Global annual temperatures are rising more rapidly as greenhouse gasses (GHGs) from human activity, and most notably from the burning of fossil fuels, trap heat at the Earth’s surface. The potential consequences—rising sea levels, extreme drought and flooding, water stress, and shorter growing seasons—could result in dramatic changes in our way of life and in long-term economic harm. Yet many forms of direct regulations are inefficient and increases in energy prices disproportionately harm low-income consumers.
The climate change challenge could be confronted by a gradually increasing tax on GHG emissions, which would encourage firms and consumers to reduce emissions. While such a proposal would raise the price of energy and disproportionately impact low-income families, revenues from the tax would fund an environmental tax credit to support low-income taxpayers. Additionally, this proposal would promote U.S. leadership on this issue, encouraging other nations to act.
This paper describes a carbon tax swap that is both revenue and distributionally neutral. The tax swap would levy a tax on greenhouse gas emissions. The revenue would be used to fund a reduction in the income tax, tied to earned income. Specifically, the proposal calls for a tax on greenhouse gas emissions at an initial rate of $15 per ton of carbon dioxide equivalent, and gradually increasing over time. A refundable tax credit would be offered for sequestered greenhouse gases and other approved sequestration activities. In addition, to offset the new carbon tax, the proposal would implement an environmental tax credit in the personal income tax equal to the employer and employee payroll taxes on initial earnings up to a limit.
This paper begins with a discussion of the problem of greenhouse gas emissions and provides a rationale for setting a price on carbon emissions. It then provides a distributional analysis of the proposal described above. Following this analysis, it makes a case for why carbon pricing through a tax should be considered a viable alternative to carbon pricing through a cap-and-trade system. It concludes with a response to various objections made to carbon pricing in general and a carbon tax in particular.