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Tax Carbon and Rebate the Money? That Could Be Expensive

Emissions during a flaring operation at the ConocoPhillips refinery near Los Angeles on Sept. 15, 2012

Photograph by Jonathan Alcorn/Bloomberg

Emissions during a flaring operation at the ConocoPhillips refinery near Los Angeles on Sept. 15, 2012

Carbon taxes could save the planet by reducing greenhouses gases that cause global warming. But there’s a debate over what to do with the money raised. A study released Friday concludes that the “cap and dividend” approach championed by Maryland Democratic Representative Chris Van Hollen—rebating the money in lump sums to every U.S. resident—would benefit the most households but also be the most expensive.

The study (pdf) by economists at Resources for the Future, a think tank in Washington, evaluates the lump-sum rebate against two other approaches: using the tax revenue to cut taxes on capital, such as dividends and capital gains taxes, and using it to cut taxes on labor, such as taxes on wages, salaries, and bonuses.

The lump-sum approach would benefit people in the bottom three-fifths of the population while hurting people in the top two-fifths, the study concludes. That’s because the lump sum, which is the same for everyone, would be an insignificant amount of money for higher-income Americans, not enough to offset the harm from higher prices on such products as gasoline, the hit to shares of energy companies whose stocks they own, etc.

The approach of cutting capital taxes would benefit only the top fifth of American households, who earn the lion’s share of capital gains and dividends. It would make everyone else worse off. Yet the Resources for the Future study concludes that it would be the least expensive for the American economy as a whole. That’s because the dollar value of gains by the top fifth would largely outweigh the losses suffered by everyone else. Cutting taxes on labor, the third option, would fall in between.

The study makes no attempt to quantify the environmental benefits of a $30-per-ton carbon tax, focusing only on its initial impact on economic output. It assumes that the economy is operating efficiently before the tax, so the tax causes it to operate less efficiently and harms output. That goes against the view of organizations such as the New Climate Economy, which argues that a carbon tax can actually strengthen the performance of economies by getting them to wring new efficiencies out of production processes.

Dallas Bertraw, an author of the Resources for the Future report, acknowledged in an interview that the assumption that the U.S. economy is operating at full efficiency now, without a carbon tax, doesn’t reflect reality: “I don’t believe the economy works at the efficient frontier.” He said a carbon tax in the real world would be less of a drag than the model suggests. And he said that a Van Hollen-style, lump-sum rebate would look better in a slack economy with unemployment, because some of the lump sum could be spent to stimulate demand and take up the slack.

Coy is Bloomberg Businessweek's economics editor. His Twitter handle is @petercoy.

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