News.” Available at http://emlab.berkeley.edu/~auerbach/Auerbach-Gale%202012-08-27.pdf

Alan J. Auerbach & Joel Slemrod, 1997. “The Economic Effects of the Tax Reform Act of 1986,” Journal of Economic Literature, American Economic Association, vol. 35(2), pages 589-632, June.

Baneman, Daniel, Jim Nunns, Jeff Rohaly, Eric Toder, and Roberton Williams. 2011. “Options to Limit the Benefit of Tax Expenditures for High-Income Households.” Tax Policy Center.

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[1] The IMF (2012) suggested 60 percent as an appropriate ratio of gross general debt-to-GDP for advanced countries while emerging and low-income countries had a lower ratio of 40 percent. The Peterson-Pew Commission on Budget Reform (2011), the Bipartisan Policy Center’s Debt Reduction Task Force (2010), and the President’s National Commission on Fiscal Responsibility and Reform (2010) all had medium-term goals of a 60 percent of debt-to-GDP ratio by 2020 or 2021. Johnson and Kwak (2012) suggested a goal of 50 percent to err on the side of caution to account for the fact that the U.S. workforce is growing more slowly and for the fears that the U.S. may lose its global reserve currency status or face another financial crisis.

[2] Authors’ calculations based on Steuerle (2004) and CBO (1983, 1991, 1993).

[3] Bartlett (2007) outlines the development of the “starve the beast” theory and shows how it failed to apply during the George W. Bush administration.  

[4] Short-term economic effects of tax-financed deficit reductions often differ from long-term effects. Consequently, the relative benefits of a tax-financed deficit reduction policy depend on the time frame of the analysis. Since this paper is concerned with a long-term fiscal solution, we focus on the long-term economic effects.

[5] The creation of carbon taxes will cause a partial, automatic reduction in other tax revenues. As one simple example of how this might work, a firm that pays $100 in carbon taxes would, in the absence of any other changes, have $100 less in corporate profits and so would owe less in corporate taxes. Studies estimate overall automatic tax offsets between 25 percent and 31 percent of the gross revenue levels, thus resulting in the net revenue levels reported in the text and shown in Table 2.

[6] Australia really has an emissions trading system. However, because most of the allowances are auctioned, and there is a price collar (at least until 2015) it looks more like a tax.

[7] Authors’ calculations based on OECD (2011).

[8] Sterner (2007), for example, estimates that fuel demand in Europe would be twice as high if European countries had faced U.S. gas tax rates.

[9] There are several options for administering the tax which we do not go into here. See Bickley (2006) and Cnossen (2009) for some discussion of these options.

[10] Toder, Nunns, and Rosenberg (2011) propose a two-pronged rebate. The rebate would be a credit equal to the VAT rate multiplied by a base of $12,000 for single households and $24,000 for married households (in 2012); the base could not exceed employment income. In addition, they propose an upward adjustment to Social Security payments to offset the reduction in real wages over time.

[11] Congressional Budget Office (CBO; 1992. xv) finds that “excluding necessities such as food, housing, utilities, and health care would lessen the VAT’s regressivity only slightly.” Toder and Rosenberg (2010) find that excluding housing, food consumed at home, and private health expenditures from the consumption tax base can somewhat increase progressivity, but not as much as a per-person payment would.

[12] All of the revenue estimates here refer to pre-ATRA baselines. Since ATRA raised tax rates, post-ATRA revenue estimates of tax expenditure reform would yield somewhat larger revenue estimates than indicated here.

[13] The Feldstein-Feenberg-MacGuineas proposal limited the tax value of itemized deductions, the health insurance exclusion, and the child tax credit, dependent care credit, and general business credit. For deductions and exemptions, the tax value is equal to the face value of the deduction or exclusion multiplied by the filer’s marginal tax rate. The tax value of a tax credit is equal to the credit.

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