Tax Swap

Probably the most frequently discussed policy option is to place a tax on carbon emissions, and use the money in a “tax swap” to reduce the tax on wages, or to reduce other taxes that especially reduce economic growth. (Other options include giving the money back to people directly, or using the money to stimulate research—the funds would be available for anything that money can be spent on.) In 2013, the US Congressional Budget Office summarized available research showing that if we ignore all of the benefits of reducing fossil-fuel emissions and avoiding global warming, a properly designed tax swap would have little impact on the economy as a whole—it might slow growth a little, or speed growth a little, but without too much change (Effects of a Carbon Tax on the Economy and the Environment, 2013). Earlier, the US EPA had conducted a similar study and found a slightly overall increase in household consumption over the next 30 years in response to a price on carbon—a stronger economy from putting a price on carbon emissions and using the money to reduce the tax on work. (U.S. Environmental Protection Agency, Office of Atmospheric Programs, 2009, Revenue recycling to reduce labor taxes, in Supplemental EPA Analysis of the American Clean Energy and Security Act of 2009 H.R. 2454 in the 111th Congress, p. 23, scenario 16.) You might think of this as arising from the fact that replacing fossil fuels is difficult, and taxing fossil fuels causes inefficiency in the economy, but replacing workers is about as difficult and perhaps even more difficult, and taxing their wages causes about as much and may be even more inefficiency in the economy.

Such studies also show that it is possible for governments to raise taxes on carbon and then use the resulting money in ways that are not as helpful to the economy so that the carbon tax really does reduce economic growth significantly. (The worst example of this might be taking the money and shredding it!) But, used appropriately, there is little economic cost and possibly economic gain from a carbon tax even if you ignore the benefits of reducing CO₂ emissions. And, as noted in the previous chapter, a cost on carbon emissions is strongly justified if the costs of global warming are included.

One objection to a carbon tax, even if implemented efficiently with a tax swap, is that it takes relatively more money from poor people than from the wealthy; such a policy is often called regressive. In contrast, income taxes tend to be designed in a progressive manner, so that wealthier people pay relatively more. However, other policies can be designed to address such issues if they are deemed important.

In his 2008 book, A Question of Balance, the Yale economist William Nordhaus (we met him in Module 10) devoted a whole chapter to “The many advantages of carbon taxes”. Three days after the Obama administration’s 21-page sketch of policy actions, economist Henry Jacoby of MIT told National Public Radio’s David Kestenbaum (Morning Edition, June 28, 2013) that economists could solve the problem with a one-page bill. Kestenbaum’s analysis in the interview says “This is why economists love a carbon tax: One change to the tax code and the entire economy shifts to reduce carbon emissions. If you do it right, a carbon tax can be nearly painless for the economy as a whole.” (And, again, this ignores the benefits of reducing global warming, which make the carbon tax more favorable.)