The 117th Congress is underway. Inauguration Day has come and gone. The carbon tax debate is again in full swing.

Niskanen Center

January 21, 2021

Economists like Janet Yellen recognize that, compared to alternatives such as regulations and mandates, a carbon tax is the most economically efficient policy to combat climate change. Using the regressivity of a carbon tax to criticize the policy without evaluating the revenue recycling options to offset it is misleading. A correct approach to evaluate the overall economic impact of a carbon tax must account for the effects of revenue recycling.

IER’s Take

Shuting Pomerleau of the Niskanen Center has emerged as one of the more cogent carbon tax commentators in Washington and this piece, too, delivers. I agree with Pomerleau that it does an injustice to the discourse to present only one side of the carbon tax argument. While tax proponents regularly do so, carbon tax naysayers also err, frequently invoking the inherent regressivity of a carbon tax without acknowledging the focus placed on mitigating that effect by some carbon tax plans.

Pomerleau cites in the piece above a number of studies which evaluate different revenue recycling approaches for a carbon tax. (Allow me here to plug the IER-commissioned study on six different scenarios released in fall 2018.) The first two studies Pomerleau cites are from the Tax Foundation and EY, respectively. Both studies find that there are revenue-recycling strategies that can mitigate the regressive effect of a carbon.

But quite significantly, both the Tax Foundation study and EY study agree with the IER-commissioned study that the lump-sum rebate approach, such as is favored by Janet Yellen’s Climate Leadership Council, is among the poorest-performing revenue recycling strategies available from the standpoint of overall economic performance.

The Tax Foundation study finds that the rebate strategy reduces regressivity but is harmful to overall economic output and harmful to employment. A payroll tax cut strategy, meanwhile, yields output and employment boosts, while also making the tax code slightly less regressive.

The EY study, similarly, reports that both a permanent extension of select Tax Cuts and Jobs Act provisions and investment in public infrastructure would outperform household rebates as carbon tax revenue uses. In the rebate scenario the entirety of the long-run positive change in annual per-household GDP would be attributable to the removal of the existing regulatory approach. In the EY analysis (figure ES-1) the rebate itself would cause losses of 0.4 percent, but be offset by gains of 1.1 percent as a result of ditching regulations.

While it may be the case that some carbon tax revenue strategies could mitigate the tax’s regressivity, the literature does not support a lump-sum rebate strategy. When you encounter the Climate Leadership Council’s claim that they present the “economists’ case” for a carbon tax, it’s important to recognize that their proposal is actually more influenced by political considerations than economics.

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