Carbon Taxes, Tax Reform and Reduced Regulation by David Montgomery

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The carbon tax has re-entered the political scene with a visit to the White House by a group of former Republican official last Wednesday. Their proposal, endorsed by Senator Van Hollen, would impose a $40 per ton of carbon tax and distribute the proceeds by sending a quarterly check to every American. Perhaps unnoticed by Senator Van Hollen, their proposal included repeal of all existing regulations made unnecessary by the carbon tax.

I agree with all of them about the need for a carbon tax.

First, what is a carbon tax? It is a tax on the carbon content of oil, natural gas, and coal, collected from their producers or importers. Coal contains about twice as much carbon as natural gas, and oil is in between so that the tax promotes switching to cleaner fuels and energy conservation. The carbon tax will show up in energy costs for consumers. A $40 per ton carbon tax is the equivalent of a gasoline tax increase of 36 cents per gallon and would also apply to natural gas, heating oil, propane and electricity generated from any of those fuels.

Why do some Republicans and Democrats like a carbon tax? For me, the reason is that the carbon tax is far less intrusive than regulations put in place over the past eight years to limit carbon dioxide emissions. It will impose far less cost on the economy and American families than the current regulations, and it will motivate free market solutions and innovation to find less costly alternatives to oil, natural gas, and coal, fuels that we cannot now do without.

Even though I am skeptical of the disasters predicted by climate activists and President Obama, there are solid scientific and economic reasons that justify looking for cost-effective ways to reduce the risks that climate change might pose. Studies from a wide variety of institutions with no common ideology agree that the carbon tax will have much lower cost and put less drag on the economy than current regulations and those that might be put in place by future administrations. Unfortunately, a carbon tax doesn’t hide its cost the way that regulations and subsidies do, nor does it give politicians the opportunity to direct benefits to the particular interests they serve like the current inefficient package of regulations and subsidies. I think that is a good thing, but it is a political handicap.

Nevertheless, I disagree in several ways with this specific proposal.

$40 per ton is too high and letting the tax increase forever is too much. Even the Obama Administration found that that the damage to the United States from carbon dioxide emissions was no more than $10 per ton. A tax at $40 per ton clearly fails the test of having costs greater than benefits. The Republican proponents of the $40 per ton tax cited the Paris Agreement, in which President Obama promised to reduce U.S. emissions to 26% – 28% below 2005 levels by 2025, as justification for that large a tax. But the numbers in the Paris Agreement, to which President Obama unilaterally committed the U.S. last year, were an arbitrary political choice, backed by no cost-benefit analysis and were a bad deal for the U.S. President Trump intends to change that deal, and he is right.

President Obama’s Paris commitments were a bad deal because more than 50% of carbon dioxide emissions that will be released in the next century will come from China and India, and their commitment in Paris was that they would start thinking about reducing emissions some time after 2030. It is bad geopolitical strategy to commit ourselves to take actions that require comparable action by others, when our counterparts have indicated no willingness to match us. Nor will fulfilling our Paris commitments do noticeable good for the world.

By the time our Paris commitments made any difference to the rate of increase in global temperature, those who now face risks of natural disasters and weather that might be made worse by climate change will have died of old age. We would do better to spend our resources now delivering aid directly to those people, not through their almost universally corrupt governments, and to do so in ways that are effective in reducing their vulnerability now as well as far in the future.

The idea of giving the revenues from a carbon tax directly to the people has many merits, including making sure it does not just go for frivolous spending. But it is not the best use of the revenues. First, Senator Van Hollen and other advocates of that approach err when they claim it will offset all the burden of the carbon tax. That is impossible. The government can return the out of pocket cost of the carbon tax by returning every dollar collected, but that will not reverse the drag on the economy that comes from replacing cheap with expensive energy. The problem with all taxes is that they create harm to the economy beyond the money they take from people’s pockets, by misallocating resources and reducing incentives to work and produce.

But some taxes are worse than others, and the best use of the revenue collected by a carbon tax would be to eliminate taxes that do far more harm. And right now there is an opportunity to make that trade that we have not seen since the 1980s.

After Obamacare, the highest priority of the Republican Congressional Leadership and the President is to enact comprehensive tax reform, which we have not seen since the Reagan Administration. President Trump has promised that action will begin in the next few weeks. A carbon tax could play a critical role in making tax reform possible and even more effective.

It is much more beneficial to use a carbon tax to fund tax reform than the rebate plan, which gives up economic benefits for political appeal. There is a cost to reducing emissions – it entails a shift to energy sources that cost more creating drag on the economy that slows wage growth and cuts into investment returns. And the carbon tax doesn’t raise enough money to cover these added costs. Using the revenue to reduce other burdensome taxes gives a Double Dividend – it not only gets the money back in the form of reduced taxes but it eliminates the disincentives for work and investment created by the current tax law. That leads to higher wage growth and better investment returns and a double dividend.

The Blueprint for Fundamental Tax Reform proposed by Speaker Ryan Chairman Brady of the House Ways and Means Committee attacks the most growth-killing taxes as well as eliminating paperwork and unfair preferences. The non-partisan Tax Foundation concluded that the Blueprint will give almost 10% higher GDP, create 1.7 million jobs and raise after-tax income for all classes of taxpayers by over 8%.

Since the Democrats have stonewalled every action by the Trump Administration, no matter what the merits, getting tax reform through requires using the Budget Reconciliation bill. This only requires 51 votes in the Senate, but the measure must be 1. relevant to the budget, which tax reform is, and 2. budget-neutral over the next ten years. To be budget-neutral, the plan only cuts taxes as much as possible without increasing the deficit. The carbon tax would make it possible to cut tax rates for individuals and businesses even further, or could overcome the revenue-draining effects of the inevitable carve-outs and exemptions for special interests. Or the carbon tax could provide a substitute for some of the provisions of the Blueprint that raise revenue if they prove too unpopular.

But none of this matters unless we roll back the badly designed and overly burdensome regulations and subsidies that have accumulated over the years. The greatest increase in regulatory burden took place during the Obama Administration, but the list of costly and ineffective regulations goes further back and further west. The Bush Administration gave us mandates and subsidies for renewables and California holds the country hostage with its ability to set fuel economy standards.

Quite literally, the power of a carbon tax to unleash market forces to find least cost solutions and stimulate innovation is neutralized by regulations that mandate particular actions to reduce emissions whether they make economic sense or not. Here is a short list of what has to go if the carbon tax is to be fully effective: the Clean Power Plan regulating electric utilities, the recent tightening of Corporate Average Fuel Economy Standards that will make new cars more and more expensive, the Renewable Fuel Standards that enrich only the ethanol lobby and require more ethanol in gasoline than engines can safely burn; and tax subsidies for renewable energy that hide its cost in the income tax rather than revealing it in electricity bills. That is a partial list of Federal regulations, but it is not enough. California was given authority to set its own fuel economy standards by President Obama, and that must also be pre-empted to relieve the burden on auto manufacturers that will otherwise be shared nationwide. Likewise, Maryland’s Renewable Portfolio Standards that force utilities to pay for excessively costly solar and wind installations must be pre-empted, if these sources are to compete on a level playing field created by the carbon tax. And there are others at the state and Federal level.

But eliminating regulations and subsidies is the hardest step. They are supported by an unholy alliance between the environmental activists and politicians who prefer government intrusion and the industries that benefit from it. I hope Senator Van Hollen is ready to break the mold and go along with this part of the proposal he endorsed, but I suspect he will change his mind when he realizes that the carbon tax will do away with the regulations and subsidies he loves so much.

So I do hope the White House listens to and sensibly modifies the proposal from moderate Republicans. The proposal fits and would advance their priorities for regulatory and tax reform. It is the most free market way to address the potential risks of climate change. But will only achieve all this as an inseparable package – carbon tax, tax reform, and rollback of regulations. There will be little benefit from a carbon tax if the money is given away and regulation remains.

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Letters to Editor

  1. Editor’s Note. Senator Van Hollen’s office reported to the Spy that there are two main inaccuracies in this opinion piece. 1) Sen. Van Hollen did not endorse the Baker proposal but instead said he appreciated their work and that we need to put a price on carbon. 2) The Senator also does not believe revenues from a carbon tax will offset all the burden of the carbon tax but instead point to a study from the University of Massachusetts Amherst study that says that more than 80 percent of families will come out ahead.

    • David Montgomery says:

      I appreciate the clarification of Senator Van Hollen’s position on the Baker proposal. His press memo on the Baker Proposal stated that Senator Hollen “welcome[s] the bipartisan support” for his proposal to put a price on carbon, and I now understand that he did not intend to endorse the Baker Proposal in its entirety. That is consistent with my expectation that Senator Hollen would not favor repeal of all current greenhouse gas regulations. I also appreciate the clarification that, unlike many proponents of a carbon tax, Senator Hollen agrees with me that simply refunding the proceeds from a carbon tax cannot fully offset its cost to consumers and the economy.

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