Dallas Burtaw and Hal Gordon:
Economists argue that the most efficient way to reduce greenhouse gas emissions is to raise the price of energy by introducing a price on carbon emissions, either through a tax or a cap-and-trade regime. A tax (or a cap-and-trade system that auctions off permits) has a secondary effect beyond providing incentives for reducing emissions: it raises a lot of new government revenue. Just what is done with this revenue weighs heavily on the distributional effects of a carbon price; in fact, it has greater relevance to the distributional outcome than the actual price on carbon emissions. In a new RFF discussion paper, with RFF’s Rob Williams and Richard Morgenstern, and Jared Carbone of the University of Calgary, we analyzed three different options for allocating the revenue from a $30 per-ton tax on carbon (which translates to $192 billion in the first year), and the effects on the distribution of the cost burden across income groups in the United States. These effects change over time. We focus here on the initial effects at the outset of the policy because these near-term consequences are the most salient in the contemporary political dialogue.
Most carbon tax proposals plan to return the money collected by the government to the people. For instance, California’s cap-and-trade scheme returns much of the revenue to utility customers with a biannual “climate credit.” The three policies we examine would recycle all carbon tax revenue—that is, the level of governments spending would not change. In one policy, an equal share of the revenue is returned to each resident in the form of a lump-sum rebate. In another, the revenue is used to pay for a cut in the marginal labor tax. And in a third, it pays for a cut in marginal capital taxes. The tax cuts are implemented as an equal percentage reduction in the tax rate at all income levels, although different approaches would have different effects. It has been well established that total economic efficiency is expected to be greatest when the revenue from a carbon tax is used to reduce the capital tax and next best when it is used to reduce the labor tax because, in each case, the policy substitutes for a preexisting distortionary policy. A lump-sum rebate does not share this characteristic. However, economic efficiency comes with particular distributional outcomes that should also be evaluated. ...
Although the capital tax recycling policy is most efficient, it is also the most regressive. The labor tax policy is somewhat less efficient, but spreads the welfare effects relatively evenly across income quintiles. The lump-sum rebate policy is the least efficient and has the most diverse distributional outcomes, but results in a strongly progressive outcome. In fact, roughly speaking, the lowest three income quintiles (60 percent of households) experience welfare gains under this policy, according to our analysis. ...
