The state of Washington is currently contemplating the tax provision I-732, which would introduce a revenue neutral carbon tax to the state ($25/ton). Ironically, this tax proposal is taking heat from environmentalists and social justice advocates, but the proposed policy alternatives are poor policy at best. A revenue neutral carbon tax represents a broadly bi-partisan solution to climate change, is the most economically efficient means of reducing emissions, and side-steps pre-existing political challenges in the climate sphere. This is a solution that both the left and right should be agreeing to—not avoiding.

What is a revenue neutral carbon tax?

A carbon tax is a simple idea: tax emissions, and people will emit less in order to save money. Pricing emissions is the most economically efficient means of cutting carbon, because individuals can more effectively adjust their behavior to capture savings than a government mandate. Unfortunately, the policy idea on its own is pretty poor. Effectively it taxes energy, and high energy prices are bad for the economy. What’s worse, in its purest form it unfairly hits the poorest Americans, who’s energy costs are a higher portion of their expenditures than higher earners. This is a major reason why Congress shot down any hope for a federal carbon tax earlier this year.

Enter a revenue neutral carbon tax. Instead of using the carbon tax to raise revenue for the government, return it to the taxpayers. There are lots of distortionary taxes in the U.S., and the most damaging are business and corporate income taxes (a big factor driving corporate inversions). If the revenue from a carbon tax is used to reduce those taxes, the net economic costs are a product of how much more distortionary a carbon tax is than the tax it replaces, not from the distortions caused by introducing a new tax. The regressivity (that it costs the poor more than the rich) can be offset by payroll tax adjustments, or the expansion of pro-growth low income tax credits (such as the earned income tax credit). In one fell swoop you are cutting emissions, reducing corporate inversions, improving the potential earnings for America’s poorest, and you aren’t raising taxes or changing the size of the government.

Why are some groups opposed?

Some groups are opposed to the policy mentioned above, which the proposed policy in Washington closely resembles (though Washington’s lack of personal income tax means most of the revenue will cut sales taxes), due to the lack of provisions for clean energy investment. Many feel that investment in clean energy is insufficient, and climate action should attempt to raise revenue from fossil fuel companies and reinvest those funds into clean energy projects as an issue of fairness.

However, such a policy not only introduces unwanted political contentiousness, it also is unnecessary. A carbon tax—even a revenue neutral one—will naturally cause the economy to shift capital from fossil fuel to clean energy as the market responds to the tax. There is no need for policy intervention beyond carbon pricing.

Levying taxes to spend on clean energy investment could actually be counter-productive, since there are many unsubsidized methods of abating emissions. This can be anything from behavior adjustment in energy consumption, to low carbon energy sources that do not receive the same subsidies as wind or solar (hydropower, nuclear power, carbon capture and sequestration, new zero emission fossil fuel cycles, etc.). If the objective is to tax fossil fuels and then invest revenues in preferred energy sources, then it could be excluding opportunities for emissions cuts that would otherwise be captured from a revenue neutral carbon tax.

A tax and spend approach could also fall victim to the classic problem of revenue raising sin taxes. If the policy objective of the tax is to reduce the sin (carbon pollution in this case), then the raised revenue will fall over time. Whatever program is funded by the sin tax would eventually fall. If low income assistance or clean energy projects are funded from fees on fossil fuels, then this creates a moral hazard. As people emit less, the government would either have to abandon those programs or (unfairly) shift the cost burden to another party.

A revenue neutral carbon tax avoids this problem entirely, since it is not introducing any new spending initiatives. If revenue falls, the consequence would be to revert to the previous tax levels. Since the revenue neutral tax should also be (somewhat) distributionally neutral, the taxes and benefits of individuals would be largely unchanged in either scenario. The only difference is a cleaner, more energy efficient economy.

Conclusion

The Energy Information Administration (EIA) expects that a carbon tax (revenue neutral or otherwise) would reduce energy related CO2 emissions by 35-89 percent over a 25-year period. They estimate that if the revenue is used exclusively to reduce business taxes, then the economic impact would be negligible. Meanwhile, the EIA expects the Clean Power Plan to cut total energy emissions by only 7 percent from the baseline, but the cumulative economic impact of that single rule is estimated to be around $1 trillion.

When compared to the piecemeal approach of incremental regulations and energy subsidies, a revenue neutral carbon tax represents the most benefits for the least cost. It would be unfortunate if these benefits were foregone merely because the proposed solution sidesteps environmental issues that are typically bundled with emissions policy.

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