Ed Dolan's Econ Blog

The Conservative Case for Carbon Dividends: A Bad Marriage of Two Good Ideas?

As a firm supporter of both carbon taxes and a universal basic income (UBI), you would think that I would be thrilled by the new report, The Conservative Case for Carbon Dividends, released Wednesday by the Climate Leadership Council (CLC).  It puts a price on carbon like a good carbon tax should, and it gives people a monthly dividend, as a UBI would do. But when I look at the proposal as a whole, I’m not as thrilled as I ought to be. I’m afraid it’s a bad marriage of two good ideas.

What’s good about the Carbon Dividend

There are some very bright guys behind the CLC proposal—Martin Feldstein, Greg Mankiw, Hank Paulson and more. They have the best of intentions. Their proposal is a conservative analog of the Carbon Fee and Dividend plan from the more liberal Citizens’ Climate Lobby (CCL). Both plans would impose a tax on carbon emissions and distribute the proceeds equally as unconditional payments to all citizens. Both plans would gradually raise the tax over time. The CLC plan would start a little more aggressively, at $40 per ton rather than $15. That part of it is fine by me.

The CLC plan also has a few add-ons that the CCL version does not. It proposes a rollback of other carbon emission regulations that would be made redundant by the tax. (The release is vague about exactly which regulations would go. I hope ethanol mandates and CAFE standards are on the hit list.) The CLC also proposes rebating the carbon tax to exporters and imposing it on the carbon content of imports. There is some logic in that, although it might take some careful drafting the make the proposal compliant with WTO rules.

What’s bad: The incentive problem

My main problem with both the CLC and CCL proposals, though, is the idea of rebating the proceeds of the carbon tax directly to households rather than integrating both elements of the tax-and-dividend scheme into a more general reform of taxes and transfers. My objection is not to the idea of revenue neutrality as such—I’m all in favor of that. Rather, the problem is one of incentives.

First, let’s look at the tax side. The CLC proposal says, reasonably enough, that “an ideal climate strategy would simultaneously reduce carbon emissions and steer America towards a path of more durable economic growth.” It is a bit of a stretch to say that a carbon tax by itself would do that. Yes, it would improve efficiency in the long run compared to the current command-and-control approach to climate regulation. In the short run, though, it would make some operations uncompetitive, lead to the scrapping of some plant and equipment, and in the process require a lot of people to move from job to job and place to place. There would be frictional costs on the road to efficiency.

Instead,  the carbon fee is made tax-neutral by using revenues to reduce other taxes that have strong disincentive or mis-incentive effects. My favorite candidates are the payroll tax, which is highly regressive and discourages work by low-skill workers, and the corporate income tax, which is not as progressive as people think and encourages corporations to move offshore and do lots of other silly things.

Revenue from a $40-and-rising carbon tax such as the CLC proposes would allow substantial reductions to the marginal rates of both taxes. Since both workers and corporate shareholders would see their after-tax incomes rise, the distributional effects would not be all that much different from sending a check to every household, but the incentive effects via lower marginal tax rates would be far more favorable. Republicans and Democrats in Congress could arm-wrestle to decide which tax gets the greater share of the reductions.

Now look at the dividend side. I have nothing against giving everyone a nice government bonus every month. That is exactly what a universal basic income is. But to produce the maximum beneficial effect on work incentives, the UBI should replace existing transfer programs, not be added on top of them.

For low-income families, the UBI should replace programs like, for example, food stamps (SNAP). Right now, SNAP takes back 30 cents for every extra dollar you earn. That is a big disincentive to someone working a minimum wage job. To improve work incentives, a UBI should replace food stamps—not in a way that reduces the total resources of low-income families, but in a way that gives them what they need without penalizing work effort.

Higher up the income scale, the UBI should replace other “middle class welfare” like the mortgage interest deduction. Not in a way that takes away resources that middle-class families might need to buy a home, but in a way that gives them a benefit that is more distributionally fair, because it helps renters as well as  homeowners and is not biased so much toward people with million-dollar residences. (See this earlier post for a complete explanation of how a UBI would replace other transfers and tax expenditures.)

The bottom line

When we look at both elements of the tax-and-dividend approach together, we see that they amount to half of a revenue-neutral carbon tax and half of a UBI. Why not go for the whole things? A true revenue-neutral carbon tax that uses its revenues to replace other taxes with far worse incentive effects. A true UBI that uses its universal dividend to replace other transfer programs, which also have far worse incentive effects.

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