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CBO’s Carbon Tax Report -Interesting but Inconclusive

11 Jun '13

The Congressional Budget Office (CBO) on May 22, 2013 published a report with respect to the potential economic and environmental consequences of the imposition of a carbon tax in the United States. The report is available here. The report highlights a number of interesting dynamics between tax and environmental policy but avoided reaching any meaningful conclusions.

A Large Source of Tax Revenue

  • If the carbon tax were set at $20 per metric ton of greenhouse emissions in 2012 and inflated at 5.6 percent a year, then in a ten year period it would raise $1.2 trillion in taxes. This is comparable to the revenues raised from all excise taxes (e.g., taxes imposed on tobacco, alcohol and gasoline) and exceeds the proceeds of estate and gift taxes.
  • A tax of $20 per ton of emissions would result in an increase in the price of gasoline of 20 cents per gallon.

A Beneficial but Regressive Tax Swap

  • The report describes using the proceeds of a carbon tax to reduce income tax rates as a “tax swap.” The report provides, “CBO has not quantified the effects of a tax swap.  However, various studies … concluded that a well-designed tax swap would significantly lower the economic costs of a carbon tax, and a few studies concluded that a tax swap could lead to a net increase in output.”
  • So a tax swap could both benefit the environment and improve the economy. The policy weakness is that the cost of the carbon tax would be disportionately borne by low income households who pay little to no income taxes and thus would not benefit from lower income tax rates. The cost of a carbon tax would be disportionately borne by low income households, because an incremental increase in the cost of gasoline, electricity or heating oil would require them to spend a larger percentage of their income than a middle class household would be required to spend to meet the same cost. However, to the extent the proceeds from the carbon tax are used to compensate low income households (rather than for a reduction in income tax rates), then the carbon tax would have a greater adverse effect on the economy. The CBO writes “lawmakers would face a trade-off between the goals of helping those households most hurt by the tax and helping the economy in general.”

Carbon Leakage

  • A carbon tax in the United States would lead to higher prices for “emission-intensive goods produced in the United States,” which would result in the production of emission intensive goods moving to outside the United States.  The report characterizes this as “carbon leakage” and notes that analysts have concluded that between 1 and 23 percent of the reduction in emissions from a carbon tax would be cancelled out due to carbon leakage. Carbon leakage could be addressed through tariffs on imported goods, but that leads to complexity and raises free trade issues.
  • If the United States imposed a carbon tax unilaterally, it would not be an environmental panacea due to the global nature of the problem. The United States currently contributes about 18 percent of global carbon emissions. “Acting on its own, the United States could have only a modest effect on the amount of warming.  [E]fforts to limit global warming are likely to require significant reductions in emissions by rapidly growing economies, such as those of China and India.”

Evasive Conclusions

  • The report has a long discussion of quantifying the environmental benefits of a carbon tax. That discussion can be summarized by saying that the level of benefit depends on modeling assumptions and particularly the discount rate applied to future environmental benefits. 
  • The report ends on a particularly mealy mouthed note:

Given the persistent nature of greenhouse gases and the dynamics of climate change, warming could continue for several decades even if emissions were quickly cut to a small fraction of today’s levels.  In general, the risk of costly damage is higher as the extent of warming increases and as the pace of warming picks up; thus, failing to limit emissions soon increase that risk.