US considers ‘greening’ the tax code

PALO ALTO, Calif. — Consider this as you stand in line at the post office tonight: What if
the government cut taxes on things it likes, such as labor and capital investments, and focused on taxing things it doesn’t — like pollution?

That’s been the thinking of several economists, who argue that a “greening” of the tax system offers a chance to shift a portion of revenue collection from methods that distort the economy to a source that corrects one of its major problems: Only rarely is the cost of pollution included in the price of a product.

With several proposals for putting a price on carbon emissions now being floated in Washington, the idea is closer than ever to becoming reality. The bills under consideration would either put a direct tax on carbon, or more likely put a cap on emissions, with the potential to raise revenues through the auctioning of permits. Indeed, the budget proposed by President Barack Obama includes estimates of an average revenue of $80 billion a year from
efforts to curb carbon emissions, money that economists suggest should be somehow returned to the taxpayer.

An important part of the thinking, said Gilbert Metcalf, an economist at Tufts University, is that the cost of cuts in carbon will be more politically palatable if accompanied by corresponding drops in income and payroll taxes.

“We don’t want to mix up environmental policy with a debate on how big the government should be,” Metcalf said.

Perhaps equally significant, from the point of view of economics, is the opportunity to use the extra revenue to reduce the distortionary impact of a tax on work. For every dollar of income taxed, the economy is estimated to suffer another 15 to 30 cents, as people — often working
mothers or teenagers — decide it’s not worth their while to take a job.

“It can really make a difference on whether they enter the market or not, or choose between full-time and part-time work,” said Larry Goulder, an economist at Stanford who has been studying the greening of the tax code since the mid-1980s.

For a period of time in the early 1990s, economists thought the benefits from freeing up labor would be enough to more than offset the effects of putting a price on carbon, in effect making a green tax a policy that pays for itself. Now, said Goulder, the consensus is that reducing income taxes will offset about half the cost to the economy of putting a price on carbon.

“It’s not a free lunch,” said Goulder. “But it’s a lunch worth paying for.”

Accompanying a carbon tax with corresponding cuts in income tax also would solve another problem: The disproportionate burden an environmental tax would place on the poor, who after all spend a larger portion of their income on carbon-intensive expenditures, such as gasoline, electricity, food and consumer goods.

Metcalf, in a paper written for the Brookings Institution, advocates returning the revenue in the form of rebates on payroll taxes, which are paid by all working Americans. Taxpayers near the bottom of the scale would see most of their payroll taxes returned to them.

Whether the greening of the tax code will come about will be determined in the coming months as legislators hash out their approach to dealing with climate change. One pitfall is the allocation of pollution permits under a cap and trade plan. If these are given away, rather than auctioned, prices will still go up, but the extra revenue is likely to be captured by energy companies, rather than the government.

Obama, for his part, seems aware of the pitfalls. His proposed budget explicitly channels 80 percent of the hikes in revenue from carbon into a “Making Work Pay” tax cut (the remaining 20 percent are allocated towards clean energy technologies).

Of course, taxing carbon has one long-term side effect that cutting the income tax can’t solve. As the economy becomes cleaner, revenue will drop. But that’s a problem Goulder would like the United States to have. “If we get to the point where’re not getting much revenue from a green tax, it means we’ve solved the issue,” he says.

More GlobalPost dispatches on climate change:

The global consequences of climate change

A climate change collision course