Carbon Tax: Deficit Reduction and
Other Considerations
Jonathan L. Ramseur
Specialist in Environmental Policy
Jane A. Leggett
Specialist in Energy and Environmental Policy
Molly F. Sherlock
Specialist in Public Finance
September 17, 2012
Congressional Research Service
7-5700
www.crs.gov
R42731
CRS Report for Congress
Pr
epared for Members and Committees of Congress
Carbon Tax: Deficit Reduction and Other Considerations
Summary
The federal budget deficit has exceeded $1 trillion annually in each fiscal year since 2009, and
deficits are projected to continue. Over time, unsustainable deficits can lead to reduced savings
for investment, higher interest rates, and higher levels of inflation. Restoring fiscal balance would
require spending reductions, revenue increases, or some combination of the two.
Policymakers have considered a number of options for raising additional federal revenues,
including a carbon tax. A carbon tax could apply directly to carbon dioxide (CO2) and other
greenhouse gas (GHG) emissions, or to the inputs (e.g., fossil fuels) that lead to the emissions.
Unlike a tax on the energy content of each fuel (e.g., Btu tax), a carbon tax would vary with a
fuel’s carbon content, as there is a direct correlation between a fuel’s carbon content and its CO2
emissions.
Carbon taxes have been proposed for many years by economists and some Members of Congress,
including in the 112th Congress. If Congress were to establish a carbon tax, policymakers would
face several implementation decisions, including the point and rate of taxation. Although the
point of taxation does not necessarily reveal who bears the cost of the tax, this decision involves
trade-offs, such as comprehensiveness versus administrative complexity.
Several economic approaches could inform the debate over the tax rate. Congress could set a tax
rate designed to accrue a specific amount of revenues. Some would recommend setting the tax
rate based on estimated benefits associated with avoiding climate change impacts. Alternatively,
Congress could set a tax rate based on the carbon prices estimated to meet a specific GHG
emissions target.
Carbon tax revenues would vary greatly depending on the design features of the tax, as well as
market factors that are difficult to predict. One study estimated that a tax rate of $20 per metric
ton of CO2 would generate approximately $88 billion in 2012, rising to $144 billion by 2020. The
impact such an amount would have on budget deficits depends on which budget deficit projection
is used. For example, this estimated revenue source would reduce the 10-year budget deficit by
50%, using the 2012 baseline projection of the Congressional Budget Office (CBO). However,
under CBO’s alternative fiscal scenario, the same carbon tax would reduce the 10-year budget
deficit by about 12%.
When deciding how to allocate revenues, policymakers would encounter key trade-offs:
minimizing the costs of the carbon tax to “society” overall versus alleviating the costs borne by
subgroups in the U.S. population or specific domestic industries. Economic studies indicate that
using carbon tax revenues to offset reductions in existing taxes—labor, income, and investment—
could yield the greatest benefit to the economy overall. However, the approaches that yield the
largest overall benefit often impose disproportionate costs on lower-income households.
In addition, carbon-intensive, trade-exposed industries may face a disproportionate impact within
a unilateral carbon tax system. Policymakers could alleviate this burden through carbon tax
revenue distribution or through a border adjustment mechanism. Both approaches may entail
trade concerns.
Congressional Research Service
Carbon Tax: Deficit Reduction and Other Considerations
Contents
Introduction...................................................................................................................................... 1
Design and Implementation............................................................................................................. 4
Point of Taxation ....................................................................................................................... 4
Rate of Taxation......................................................................................................................... 8
Carbon Tax Effects on Fossil Fuel Prices.................................................................................. 9
Framework for Evaluation............................................................................................................. 13
Adequacy—The Potential to Generate Revenues.................................................................... 14
Economic Efficiency ............................................................................................................... 18
Many Taxes Have Distortionary Effects ........................................................................... 18
Taxes May Correct Market Failures.................................................................................. 19
An Economically Efficient Carbon Tax Rate.................................................................... 20
Equity ...................................................................................................................................... 20
Vertical Equity................................................................................................................... 20
Horizontal Equity .............................................................................................................. 21
Individual Equity............................................................................................................... 21
Generational Equity........................................................................................................... 21
Operability............................................................................................................................... 22
Administrative Ease .......................................................................................................... 22
Consistency with Federal and International Norms and Standards................................... 22
Potential Perverse Effects.................................................................................................. 23
Transparency ..................................................................................................................... 23
Political Feasibility.................................................................................................................. 24
Contribution to Deficit Reduction ................................................................................................. 24
Alternative Uses for Carbon Tax Revenues................................................................................... 26
Distribute Carbon Tax Revenues to Households ..................................................................... 26
Address Economy-Wide Costs ................................................................................................ 29
Assist Carbon-Intensive, Trade-Exposed Industries................................................................ 30
Concluding Observations............................................................................................................... 31
Figures
Figure 1. Illustration of Options for Points of Taxation within the Energy Production-to-
Consumption Chain ...................................................................................................................... 5
Figure 2. FY2011 Federal Receipts by Source .............................................................................. 16
Figure 3. Annual Carbon Tax Revenues in the Electricity Sector.................................................. 17
Figure 4. CBO Estimated Revenues from a $20/mtCO2 Carbon Tax Compared to Two
CBO Budget Deficit Projections ................................................................................................ 25
Tables
Table 1. Selected Sources of U.S. GHG Emissions and Potential Applications of a Carbon
Tax ................................................................................................................................................ 6
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Carbon Tax: Deficit Reduction and Other Considerations
Table 2. CO2 Emissions Per Unit of Energy for Fossil Fuels ........................................................ 10
Table 3. Estimated Taxes Levied on Fossil Fuels and Motor Gasoline Based on Selected
Carbon Tax Rates........................................................................................................................ 11
Table 4. Estimated Revenues from a CBO CO2 Emissions Pricing Model.................................... 15
Table 5. Distributional Effects of Carbon Tax with Different Applications of Carbon Tax
Revenues..................................................................................................................................... 28
Appendixes
Appendix. Carbon Tax and Carbon Pricing Proposals in the 111th Congress ................................ 33
Contacts
Author Contact Information........................................................................................................... 33
Congressional Research Service
Carbon Tax: Deficit Reduction and Other Considerations
Introduction
The federal budget deficit has exceeded $1 trillion annually in each fiscal year since 2009. In
August 2012, the Congressional Budget Office (CBO) estimated an FY2012 budget deficit of
$1.1 trillion, or 7.3% of gross domestic product (GDP).1 Under CBO’s alternative fiscal scenario,
which assumes continuation of many current policies, the deficit as a percentage of GDP will be
above 5% and rising from 2021 onward. Budget deficits are projected to continue, as the current
mix of federal fiscal policies is widely viewed as being unsustainable in the long term.2 Over
time, unsustainable deficits can have negative macroeconomic consequences, including reduced
savings for investment, higher interest rates, and higher levels of inflation.3 Restoring fiscal
balance will require spending reductions, revenue increases, or some combination of the two.
Policymakers have considered a number of options for raising additional federal revenues (see the
text box below). One potential option is a carbon tax. Several economists and policy analysts
from across the political spectrum have expressed interest in a carbon tax mechanism in recent
years.4 As of the date of this report, Members have introduced two carbon tax bills in the 112th
Congress.5 Several carbon price systems were proposed in the 111th Congress—as identified in
the Appendix—most frequently as an efficient means to stimulate greenhouse gas (GHG)
emission reductions. In addition, some countries have levied carbon taxes (or something similar)
for over 20 years.6
1 Congressional Budget Office, An Update to the Budget and Economic Outlook: Fiscal Years 2012 to 2022,
Washington, DC, August 2012, http://www.cbo.gov/publication/43539.
2 For background on budget baselines, see CRS Report R42362, The Federal Budget: Issues for FY2013 and Beyond,
by Mindy R. Levit and CRS Report R41778, Reducing the Budget Deficit: Policy Issues, by Marc Labonte.
3 See CRS Report RL33657, Running Deficits: Positives and Pitfalls, by D. Andrew Austin.
4 A sampling of recent news and academic articles includes Mark Golden and Mark Shwartz, “Stanford’s George
Shultz on Energy: It’s Personal,” Stanford University, July 12, 2012; Jon Greenberg, “Laffer Carbon Tax: A Carbon
Tax With a Twist to Please GOP—Maybe,” New Hampshire News, December 14, 2011; Robert Inglis, “Fixing Market
Distortions: A Free-Market Solution for Energy and Climate,” University of Chicago Booth School of Business, April
11, 2012; Gilbert Metcalf, “Designing a Carbon Tax to Reduce U.S. Greenhouse Gas Emissions” Review of
Environmental Economics and Policy 3, no. 1, pp. 63-83, September 2008; Brad Plumer, “Romney’s One Big Idea on
Climate—and Why He’s Unlikely to Pursue It,” The Washington Post, March 8, 2012; Amy Wolf, “Economist Arthur
Laffer Proposes Taxing Pollution Instead of Income,” Vanderbilt University, February 20, 2012.
5 See the Save Our Climate Act of 2011 (H.R. 3242) and the Managed Carbon Price Act of 2012 (H.R. 6338).
6 For a review of carbon taxes levied in other countries, see Jenny Sumner, et al., Carbon Taxes: A Review of
Experiences and Policy Design Considerations, National Renewable Energy Laboratory, NREL/TP-6A2-47312,
December 2009.
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Carbon Tax: Deficit Reduction and Other Considerations
Options for Raising Federal Revenues
Congress could utilize one or more policy options to raise federal revenue. One frequently discussed option is to
“broaden the tax base” by reforming or eliminating certain tax preferences. Some proponents of tax-base broadening
suggest that any revenues raised should be used to reduce marginal rates, such that tax reform is revenue neutral.7
Accordingly, tax-base broadening may have limited potential to generate additional federal revenues.8 A second
option for raising additional revenues is to increase other existing taxes. For example, Social Security reform might
include increased payroll taxes.9 Another option would be an increase in the motor fuel excise tax (e.g., the gas tax).10
In addition, a number of alternative revenue sources could be used for deficit reduction, many of which are not widely
used at the federal level. As one example, the United State could consider a value-added tax (VAT).11
For more information, see CRS Report R41641, Reducing the Budget Deficit: Tax Policy Options, by Molly F. Sherlock and
Congressional Budget Office, Reducing the Deficit: Spending and Revenue Options, Washington, DC, March 2011.
Other policy considerations, including environmental concerns, may also lead to consideration of
a carbon tax. GHG in the atmosphere trap radiation as heat, warming the Earth’s surface and
oceans. The key human-related GHG is carbon dioxide (CO2), primarily generated through the
combustion of fossil fuels: coal, oil, and natural gas.12 Although fossil fuels have facilitated
economic growth in the United States and around the world, fossil fuel combustion has
inadvertently raised the atmospheric concentration of CO2 by about 40% over the past 150
years.13 Almost all climate scientists agree14 that these CO2 increases have contributed to a
warmer climate today, and that, if they continue, will contribute to future climate change.
7 See, e.g., House Committee on the Budget Chairman Paul Ryan’s “Path to Prosperity” report, released to accompany
the FY2012 Budget Resolution (H.Con.Res. 34), which suggests eliminating unspecified tax expenditures to allow for
reduced marginal tax rates. This report also states that eliminating tax expenditures would not be for the purpose of
generating additional tax revenues. President Obama also expressed support for a revenue-neutral corporate tax reform
as part of his 2012 State of the Union Address. Text of this address is available online at http://www.whitehouse.gov/
the-press-office/2012/01/24/remarks-president-state-union-address.
8 CRS Report R42435, The Challenge of Individual Income Tax Reform: An Economic Analysis of Tax Base
Broadening, by Jane G. Gravelle and Thomas L. Hungerford.
9 Both the Fiscal Commission and Debt Reduction Task Force plans would increase the wage base upon which payroll
taxes are applied, thus increasing payroll tax revenues.
10 The Fiscal Commission’s deficit reduction proposal included a $0.15 per gallon increase in the federal motor fuel
excise tax.
11 See CRS Report R41602, Should the United States Levy a Value-Added Tax for Deficit Reduction?, by James M.
Bickley and CRS Report R41708, Value-Added Tax (VAT) as a Revenue Option: A Primer, by James M. Bickley.
12 Carbon dioxide (CO2) accounted for approximately 84% of U.S. GHG emissions in 2010. Approximately 94% of the
CO2 emissions resulted from fossil fuel combustion activities. See U.S. Environmental Protection Agency, Inventory of
U.S. Greenhouse Gas Emissions and Sinks, 1990-2010, April 2012, at http://epa.gov/climatechange/ghgemissions/
usinventoryreport.html.
13 For more information on climate change science, see CRS Report RL34266, Climate Change: Science Highlights, or
CRS Report RL33849, Climate Change: Science and Policy Implications, both by Jane A. Leggett.
14 See, for example, in 2007, the InterAcademy Council and the International Council of Academies of Engineering and
Technological Sciences—both representing academies of sciences from dozens of nations—issued statements
concurring that warming of the climate over the past 50 years is likely to have been caused by increased concentrations
of GHG emissions in the atmosphere, with that increase having been caused by human-related GHG emissions. The
views of a relatively small circle of scientists have been widely publicized as opposing mainstream conclusions;
however, for these individuals the disagreement lies not in whether GHG increases have been caused by human
activities, but whether these exert a “dangerous” influence on climate. See, for example, Robert M. Carter, “Knock,
Knock: Where Is the Evidence for Dangerous Human-Caused Global Warming?” Economic Analysis & Policy,
September 2008; S. Fred Singer, “Human Contribution to Climate Change Remains Questionable.” EOS Transactions
80, April 20, 1999, pp. 183–187.
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Carbon Tax: Deficit Reduction and Other Considerations
Many economists have argued that current fossil fuel prices reflect a market failure, because
GHG emissions from fossil fuels contribute to current and future climate change, yet fossil fuel
prices do not reflect climate change-related costs. Market failures distort economic efficiency by
affecting consumer behavior. For example, energy consumers may make choices that are not in
society’s best interest, consuming more than the optimal amount of GHG emitting fuels, if prices
do not reflect climate change-related costs.
Carbon taxes, or GHG fees, have been proposed as one means to correct such a market failure.
Another option is a cap-and-trade program, which would attach a price to GHG emissions by
limiting their generation.15 To some extent, a carbon tax and cap-and-trade program would
produce similar effects: Both would place a price on carbon, and both are estimated to increase
the price of fossil fuels. Preference between the two approaches ultimately depends on which
variable one prefers to control—GHG emissions or costs.16
A tax based on carbon content of fuels is different from a tax based on energy content, such as a
Btu tax (see the text box below). Placing an emissions fee on CO2 (and possibly other GHG
emissions) could stimulate lower emissions and spur innovation in new lower-emitting
technologies. A tax or fee based approach would allow markets to determine the level of
investment in lower-emissions technologies. In addition, carbon tax revenues could be used to
support multiple objectives, such as deficit reduction, or to replace existing taxes (e.g., payroll,
income).
The 1993 Btu Tax
The deficit reduction package proposed by President Clinton in 1993 would have levied a tax based on energy
content, measured in British thermal units (Btu). The 1993 Btu tax proposal called for a levy of 25.7 cents per million
Btu, with a surcharge of 34 cents/mil ion Btu on petroleum. The goals of the 1993 Btu tax proposal were to promote
energy conservation and raise revenue. At the time, the proposed tax would have generated a new revenue stream of
about $30 billion per year. The proposal was met with strong opposition and was not enacted; Congress ultimately
enacted an (approximately 5-cent per gal on) increase in the motor fuels taxes.
The first section of this report examines carbon tax design and implementation issues, including
the point of taxation, the rate of taxation, and the distribution of tax revenue. The second section
discusses several carbon tax policy considerations: revenue potential, economic efficiency, equity,
and operability. The final section highlights key issues related to the use of carbon tax revenues.
Specifically, how might addressing the regressivity of a carbon tax diminish its revenue-raising
potential, and what is the potential for a carbon tax to contribute to deficit reduction goals?
15 Regulatory approaches can also be used to address market failures. Regulation-based emissions controls that reduce
emissions would also be expected to increase the price of fossil fuels. The higher price faced by consumers may be
closer to the true cost associated with consumption of emissions-producing fossil fuels.
16 For a discussion see CRS Report R40242, Carbon Tax and Greenhouse Gas Control: Options and Considerations
for Congress, by Jonathan L. Ramseur.
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Carbon Tax: Deficit Reduction and Other Considerations
Design and Implementation
When establishing a carbon tax, there are several implementation decisions to be considered. Key
considerations include (1) the point of taxation—where to impose the tax and what to tax; and (2)
the rate of taxation. Information on how a carbon tax might affect fossil fuel prices is also
provided.
Point of Taxation
The point of taxation would influence which entities would be required to (1) make tax payments
based on emissions or emission inputs (e.g., fossil fuels), (2) monitor emissions or emission
inputs, and (3) maintain records of relevant activities and transactions. The point of taxation does
not necessarily reveal who bears the cost of the tax, as the cost may be passed on to intermediate
producers or consumers. (This will be discussed in a later section.)
GHG emissions are generated throughout the economy by millions of discrete sources:
smokestacks, vehicle exhaust pipes, households, commercial buildings, livestock, etc. Although
CO2 is the primary GHG at many sources, some sources predominantly emit non-CO2 GHGs,
such as methane.17 When determining which sources and which GHG gases to control through a
tax, policymakers would need to balance the benefits of comprehensiveness with administrative
complexity and costs. Applying a carbon tax at the points of emissions from all GHG sources
would present enormous logistical challenges.
CO2 emissions are fairly easily to verify from large stationary sources, such as power plants. For
almost 20 years, measurement devices have been installed in smokestacks of large facilities,
reporting electronic information to the U.S. Environmental Protection Agency. For smaller
sources, CO2 emissions are a straightforward and accurate calculation based on the carbon
content of fossil fuels consumed. Other GHG emissions, such as methane, nitrous oxides, sulfur
hexafluoride, and others, could be more difficult or less reliable to verify. Thus, administrative
costs and non-compliance risks would likely increase with a broader scope of an emissions tax.
However, limiting the tax scope could result in perverse effects, with sources potentially shifting
processes, facility size, or location to avoid taxes.
Policymakers may consider limiting the tax to sectors or sources that emit large percentages of
the total U.S. GHG emissions or those that are relatively easy to measure. Or, the tax could be
applied to reliable proxies for emissions in the production-to-emission chain. For example, the
fossil fuel supply chain offers some options. As illustrated in Figure 1, potential emissions could
be taxed at an “upstream” stage in that process, when the carbon-containing fossil fuel is first sold
following production. Or, the point of taxation could, theoretically, be “downstream” where the
pollution is released to the atmosphere.18
17 Carbon tax proposals that apply only to CO2 generally attach a price to a metric ton of CO2 emissions (tCO2). Non-
CO2 GHG emissions could be addressed by attaching a price to a metric ton of CO2 emissions-equivalent (tCO2e). This
term of measure is used because GHGs vary by global warming potential (GWP). GWP is an index of how much a
GHG may contribute to global warming over a period of time, typically 100 years. GWPs are used to compare gases to
CO2, which has a GWP of 1. For example, methane’s GWP is 25, and thus a ton of methane is 25 times more potent a
GHG than a ton of CO2.
18 A non-carbon example could be taxing nitrogen-based fertilizers based on their propensity to be emitted from
(continued...)
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Carbon Tax: Deficit Reduction and Other Considerations
Table 1 lists the top emission sources of six principal GHGs in the United States. These sources
combine to account for approximately 95% of these gases (based on 2010 data).19 Table 1 also
provides potential points of taxation that would cover the emissions from these sources. For
example, policymakers could address CO2 emissions from fossil fuel combustion and non-energy
uses by levying an “upstream”20 carbon tax on fewer than 2,300 entities—in aggregate 80% of
U.S. GHG emissions.
Figure 1. Illustration of Options for Points of Taxation within the
Energy Production-to-Consumption Chain
Up
U st
p r
st e
r am
e
Oil w
l el
e ls
l
Natural gas w
ells
e
Coa
Co l m
l
in
i e
n s
e
Importer
m
s
porter
Midstrea
s
m
Natura
Na
l gas
l ga
Oil refine
re
rie
ri s
e
Elec
e tric
tri utilities
process
es or
o s
r /pipelines
n
Downstream
Vehicle
l s
e
Hous
H
eholds
Commerc
Commer ial
holds
Commercia
bui
bu lidi
d ng
i
s
Industr
t y
ngs
ng
Industr
Source: Prepared by CRS.
Note: Electric utilities could be listed as either downstream entities—because they are direct sources of
emissions—or midstream, because their emissions are tied to the electricity consumption of their customers,
the further downstream consumers.
(...continued)
agricultural soils as nitrous oxide (N2O), another GHG the emissions of which would be difficult to measure directly.
19 There are additional GHGs, but they are smaller influences (though rapidly growing in some cases) and less
measured. Also, this does not account for the emissions and removals of carbon dioxide from the atmosphere by land
use, land use change, and forestry (LULUCF). For more information, see CRS Report RL34266, Climate Change:
Science Highlights, by Jane A. Leggett.
20 An upstream approach would apply a carbon tax to fossil fuels when they enter the U.S. economy, either at the mine,
wellhead, or another practical “chokepoint” in the production chain, such as oil refineries.
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Carbon Tax: Deficit Reduction and Other Considerations
Alternatively, policymakers could employ a “downstream” approach, applying a carbon tax at the
point where the gas is released to the atmosphere. For example, the FY2008 Consolidated
Appropriations Act (P.L. 110-161) requires all large sources to annually report their GHG
emissions to the EPA’s Greenhouse Gas Reporting Program (GHGRP).21 The program covers
between 85-90% of all U.S. GHG emissions from approximately 13,000 facilities.22
Table 1. Selected Sources of U.S. GHG Emissions and Potential
Applications of a Carbon Tax
Percentage of U.S.
Potential Carbon Tax Applications
GHG Emissions
GHG Emission Source
(2010 data)
Entity Number
CO2 from fossil fuel combustion:
78.9
Coal minesa
1,257
- electricity generation
or
- transportation
Coal-fired power plantsb
641
- industrial
Power plantsc using
26
imported coald
- commercial/residential
Petroleum refineriese 150
Petroleum importersf 220
Natural gas processorsg 530
Natural gas importersh 45
N2O from agricultural soils
3.0
Farmsi
>2 million
CO2 from non-energy use of fuels
1.8
Covered by the tax applied to fuels (above)j
CH4 from livestock (enteric
2.1 Cattle
operationsk 967,440
fermentation)
CH4 from landfills
1.6
Landfillsl 1,800
HFCs from the substitution of ozone
1.7 HFC
manufacturersm 5
depleting substances
CH4 from natural gas systems
3.1
Natural gas processors
530
CH4 from coal mines
1.1
Coal minesn 1,257
CO2 from iron/steel production
0.8
Raw steel production
116
facilities;
Integrated steel millso
18
CO2 from cement manufacturing
0.5
Cement plantsp 118
CH4 from manure management
0.8
Cattle operations;
967,440
Swine operationsq
65,640
Percentage of Total GHG Emissions
95.4
Source: Prepared by CRS; GHG emission data from EPA, EPA, Inventory of U.S. Greenhouse Gas Emissions and
Sinks: 1990-2010, April 2012; data for number of entities from multiple sources, cited in notes below.
21 See 40 CFR Part 98.
22 EPA, Fact Sheet: Mandatory Reporting of Greenhouse Gases (40 CFR Part 98), June 2011.
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Carbon Tax: Deficit Reduction and Other Considerations
a. This figure accounts for mines in operation in 2010. EIA, Coal Production and Number of Mines by State and
Mine Type, (2011).
b. In 2006, there were 641 plants with at least one coal-fired generating unit (EIA, 860 Database).
c. Number of plants comes from EIA database, Monthly Nonutility Fuel Receipts and Fuel Quality Data
(Database 423). CRS was unable to determine the number of companies that act as coal importers,
analogous to petroleum importers.
d. In 2006, the United States imported approximately 36 million short tons of coal (EIA, Quarterly Coal Report
(2008), table 4)—3.5% of the amount of coal consumed domestical y in that year (EIA, Annual Coal Report
2006 (2007), table 26). Coal imports have increased by more than 200% since 2002.
e. This figure represents the number of “operable” refineries. EIA, Refinery Capacity Report (2008).
f.
EIA, Company Level Imports (as of November 2008). Note that some of these companies may import only
crude oil, whose emissions would be covered by the tax at the domestic refineries. Thus, this figure
represents an upper bound of petroleum product importers potential y subject to a carbon tax.
g. EIA, Natural Gas Processing: The Crucial Link Between Natural Gas Production and Its Transportation to
Market (2006).
h. This includes pipelines and liquefied natural gas facilities. EIA, About U.S. Natural Gas Pipelines (as of
September 2008).
i.
U.S. Department of Agriculture, Farms, Land in Farms, and Livestock Operations: 2007 Summary (2008). The
resource defines a farm as “any place from which $1,000 or more of agricultural products were produced
and sold, or normally would have been sold, during the year.”
j.
Fossil fuels are used for a wide range of non-energy purposes. EPA estimates that of the total carbon
consumed for non-energy purposes, approximately 62% is stored in products, and not released to the
atmosphere (EPA, Inventory of U.S. Greenhouse Gas Emissions and Sinks: 1990-2006 (April 2008), tables 3-14
and 3-15). The 2% value in Table 4 represents the emissions. In an upstream carbon tax system, fuels would
be taxed before they are used. Congress could choose to consider providing tax credits for the amount of
carbon stored in products.
k. U.S. Department of Agriculture, Farms, Land in Farms, and Livestock Operations: 2007 Summary (2008).
l.
EPA, Inventory of U.S. Greenhouse Gas Emissions and Sinks: 1990-2006 (April 2008), citing BioCycle, 15th
Annual BioCycle Nationwide Survey: The State of Garbage in America (2006).
m. Intergovernmental Panel on Climate Change, Safeguarding the Ozone Layer and the Global Climate System,
Issues related to Hydrofluorocarbons and Perfluorocarbons (2005), Figure 11.1.
n. Methane from underground mines, which accounts for about 61% of coal mine methane, is removed
through ventilation systems for safety reasons. These emissions would be easier to monitor under a carbon
tax than aboveground coal mine methane emissions.
o. Data from U.S. Geological Survey, Mineral Commodity Summary, Iron and Steel Production (2008), at
http://minerals.usgs.gov/minerals/pubs/commodity/iron_&_steel/.
p. Cement manufacturing information from Portland Cement Association, at http://www.cement.org/basics/
cementindustry.asp.
q. U.S. Department of Agriculture, Farms, Land in Farms, and Livestock Operations: 2007 Summary (2008). Other
animals—chickens, horses, and sheep—contribute approximately 10% of the total emissions from manure
(EPA, Inventory of U.S. Greenhouse Gas Emissions and Sinks: 1990-2006 (April 2008), table 6-6).
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Carbon Tax: Deficit Reduction and Other Considerations
Rate of Taxation
Although setting the carbon tax rate would likely involve political considerations, several
economic approaches could be used to inform the debate. As a public finance instrument, the tax
rate could be based on the estimated revenues needed to reduce or eliminate projected budget
deficits.23 This approach would be challenging, because estimates of future budget deficits (and
thus the revenues needed to address them) are “inherently uncertain.”24 Moreover, a carbon tax
would have some impact on the overall economy (and thus the overall tax base) that would make
such a calculation more difficult.
Alternatively, the tax rate could be tied to climate change objectives. For example, Congress
could set a tax rate based on the estimated benefits associated with avoiding climate change
impacts. Some economists would say that the optimal level of a carbon tax would be at the
“marginal cost of climate change,” which is the incremental cost of damages of one more ton of
emissions. This is sometimes called the Social Cost of Carbon (SCC).25 The rate could include, as
well, the cost of incremental damages of ocean acidification and other possible effects associated
with carbon emissions (e.g., related air pollution).26
Estimates of the risks of GHG emissions are uncertain and cover a wide range. Analysts must
place monetary values on goods and services that may be difficult or controversial to estimate,
such as human health/life, water supplies, agricultural production, recreational activities. In
addition, the element of time particularly complicates the valuation. The factor of time would
demand a consideration of what global society should be willing to pay now to avoid future
damages due to additional emissions generated today.27 In short, basing the tax rate on a precise
estimate of GHG emission-related risks would present extraordinary challenges.28
23 The ability of a carbon tax to contribute to deficit reduction is analyzed in greater detail elsewhere in this report. See
the section “Contribution to Deficit Reduction” below.
24 Congressional Budget Office, The 2012 Long-Term Budget Outlook, June 2012.
25 The SCC has been estimated for the purposes of allowing government agencies to consider social benefits from
reduced carbon emissions in cost-benefit analysis. Details on the SCC for this purpose can be found in Interagency
Working Group on the Social Cost of Carbon, United States Government, Technical Support Document: Social Cost of
Carbon for Regulatory Impact Analysis Under Executive Order 12866, February 2010. SCC estimates are also
provided in William D. Nordhaus, Estimates of the Social Cost of Carbon: Background and Results from the Rice-2011
Model, National Bureau of Economic Research, Working Paper 17540, Cambridge, MA, October 2011.
26 These costs may be estimated simultaneously, or separately, as is done in National Academy of Sciences, Hidden
Costs of Energy: Unpriced Consequences of Energy Production and Use, 2010; and Michael Greenstone and Adam
Looney, A Strategy for America’s Energy Future: Illuminating Energy’s Full Costs, The Hamilton Project, Strategy
Paper, May 2011.
27 A critical and controversial assumption here is the discount rate used to discount future dollars into a present value.
The use of low discount rates, such as some analyzed in Nicholas Stern’s 2007 Review on the Economics of Climate
Change, imply that aggressive policy action should be taken today to address future costs associated with climate
change. Higher discount rates, such as those favored by William Nordhaus, would recommend applying fewer of
today’s resources to addressing climate change in the future (see William D. Nordhaus, “A Review of the Stern Review
on the Economics of Climate Change,” Journal of Economic Literature, vol. 45, no. 3 (September 2007), pp. 686-702.)
Higher discount rates mean that costs in the future are worth less today, and less investment is warranted in the present
to address future costs of climate change impacts. On the other hand, a fairness issues is raised by some in that high
discount rates place little value on costs borne by generations yet to be born, whose preferences are generally not
reflected in current generations’ discount rates. There is little agreement in the economics community on appropriate
discount rates to value such inter-generational problems.
28 For further details see CRS Report R40242, Carbon Tax and Greenhouse Gas Control: Options and Considerations
for Congress, by Jonathan L. Ramseur. See also the section on economics-based policy approaches in CRS Report
(continued...)
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Carbon Tax: Deficit Reduction and Other Considerations
An alternative climate change approach would involve basing the tax rate on an estimate of the
carbon price needed to meet a specific GHG emissions target. Such estimates, though relatively
more certain than the SCC, are similarly based on multiple assumptions. Accordingly, estimates
of carbon prices in hypothetical carbon reduction schemes have varied dramatically. For example,
multiple parties prepared such estimates during the development of H.R. 2454 (in the 111th
Congress), which intended to reduce GHG emissions to 17% below their 2005 levels by 2020.29
The emission allowance price estimates ranged from $16/metric tons of CO2 equivalent (mtCO2e)
to $49/tCO2e in 2015, with the estimated range increasing over time.30 Moreover, it could be
challenging to reach political agreement on the GHG emissions target sought as well as the tax
rate that would achieve it.
Given the uncertainty in the above estimates and a desire to avoid “shocking” the economy with a
sudden change in tax policy, some have proposed starting a carbon tax with a rate that is initially
set at a low rate, with that rate rising annually as announced for a fixed period or indefinitely.
This approach would have several potential advantages: it is simple to explain and understand; it
provides predictability to investors and consumers; and it allows policymakers to hedge31 against
the risks of carbon emissions.
Carbon Tax Effects on Fossil Fuel Prices
Different fossil fuels generate different amounts of CO2 emissions per unit of energy. Therefore, a
carbon tax, which is based on CO2 emissions, would levy a higher charge (per unit of energy) on
some fuels than others. As indicated in Table 2, coal generates approximately 80% more CO2
emissions per unit of energy than natural gas, and approximately 28% more emissions per energy
than crude oil. These differences in emissions intensity would lead to different tax rates per unit
of energy across different fuels in a carbon tax regime.
(...continued)
R41973, Climate Change: Conceptual Approaches and Policy Tools, by Jane A. Leggett.
29 H.R. 2454 (the American Clean Energy and Security Act of 2009, often called the “Waxman-Markey” bill) passed
the House on June 26, 2009.
30 For more information, see CRS Report R40809, Climate Change: Costs and Benefits of the Cap-and-Trade
Provisions of H.R. 2454, by Larry Parker and Brent D. Yacobucci.
31 To “hedge” is to insure oneself against losses. Investors typically face uncertainty and may use “hedging” as a
strategy to reduce losses if/when adverse conditions occur. Investors may take actions that would offset the risk of
another investment. Many analysts have recommended that policymakers hedge against future climate change risks by
making investments, perhaps at a lower rate of return than other options, that would make sense whether or not future
climate change is seriously adverse. For example, investing in low-emitting technologies may be one kind of hedge
against climate change; stimulating such investments through a carbon tax may also be considered a hedge by many.
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Carbon Tax: Deficit Reduction and Other Considerations
Table 2. CO2 Emissions Per Unit of Energy for Fossil Fuels
CO2 Emissions Per Unit of Energy
Fossil Fuel
(million metric tons/quadrillion BTU)
Coal 96
Crude oil
75
Natural gas
53
Source: Prepared by CRS, based on Energy Information Administration (EIA), “Emissions
Factors and Global Warming Potentials,” updated January 2011, at http://www.eia.gov/oiaf/
1605/emission_factors.html.
Notes: Coal emissions intensity values vary by type of coal, from 93-104 million metric
tons/quadrillion BTU. The value above is for coal use in the electric power sector. The natural
gas value above is the weighted national average of all uses, as prepared by EIA.
Table 3 includes estimates of the tax levied on fossil fuels and motor gasoline at different carbon
tax rates. The change in price that consumers would see would likely not be the same as the
carbon tax. Carbon taxes could affect fuel prices in complex ways. For example, energy
consumers, to the extent possible, would likely shift their preferences to less expensive fuels, and
the underlying prices of the fuels would change. Actual price increases that result from the
illustrative carbon taxes in Table 3 would depend on whether
• a carbon tax is applied at the beginning of the production process (“upstream”) to
fossil fuels (Figure 1);
• the price impacts are passed through to end-users and not absorbed by upstream
energy producers or midstream entities (such as retailers); and
• consumers modify their behavior in the marketplace—energy conservation, fuel
substitution, etc.
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Table 3. Estimated Taxes Levied on Fossil Fuels and Motor Gasoline Based on Selected Carbon Tax Rates
Carbon Tax Ratea
Coal
Crude Oil
Natural Gas
Motor Gasoline
$5/
$9.50/
$2.15/
$0.25/
$0.05/
mtCO2
short ton
barrel
mcfb
gallon
$15/
$28.50/
$6.45/
$0.75/
$0.15/
mtCO2
short ton
barrel
mcf
gallon
$25/
$47.50/
$10.75/
$1.25/
$0.25/
mtCO2
short ton
barrel
mcf
gallon
$50/
$95.00/
$21.50/
$2.50/
$0.50/
mtCO2
short ton
barrel
mcf
gallon
CO2 Emissions Intensities Used in Above Comparison
Metric tons of CO2 (mtCO2)
1.9 mtCO2/
0.43 mtCO2/
0.05 mtCO2/
0.01 mtCO2/
per unit of fuel
short tonc
barreld
mcfe
gallonf
Recent Market Prices for Each Fuel Type: Average Price Between 2000-2010 (2005 dollars)
Coal Type ($/short ton)g
Production Location($/barrel)
Economic Sector ($/mcf)
Unleaded Regular
($/gallon): $2.14
Bituminous coal: $37
Domestic first purchase price:h $47
Residential: $11
Sub-bituminous: $9
Import landed costs:i $48
Commercial: $10
Lignite: $14
Industrial: $6
Anthracite: $48
Transportation: $8
Electric power: $6
Source: Prepared by CRS. CRS calculated the estimated taxes for each fuel by multiplying a carbon tax rate by the CO2 emissions intensities for each fuel. CRS generated
these inputs (the last row of the table) from the CO2 coefficients (i.e., CO2 emissions per quadrillion BTU) and thermal conversion factors (i.e., BTU per fuel unit) for each
fuel. CO2 coefficients are from EIA, “Emissions Factors and Global Warming Potentials,” updated January 2011, at http://www.eia.gov/oiaf/1605/emission_factors.html;
thermal conversion factors from EIA, Annual Energy Review 2010, October 2011, Appendices A1 (motor gasoline), A2 (crude oil), A4 (natural gas), and A5 (coal).
Fuel prices: Coal prices from EIA, Annual Energy Review 2010, Table 7.9, October 2011. Crude oil prices from Table 5.18 (domestic) and Table 5.19 (imported). CRS
converted the nominal dollar values in Table 5.19 to $2005, using the GDP implicit price deflator provided in Appendix D of the Annual Energy Review 2010. Natural gas
prices from Table 6.8. Gasoline prices from Table 5.24.
a. The tax rates in the table were selected for comparison purposes. The initial carbon tax rates in recent legislative proposals fall within the range identified above. Most
proposals include annual rate increases, some of which generating tax rates that would approach the upper end of the range after several years.
b. MCF is thousand cubic feet.
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Carbon Tax: Deficit Reduction and Other Considerations
c. This value represents the CO2 coefficient for coal (electric power sector) and the thermal conversion factor for coal consumption from the electric power sector
(2010).
d. This value represents the CO2 coefficient for crude oil and the thermal conversion factor for “unfinished oil.”
e. This value represents CO2 coefficient for natural gas (“weighted national average”) and the thermal conversion factor for end-use sectors (2010).
f.
This value represents the CO2 coefficient for “motor gasoline” and the thermal conversion factor for motor gasoline (conventional).
g. Bituminous and Subbituminous coal, in aggregate, accounted for 93% of U.S. coal production in 2010 (EIA, Annual Energy Review 2010, Table 7.2, October 2011).
h. EIA defines this price as “the price for domestic crude oil reported by the company that owns the crude oil the first time it is removed from the lease boundary.”
(Annual Energy Review 2010, Glossary).
i.
EIA defines this price as “Crude Oil Landed Cost: The price of crude oil at the port of discharge, including charges associated with purchasing, transporting, and
insuring a cargo from the purchase point to the port of discharge. The cost does not include charges incurred at the discharge port (e.g., import tariffs or fees,
wharfage charges, and demurrage).” (Annual Energy Review 2010, Glossary).
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Carbon Tax: Deficit Reduction and Other Considerations
Framework for Evaluation
Policymakers may consider a carbon tax based on a number of policy motivations and potential
benefits, including
• increased federal revenues,
• reduced federal budget deficits,
• reduced GHG emissions, climate change, and ocean acidification,32
• enhanced energy security,
• improved economic efficiency, and/or
• reduced tax rates from other revenue sources.
In recent years in the United States, most carbon tax proposals have aimed primarily to
discourage GHG emissions.33 In these proposals, a tax or fee would be levied on GHG emissions
or the inputs (i.e., fossil fuels) that lead to emissions. The tax or fee raises the price of the
emission-generating products, and therefore can, on the one hand, motivate suppliers to reduce
the emissions involved in making the product and, on the other hand, encourage consumers to
buy less of the product. This policy instrument sets the tax (cost) per unit of emissions and relies
on private decision-makers to find the most efficient means to reduce the emissions. A carbon tax
is one of several “market mechanisms” that relies on the efficiencies of markets to maximize cost-
effectiveness.
Though this policy instrument is commonly called a “carbon tax,” its application could be
broader than this term suggests. First, the policy may apply not just to CO2 emissions, but also to
multiple GHGs (e.g., methane or sulfur hexafluoride), including some that may have no
molecular carbon.34 Second, if the levy’s primary purpose were to charge those who use the
atmosphere to absorb the full cost of their GHG emissions, the levy might instead be considered a
“user fee.”35 Regardless, this report uses the term “carbon tax,” because this report focuses on the
policy instrument’s potential to raise revenues and reduce the federal budget deficit.
32 For explanation of how carbon emissions may acidify oceans and the potential effects, see CRS Report R40143,
Ocean Acidification, by Eugene H. Buck and Peter Folger.
33 Most legislative attention to reduce GHG emissions, however, has been given to emissions cap-and-trade schemes
and tax incentives. See for example, CRS Report R40242, Carbon Tax and Greenhouse Gas Control: Options and
Considerations for Congress, by Jonathan L. Ramseur; CRS Report R40556, Market-Based Greenhouse Gas Control:
Selected Proposals in the 111th Congress, by Brent D. Yacobucci, and Jonathan L. Ramseur. For other policy
instruments, see CRS Report R41973, Climate Change: Conceptual Approaches and Policy Tools, by Jane A. Leggett,
and CRS Report R41769, Energy Tax Policy: Issues in the 112th Congress, by Molly F. Sherlock and Margot L.
Crandall-Hollick.
34 Non-carbon GHGs could be subject to the tax based on their contribution to global warming in relation to CO2.
Global warming potential (GWP) is an index of how much a GHG may contribute to the average annual increase in
worldwide temperature integrated over a period of time, typically 100 years but sometimes as short as 20 years. GWPs
are used to compare gases to carbon dioxide, which has a GWP of 1. For example, methane’s GWP is 25, and is thus
25 times more potent a GHG than CO2. The GWPs listed in this report are from: Intergovernmental Panel on Climate
Change, Climate Change 2007: The Physical Science Basis, 2007, p. 212.
35 The Congressional Budget Office defines user charges as fees or taxes that are based on benefits individuals or firms
receive from the federal government or that in some way compensate for costs they might impose on society or its
(continued...)
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Carbon Tax: Deficit Reduction and Other Considerations
There are a number of issues to be considered when evaluating tax policy proposals.36 The
following sections analyze a generic carbon tax option using the criteria listed below:
• adequacy—the ability to generate a desired amount of revenues;
• economic efficiency—the potential to enhance or diminish the productivity of the
U.S. economy;
• equity—the subjective determination of a proposal’s fairness;
• operability—the combination of multiple factors, including administrative ease,
transparency, avoidance of perverse outcomes, and consistency with federal and
international norms and standards;37 and
• political feasibility—the likelihood of enactment given a tax’s visibility to the
public and public opinion, differential regional implications, contribution to
deficit reduction or other objectives, pledges made by some lawmakers not to
raise taxes, etc.38
Adequacy—The Potential to Generate Revenues
The revenues that would be generated under a carbon tax vary greatly depending on the design
features of the tax, namely the tax scope (i.e., base) and rate, as well as such independent factors
as prices in global energy markets. Several recent proposals to price or tax carbon, where revenue
estimates are available, are presented below.
In 2011, the Congressional Budget Office (CBO) evaluated a hypothetical cap-and-trade program
in which CO2 emission allowances (i.e., permits to emit one metric ton of CO2 emissions) would
be sold at auction and traded in a carbon market. The auction revenues generated in this program
would be analogous to tax revenues under a carbon tax system. CBO estimated the allowance
price, which, under an actual program, would be determined by market forces, would begin at
$20 per metric ton of CO2 (mtCO2) in 2012 and increase 5.6% annually. This allowance price
estimate, and its projected annual increase, is akin to a prescribed carbon tax rate. CBO estimated
that such a regime would raise $1.2 trillion over the 2012 to 2021 budget window (Table 4).
(...continued)
resources. See Congressional Budget Office, The Growth of Federal User Charges, August 1993. See also GAO,
Federal User Fees: A Design Guide, GAO-08-386SP, May 2008.
36 See, for example, the evaluation criteria identified in American Institute of CPAs. “AICPA Tax Policy and Tax
Reform Materials: No.1 Guiding Principles of Good Tax Policy: A Framework for Evaluating Tax Proposals”, 2001,
available at http://www.aicpa.org/INTERESTAREAS/TAX/RESOURCES/TAXLEGISLATIONPOLICY/Pages/
TaxReform.aspx.
37 See this categorization in, for example, Joseph T. Sneed, “The Criteria of Federal Income Tax Policy,” Stanford Law
Review 17, no. 4 (April 1, 1965) pp. 567-613; B.G. Peters, The Politics of Taxation: A Comparative Perspective, 1991,
at http://www.tau.ac.il/law/cegla3/tax2/9%20The%20Politics%20of%20Taxation%20-%20Peters.pdf.
38 For example, the Taxpayer Protection Pledge promoted by the Americans for Tax Reform interest group;
Information at http://www.atr.org/taxpayer-protection-pledge and http://www.atr.org/about-grover.
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Carbon Tax: Deficit Reduction and Other Considerations
Table 4. Estimated Revenues from a CBO CO2 Emissions Pricing Model
$20/mtCO2 in 2012, increasing 5.6% annual y (bil ions of dollars)
2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012-2016 2012-2021
Revenues 88 93 99 105 112 119 127 136 144 154
499
1,179
Source: Congressional Budget Office, Reducing the Deficit: Spending and Revenue Options, Washington, DC, March
2011, pp. 205-206.
Notes: The CBO assessment does not precisely describe the scope of its carbon tax scenario (i.e., which
industries would be covered). Also, estimated revenues reflect reductions in income and payroll tax revenues
that would result from the effects of a charge for emitting carbon.
As a point of reference for the above carbon tax revenue estimates, Figure 2 identifies the major
sources of federal receipts in FY2011. As the figure illustrates, the range of potential carbon tax
revenues is comparable (at least in the early years of the carbon tax system) to the revenues
collected from current federal excise taxes. Nearly half of all federal excise tax receipts come
from taxes on gasoline and diesel fuels.39
Legislation introduced in the 112th Congress, the Save Our Climate Act of 2011 (H.R. 3242),
would establish a carbon tax on domestic and imported fossil fuels, as well as the carbon content
of biomass, municipal solid waste, and any organic material used as fuel. The tax rate would
begin at $10 per short ton40 of CO2 emissions (tCO2), increasing by $10 annually until total U.S.
CO2 emissions are 20% or less of CO2 emissions in 1990. The bill states that it would reduce the
federal budget deficit by a $480 billion over ten years.
Other revenue estimates have been made in recent years of carbon taxes considered or included in
a number of deficit and debt reduction proposals.41 As one example, in 2010, the bipartisan Debt
Reduction Task Force (Domenici-Rivlin) considered, but did not ultimately recommend, a tax on
CO2 emissions. The report estimated that a tax of $23 per ton of CO2 emissions starting in 2018,
increasing 5.8% annually, would raise approximately $1.1 trillion in cumulative revenues through
2025.42
39 For data on federal excise tax collections, see Internal Revenue Service (IRS), Statistics of Income (SOI) Historical
Table 20, http://www.irs.gov/taxstats/article/0,,id=175900,00.html.
40 In this proposal, a ton is a short ton, or 2,000 pounds. Most of the more recent proposals and models use metric tons
(or tonnes), which are 2,240 pounds.
41 The Committee for a Responsible Federal Budget’s (CRFB) online comparison tool is a good starting point for
comparing various debt and deficit reduction proposals. This tool is available at http://crfb.org/compare/.
42 Bipartisan Policy Center, Restoring America’s Future: Reviving the Economy, Cutting Spending and Debt, and
Creating a Simple, Pro-Growth Tax System, November 2010, http://bipartisanpolicy.org/projects/debt-initiative/about.
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Carbon Tax: Deficit Reduction and Other Considerations
Figure 2. FY2011 Federal Receipts by Source
Excise
Ex
Taxe
x s
Other
Ot
$72 bil
$
l
72 bil ion
o
n (3
( %
3 )
%
$140 billion (6%)
FY2
Y 011
Soci
Soc al In
al I su
s ra
r nc
a e a
nc
n
e a d
n
Indivi
v dua
u l Income Taxe
x s
Total R
Tot
e
al R ce
c ipts
ipt :
Re
R tire
r m
e en
e t R
t ece
c ipt
p s
$2.3 tril
r lion
o
$1
$ ,0
, 9
0 1
9 bill
bi i
ll on (4
o
7%
n (4
)
7%
$819 billion (36%)
FY2
Y 011
Total R
Tot
e
al R ce
c ipts
ipt :
$2.3 tril
r lion
o
Corp
Co or
rp at
or e I
at n
e I co
c me
m Tax
e
Tax s
$181 billion (8%)
Source: Prepared by CRS with data from Office of Management and Budget, Historical Tables 2.1 and 2.2, at
http://www.whitehouse.gov/omb/budget/historicals.
In addition to a carbon tax design, a 2012 Resources for the Future (RFF) study43 identified
several factors—electricity demand and natural gas prices—that could influence carbon tax
revenue. The study found that the magnitude of these factors’ influence increases as the tax rate
increases. Figure 3 illustrates the RFF study findings.
In Figure 3, RFF compares tax revenue estimates using assumptions from EIA’s 2009 and 2011
Annual Energy Outlook (AEO) publications. According to the study, the AEO assumptions
regarding future electricity demand and fuel prices, namely natural gas, varied dramatically
between the 2009 and 2011 versions. These variances lead to different estimates of potential
carbon tax revenue. For example, as illustrated in Figure 3, estimated revenues in 2020 from a
tax rate of $25/mtCO2 would vary across scenarios by about $10 billion. A $40/mtCO2 tax rate
would generate an estimated revenue range across scenarios of almost $20 billion in 2020.
43 Karen Palmer et al., The Variability of Potential Revenue from a Tax on Carbon, Resources for the Future, May
2012.
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Carbon Tax: Deficit Reduction and Other Considerations
Further, Figure 3 highlights a key result of a carbon tax that may affect its ability to provide a
reliable source of revenue. Note that the tax revenues in the electricity sector begin to decline
around 2030 with the $40/mtCO2 tax rate. The study concluded this decline is due to a
diminishing reliance on fossil fuels and relatively greater reliance on low-carbon energy sources,
such as renewables and nuclear.
The projected scenario in Figure 3 highlights a fundamental revenue adequacy concern
associated with a carbon tax approach: if a primary goal of a carbon tax is to reduce its own tax
base (i.e., carbon emissions), would this tax provide a reliable stream of revenues over time? With
revenue reliability as a primary goal, governments impose taxes on activities to which producers
and consumers are not very price-sensitive. In other words, the imposed taxes lead to minimal
changes in market behavior. Researchers debate how much producers and consumers would
respond to a tax on GHG emissions by reducing emissions or switching to goods and services that
generate fewer emissions (because they embody lower taxes). With a higher degree of
responsiveness, either revenues would decline or the tax rate per ton of emissions would need to
increase over time to maintain the revenue stream (assuming that maintaining certain revenue
stream is determined to be a policy objective).
Figure 3. Annual Carbon Tax Revenues in the Electricity Sector
Billions of 2009$
Source: Karen Palmer et al, The Variability of Potential Revenue from a Tax on Carbon, Resources for the Future,
May 2012.
Notes: AEO09 and AEO11 refer to EIA’s 2009 and 2011 Annual Energy Outlook. The carbon taxes are levied on
metric tons of CO2 emissions (mtCO2), with rates starting in 2016 and growing 5% annually.
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Carbon Tax: Deficit Reduction and Other Considerations
Economic Efficiency
Economic theory suggests that a carbon tax could improve the efficiency of the economy by at
least three means:44
• First, markets could produce a more optimal mix of goods and services if the
costs of emitting GHG while manufacturing products, providing services, or
using goods were “internalized” into market prices; producers and consumers
would more fully respond to the full costs of their decisions, resulting in a more
economically efficient outcome;
• Second, a tax on an activity that yields pollutants, such as GHG emissions,45
would discourage the polluting activity and therefore could be more efficient than
an alternative tax that yields the same revenues but discourages a beneficial
activity (e.g., investment); and
• Third, adding a smaller tax on a new activity, such as potential carbon emissions,
could be less distortionary to production and consumption than increasing the tax
rate on currently taxed activities.46
The difficulty associated with setting an optimal carbon tax rate makes achieving potential
efficiency gains challenging. Further, a stand-alone carbon tax (e.g., one where revenues were not
used to offset other taxes) could have efficiency costs, as a carbon tax would increase existing
distortions on inputs in the production process. The difficulty of implementing an efficiency-
enhancing carbon tax is compounded in a tax system that already contains a number of
distortionary taxes.47
Many Taxes Have Distortionary Effects48
Many people are concerned about several potentially “distortionary” effects of taxes on society.
Many economists consider that taxes take money away from people and change the relative prices
of goods and services compared to what they would be without taxes; thus, taxes are considered
“distortionary” by altering free market decisions. To minimize distortions (and generate a reliable
stream of revenues), governments often prefer to tax products or activities for which consumer
44 Achieving economic efficiency means using limited resources such that the production of goods and services is
maximized at the lowest possible cost.
45 Though some people contend that GHG emissions may not pose adverse risks, this is the view of a minority of
scientific and economic experts in the field of climate change, and the suggestion of no adverse risk is not supported by
empirical evidence to date.
46 This assumes that a new tax on carbon would ultimately apply to a broader base, and not simply compound existing
distortions to labor and capital that exist in the current tax system. A stand-alone carbon tax could compound existing
tax-induced distortions in labor markets, for example. Thus, a carbon tax could have efficiency costs to the extent that a
carbon tax further reduces labor supply.
47 For an extensive theoretical exposition of conditions under which a carbon tax can enhance economic efficiency, see
A. Lans Bovenberg and Lawrence H. Goulder, “Environmental Taxation and Regulation,” in Handbook of Public
Economics, ed. Alan J. Auerback and Martin Feldstein, vol. 3 (Elsevier, 2002), pp. 1471-1545.
48 A head tax, or a lump-sum tax levied on individuals regardless of income or wealth, is considered a non-distortionary
tax since individuals cannot avoid the tax by changing their behavior. Since most taxes can be avoided with changes in
behavior, non-distortionary taxes often do not exist in practice.
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demands are relatively insensitive to price increases.49 Some of these taxed items are recognized
as essential or socially desirable, such as income, employment, and investment. Taxes may also
be “distortionary” because they discourage a taxed but beneficial activity. For example, many
economists argue that payroll and income taxes are distortionary because they discourage
employment and investment.50 If these taxes were reduced, the incentives to hire/work and invest,
they argue, would be greater.
Also, as tax rates (i.e., the tax per unit of a product or service) increase, they become more
distortionary. That is, higher tax rates have greater potential to shift choices away from optimal
“free market” outcomes. As an example, consumers may respond proportionately more strongly
to a $1.00 tax per gallon on gasoline than a $0.20 tax per gallon (in other words, the efficiency
losses associated with a tax increase exponentially with the tax rate). Thus, applying lower tax
rates to broader tax bases can help minimize inefficiencies.51
Taxes May Correct Market Failures
Not all results from economic activity are considered desirable—pollution being one example.
When producers or consumers discharge pollution—including GHG emissions—to another
person’s private property or a publicly shared resource—such as the atmosphere—without paying
to do so, they are not paying for the full cost of a product or activity. Economists would describe
this outcome as a “market failure,” because the costs associated with GHG emissions are not
captured in the economic decision process. Economists contend that levying a charge on GHG
emission would be an economically efficient way to correct the failure.52 For example, in terms of
environmental policy, fossil fuel prices do not reflect the costs—related to climate change and
ocean acidification damages—associated with the GHG emissions. A pollution discharge fee
could internalize these external costs into market prices.
A primary argument in favor of a carbon tax is that it would, in theory, increase the efficiency of
markets by discouraging “bad” activities. A carbon tax would discourage pollution that imposes
costs on others who do not necessarily benefit from the polluting activity. These may include
future generations that bear the dislocations of climate change, or fishery sectors in developing
countries that experience lower yields in acidified oceans.
A carbon tax would encourage energy consumers—for example, power plants, industry,
households, etc.—to (1) switch to less carbon-intensive fuels; (2) use less energy or use energy
more efficiently; and (3) prefer products or services that are lower-priced by virtue of
incorporating less emission tax. Each of these activities would reduce GHG emissions compared
to a business-as-usual track and could improve economic efficiency.
49 In economics parlance, a small response of consumer demand may be termed “price inelastic.”
50 See, e.g., Gilbert Metcalf, A Green Employment Tax Swap: Using a Carbon Tax to Finance Payroll Tax Relief, 2007;
Nathaniel Keohane and Sheila Olmstead, Markets and the Environment (Island Press, 2007); Ian Parry “Fiscal
Interactions and the Case for Carbon Taxes over Grandfathered Carbon Permits,” in Climate Change Policy, Dieter
Helm, editor, (Oxford University Press, 2005).
51 A theoretical exposition illustrating how marginal distortionary effects rise with the rate of taxation can be found in
Jonathan Gruber, Public Finance and Public Policy (New York: Worth Publishers, 2007), pp. 584-585.
52 Imposing regulations can also correct for market failures.
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An Economically Efficient Carbon Tax Rate53
To improve efficiency, a carbon tax would need to be set at the “right” level. According to basic
economic theory, the “right” level would be one that equilibrates the tax rate to the incremental
harm, now and in the future, that a ton of GHG emissions imposes. To find this tax rate precisely,
one would need to know the marginal costs of climate change and ocean acidification.
However, estimating the effects and placing a monetary value on them is both controversial and
reliable only over a wide range. Hence, no consensus is likely to emerge regarding a precisely
“right” carbon tax rate.54 An analytical or political estimate is feasible but may not be the most
economically efficient outcome. Further, setting carbon tax rates based on revenue needs for
deficit reduction, or some other purpose, would not necessarily result in setting a rate that is
proportional to the incremental harm of GHG emissions.
Equity
The “equity” or “fairness” of taxes can be evaluated by looking at how different parties are
affected. How the burden of a tax is ultimately divided between different parties is described as
the economic incidence of the tax.55 To evaluate the subjective concepts of “equity” and
“fairness” in tax policy, economists often examine two different types of equity: vertical and
horizontal. In addition, some economists consider individual and generational equity. A complete
policy analysis might consider the potential trade-off between economic efficiency and equity.56
These four elements of tax equity are discussed below.
Vertical Equity
The notion of vertical equity suggests that those with a greater ability to pay should contribute
more. Without some of tax revenue redistribution, carbon taxes are generally considered to be
“regressive,” because lower-income households generally spend a higher percentage of their
income on energy-related goods and services than do higher-income households.57 The actual or
perceived regressivity of carbon or fuel taxes can have a strong influence on the political
feasibility of the instrument.58 For example, the coalition of advocates for low-income people and
opponents of energy taxes arguably contributed to the failure of President Clinton’s 1993 “Btu
Tax” proposal (see the text box above), which was introduced as part of a deficit reduction
package.
53 A related discussion appears in the “Rate of Taxation” section above.
54 For more information on the challenges of estimating the environmental and health costs of GHG emissions, see
CRS Report R41973, Climate Change: Conceptual Approaches and Policy Tools, by Jane A. Leggett.
55 This is in contrast to the statutory incidence, where the statutory incidence falls on the person responsible for
remitting the tax to the tax authorities.
56 See CRS Report R41641, Reducing the Budget Deficit: Tax Policy Options, by Molly F. Sherlock.
57 See CRS Report R40841, Assisting Households with the Costs of a Cap-and-Trade Program: Options and
Considerations for Congress, by Jonathan L. Ramseur and Libby Perl.
58 See Stephen Moore, “Federal Budget Issue: Do We Need an Energy Tax?” National Center for Policy Analysis, June
1993, at http://www.ncpa.org/pub/bg127?pg=4, as an example of expressed concerns.
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Particular carbon tax design elements could reduce its regressivity. For example, carbon tax
revenues could be used to reduce other taxes (e.g., income) or be redistributed to lower-income
households through a variety of funding mechanisms (see the section “Alternative Uses for
Carbon Tax Revenues” below).
Horizontal Equity
Horizontal equity examines whether potential tax-payers with similar characteristics would
receive equivalent tax treatment. Questions of horizontal equity may arise if particular industries
or economic sectors that predominately emit non-CO2 GHG emissions (e.g., methane) were
exempted from the carbon tax regime, while industries or sectors of comparable size were
included based on their CO2 emissions.59
Individual Equity
Some people consider taxes unfair when they involve government interference in private
transactions, including freedom to use one’s resources as one chooses. This is sometimes
considered a violation of “individual equity.” 60 To minimize infringement of individual equity,
some would argue that taxes should be levied on, and commensurate with, the benefit an
individual receives from the taxed activity, or “benefit taxation.”61 (Proponents contend that not to
violate individual equity would require that the tax be voluntary.) Some might counter that a
carbon tax is a kind of “benefit taxation,” levied on the benefit the carbon source receives by
being allowed to discharge the pollution to the atmosphere.
Generational Equity
Are the burdens of taxation and benefits from governmental spending fairly distributed across
generations? This is a particular concern in the context of the federal deficit and GHG-induced
climate change, both of which would likely shift costs from the current generation to subsequent
generations. At first glance, a carbon tax could potentially support generational equity by helping
to slow or reduce GHG-induced climate change and by potentially reducing the deficit
(depending on the fate of tax revenues).
However, an assessment of generational equity is complex. Some may argue that a carbon pricing
mechanism would reduce the wealth of the current generation, consequently reducing the
productive capacities of future generations. Moreover, some may argue that, instead of a carbon
price approach, increased investment in technology would yield greater benefits for future
generations. Others may counter that increased investments today may result in increased
59 During the debates of the 1993 Btu tax proposal, exemptions allowed to various interests may have contributed to a
perception of its unfairness. For one view of the politics of the Btu tax debate and demise, see Dawn Erlandson, “The
Btu Tax Experience: What Happened and Why It Happened,” Pace Environmental Law Review 12, no. 1, 1994.
60 C. Eugene Steuerle, “And Equal (Tax) Justice for All?” in Tax Justice: The Ongoing Debate, edited by Joseph J.
Thorndike and Dennis J. Ventry (Urban Institute Press, 2002).
61 Discussions of individual equity and benefit taxation arise mostly in discussions of public finance for education,
Social Security, and other kinds of programs that offer an explicit benefit. See, for example, American Academy of
Actuaries, “Social Security Reform: Changes to the Benefit Formula and Taxation of Benefits” at
http://www.actuary.org/pdf/socialsecurity/benefit_05.pdf; or Kent E. Portney, “Individual Equity And School Finance:
Implications For Taxation And State Aid.” Journal of Education Finance 2, no. 2, 1976.
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consumption, providing minimal benefits for future generations and foregoing the opportunity to
address climate change impacts. Such an outcome would disproportionately burden future
generations.
Operability
Some tax options may be elegant in terms of economic theory but, in practice, present
considerable logistical challenges. This section identifies some of the key administrative issues
that might arise when implementing a carbon tax.
Administrative Ease
In previous debates over carbon taxes, which largely focused on discouraging GHG emissions,
many proponents asserted that carbon taxes would be administratively simple compared to the
principal emissions control alternatives—notably, a cap-and-trade program62 or emissions
performance standards. As with other comparisons, the relative advantage of a carbon tax would
depend on the designs of the instrument alternatives under scrutiny.
Any new kind of tax would require new administrative systems, but a carbon tax system could
potentially take advantage of existing frameworks. A well-developed administrative structure for
collecting taxes already exists in the United States. In addition, approximately 13,000 facilities
report annual GHG emissions to EPA.63 Therefore, EPA already collects carbon tax emissions
data covering about 90% of all U.S. GHG emissions. However, a tax program would presumably
be administered by the Department of the Treasury. Transferring data should not be technically
difficult, but broader cooperation across agencies would likely be necessary to share respective
expertise and to promote compliance.
Consistency with Federal and International Norms and Standards
Policymakers might consider the degree to which a carbon tax is consistent with other policies
that support other objectives: pollution control, energy affordability, national security.
Superficially, carbon taxes would seem to be consistent with other GHG emission control
standards, but would conflict with incentives to make fossil fuels more affordable.
In terms of linking a U.S. GHG emission reduction scheme with international efforts, a carbon tax
may be at a disadvantage, because the most prominent international activity, namely the European
Union’s Emission Trading Scheme,64 currently involves a cap-and-trade approach.
62 A cap-and-trade system is arguably is more administratively complex than a tax. However, both systems, if they
apply to all GHG and all large sources of emissions, involve many components. Moreover, as policymakers include
more flexible design elements—primarily to improve efficiency and control price volatility—a cap-and-trade program
would increase in complexity. It would be more costly to administer; more open to exploitation (for example, by traders
of derivative financial instruments); potentially less transparent; and harder for regulators to ensure compliance.
63 EPA’s Greenhouse Gas Reporting Program in 40 CFR Part 98.
64 See CRS Report R42392, Aviation and the European Union’s Emission Trading Scheme, by Jane A. Leggett, Bart
Elias, and Daniel T. Shedd.
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Potential Perverse Effects
Some carbon pricing policies may yield unexpected and unwelcome results. For carbon taxes, one
such “perverse effect” would be the potential to increase the cost of business activity in the
United States. Over time, this could result in reduced revenue from both the carbon tax and other
taxes.65 This consideration has led some other countries to exempt energy-intensive
manufacturers in specific or strategic sectors from energy or carbon taxes.66
In addition, a carbon tax could lead to emissions “leakage,” if businesses moved operations
overseas to avoid the tax. This outcome would depend on a number of factors, however, including
relative fuel mixes, efficiencies of power production and transportation, border taxes, etc.
Transparency
Tax policies that are transparent may be more likely viewed as fair, as taxes being paid are
understood by those responsible for paying the tax. In recent years, many have grown more
skeptical of complex financial structures.67 Potential complexity and opaqueness of a cap-and-
trade program was one factor that led some advocates of GHG control policies to prefer carbon
taxes as a policy instrument.
While a carbon tax could be designed to be simple and transparent, Congress could also choose to
establish a carbon tax framework that rivals the complexity of a cap-and-trade program. For
instance, policymakers could provide subsidies or exemptions to the fossil fuel industry or certain
consumers (e.g., agricultural users) or enact incentives for producing, processing, and exporting
fossil fuels. In addition, policymakers could allow for tax credits for carbon sequestration
projects, similar to carbon offsets in a cap-and-trade regime.68 As with carbon offsets in a cap-
and-trade program, this would require a further level of administrative responsibilities, and
potentially weaken the program.69
Ironically, transparency, particularly in regards to costs, could be a political liability for a carbon
tax. Although both a carbon tax and a cap-and-trade program would impose higher energy costs,
the costs from a cap-and-trade program would be more difficult to estimate, because the market
would determine the price of emission allowances (and thus the overall costs of the program).
65 The CBO takes this into account when estimating net revenues from a carbon tax.
66 See CRS Report R40936, An Overview of Greenhouse Gas (GHG) Control Policies in Various Countries, by Jane A.
Leggett et al.
67 See CRS Report RL34488, Regulating a Carbon Market: Issues Raised By the European Carbon and U.S. Sulfur
Dioxide Allowance Markets, by Mark Jickling and Larry Parker.
68 The tax code already contains provisions allowing tax credits for carbon sequestration (see Internal Revenue Code
§45Q).
69 See CRS Report RL34436, The Role of Offsets in a Greenhouse Gas Emissions Cap-and-Trade Program:
Potential Benefits and Concerns, by Jonathan L. Ramseur.
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Political Feasibility
Certain stakeholders are likely to exercise strong opposition to a carbon tax. These include
energy-intensive manufacturers, farmers, and regional energy interests—especially those whose
asset values may fall with expected impacts on profitability of owned or leased coal and oil
resources. One may look to numerous reviews of the histories of both the Clinton Btu tax
proposal and more recent cap-and-trade bills for lengthier views regarding political feasibility.70
Contribution to Deficit Reduction
The possible contribution of a carbon tax to deficit reduction would depend on the magnitude and
scope of the carbon tax, various market factors (discussed above), and assumptions about the size
of the deficit. In August 2012, CBO released updated budget projections for fiscal years 2012 to
2022. Under current law, CBO estimated the 10-year budget deficit at $2.3 trillion, or 1.1% of
GDP.71 However, using an alternative fiscal scenario,72 CBO’s projected a larger deficit—$10.0
trillion, or 4.9% of GDP.
Enacting the carbon tax options discussed in the previous section could reduce future budget
deficits. As illustrated in Figure 4, a $20/mtCO2 price on carbon (increasing by 5.6% annually)
would have a considerable impact on budget deficits using CBO’s August 2012 baseline
projection.
• The 10-year budget deficit could be reduced from $2.3 trillion to $1.1 trillion, or
from 1.1% to 0.5% of GDP.
• Overall, a $20/mtCO2 price on carbon would reduce the 10-year budget deficit by
more than 50%.
Under CBO’s alternative fiscal scenario, the same carbon tax would have a smaller impact on
budget deficits.
• The deficit would be reduced from $10.0 trillion to $8.8 trillion, or from 4.9% to
4.4% of GDP.
• Overall, a $20/mtCO2 price on carbon would reduce the 10-year budget deficit by
about 12%.
70 See, for example, Dawn Erlandson, “The Btu Tax Experience: What Happened and Why It Happened” Pace
Environmental Law Review 12, no. 1 (Fall 1994); Lisa Lerer, “Is Cap and Trade Dems’ Next ‘BTU’?” Politico, July 13,
2009; Joseph E. Aldy and Robert N. Stavins, “Using the Market to Address Climate Change: Insights from Theory and
Experience,” National Bureau of Economic Research Working Paper Series No. 17488 (2011).
71 The 10-year budget deficit covers fiscal years 2013 through 2022.
72 This scenario assumes that (1) most expiring tax provisions are extended and the Alternative Minimum Tax (AMT)
is adjusted for inflation, (2) Medicare’s payment rates for physicians’ are held constant at current levels, and (3) that
the automatic spending reductions required by the Budget Control Act (BCA) do not occur.
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Figure 4. CBO Estimated Revenues from a $20/mtCO2 Carbon Tax Compared to
Two CBO Budget Deficit Projections
FY2013-FY2022
400
200
0
-200
rs
lla
o
-400
f D
s o
n
-600
illio
B
-800
-1,000
-1,200
-1,400
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
August 2012 Baseline
Alternative Fiscal Scenario
Carbon Tax Revenue
Source: Prepared by CRS. Carbon tax revenue estimates from CBO, Reducing the Deficit: Spending and Revenue
Options, Washington, DC, March 2011, pp. 205-206; Budget deficit estimates from CBO, An Update to the Budget
and Economic Outlook: Fiscal Years 2012 to 2022, August, 2012.
Notes: The 2012 baseline estimates are based on current law. The alternative scenario assumes that (1) most
expiring tax provisions are extended and the Alternative Minimum Tax (AMT) is adjusted for inflation, (2)
Medicare’s payment rates for physicians’ are held constant at current levels, and (3) that the automatic spending
reductions required by the Budget Control Act (BCA) do not occur. Revenues from the carbon tax are assumed
to start in FY2013.
Carbon tax proposals that raise less revenue would contribute less to deficit reduction. The Save
Our Climate Act of 2011 (H.R. 3242) states that this legislation would reduce the deficit by $480
billion over the 10-year budget window. Relative to the CBO’s alternative fiscal scenario, the
$480 billion would reduce the budget deficit by 4.8%, from an estimated $10.0 trillion to roughly
$9.5 trillion, or 4.9% to 5.7% of GDP.
The analysis above assumes that 100% of carbon tax revenue would be applied toward deficit
reduction. The following section explores possible alternative uses for carbon tax revenues.
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Alternative Uses for Carbon Tax Revenues
Carbon tax revenues may be used to achieve a variety of policy goals. However, one revenue use
necessarily forgoes the opportunity to apply that level of revenue to support other objectives, like
deficit reduction. Therefore, in deciding how to allocate carbon tax revenues, policymakers would
encounter trade-offs among objectives. Such trade-offs include
1. minimizing economy-wide costs resulting from a carbon tax;73
2. alleviating the costs borne by subgroups in the U.S. population, regions,
economic sectors, and generations; and
3. supporting specific policy objectives, such as deficit reduction, climate change
mitigation, energy efficiency, technological advances, domestic employment, or
energy diversity.
A comprehensive discussion of alternative uses of carbon tax revenues and the involved trade-
offs is beyond the scope of this report.74 Three possible options, which have received some
attention in recent years, are discussed below.
Distribute Carbon Tax Revenues to Households
If Congress were to consider a carbon tax system, a key debate would likely involve the degree to
which carbon tax revenues would be returned to households to alleviate the expected financial
burden imposed by the carbon tax.75 A 2007 study estimated that households and businesses that
are end users would experience the vast majority (89%) of the private costs under a carbon
pricing regime (the remaining 13% was attributed to coal, oil, and gas producers and fossil
electricity generators).76 Moreover, businesses—to the extent they were able—would likely pass
through to household consumers some of their increased energy/electricity costs in the form of
higher prices for their goods and services. Costs that are not passed through to consumers in the
form of higher prices are borne by either labor, through reduced wages, or owners of capital,
through reduced returns on investment.
Depending on how and to whom carbon tax revenues are distributed, lower-income households
could face a disproportionate increase in tax burden. As illustrated in Table 5, a carbon tax “in
isolation” (i.e., without revenue redistribution of some kind) could have a disproportionately
greater impact on lower-income households than higher-income households—a regressive
73 One way to interpret this efficiency objective would be to maximize growth of GDP, though other measures of
broader well-being may be an alternative. However, even using a narrow GDP measure would involve decisions about
whether economic efficiency pertains to the United States only or international efficiency, or to current taxpayers
versus future generations.
74 For more information, see CRS Report R40242, Carbon Tax and Greenhouse Gas Control: Options and
Considerations for Congress, by Jonathan L. Ramseur and Larry Parker; and CRS Report R40841, Assisting
Households with the Costs of a Cap-and-Trade Program: Options and Considerations for Congress, by Jonathan L.
Ramseur and Libby Perl.
75 This issue received considerable attention during the debate over H.R. 2454 (“Waxman-Markey”) in the 111th
Congress. H.R. 2454, which passed the House on June 26, 2009, would have, among other things, established a price
on GHG emissions through a cap-and-trade system.
76 National Commission on Energy Policy, Allocating Allowances in a Greenhouse Gas Trading System, 2007.
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outcome.77 As Table 5 illustrates, a carbon tax in isolation would reduce after-tax income for
taxpayers in the lowest income deciles by 3.4%, while taxpayers in the highest income deciles
would see their income fall by 0.8%.78
The remaining rows in Table 5 show how the household impacts would change if carbon tax
revenues were rebated to households using different rebate mechanisms.79
• An equal lump-sum rebate of carbon tax revenues would be progressive,
increasing incomes for those in the lowest income deciles relative to higher-
income brackets.80
• A payroll tax rebate for workers, in this case, would reduce but not eliminate the
regressivity of the carbon tax. Lower-income households without individuals in
the workplace would not receive a rebate under this approach.81
• Adding a rebate for Social Security recipients to the payroll tax rebate would
address the lower-income households with individuals not in the workplace, and
further enhance the progressivity of this policy option.82
In this scenario, both a lump-sum carbon tax rebate and a carbon tax rebate that includes Social
Security recipients increase the after-tax income of lower-income households while decreasing
the after-tax income of higher-income households. Using carbon tax revenues to reduce payroll
taxes would increase the after-tax income of middle-income households, while lower-income
households would see their after-tax income fall.
77 As mentioned above, this is the expected outcome because lower-income households generally spend a higher
percentage of their income on energy-related goods and services than do higher-income households.
78 This study assumed a carbon tax of $15 per ton of CO2.
79 For more information on these different mechanisms, see CRS Report R40841, Assisting Households with the Costs
of a Cap-and-Trade Program: Options and Considerations for Congress, by Jonathan L. Ramseur and Libby Perl.
80 The per-capita, lump-sum rebate amount assumed in this study was $274.
81 The credit would cover the first $560 in payroll taxes (or first $3,660 of wages per covered worker, using 2003 data).
82 Under this option, the maximum credit amount would be $420.
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Table 5. Distributional Effects of Carbon Tax with Different Applications of Carbon
Tax Revenues
Percentage Change in After-Tax Household Income by Income Bracket
(1= Lowest, 10=Highest)
Distributional
Scenarios
1 2 3 4 5 6 7 8 9 10
Carbon Tax in Isolation (before
-3.4 -3.1 -2.4 -2.0 -1.8 -1.5 -1.4 -1.2 -1.1 -0.8
revenue redistribution)
Carbon Tax with a Lump-Sum
2.1 1.0 0.6 0.4 0.3 0.1 -0.1 -0.1 -0.2 -0.2
Distribution to Households
Carbon Tax with Payroll Tax
-0.7 -1.0 -0.2 0.1 0.1 0.3 0.2 0.2 0.0 0.0
Rebate for Workers
Carbon Tax with Payroll Tax
1.4 1.0 0.6 0.3 0.1 0.1 0.1 -0.1 -0.1 -0.2
Rebate for Workers and
Equivalent Rebate for Social
Security Recipients
Source: Prepared by CRS with data from the fol owing: Gilbert Metcalf, A Proposal for a U.S. Carbon Tax Swap: An
Equitable Tax Reform to Address Global Climate Change (2007), The Hamilton Project, Brookings Institution.
Note: These results do not account for consumers’ behavioral responses to the carbon tax. Metcalf points out
that the results provide a “reasonable first approximation” of the different impacts to household incomes
(Metcalf (2008)).
Amongst the policies surveyed in Table 5, using carbon tax revenues to finance lump-sum rebates
to households provides the most benefit to the lowest-income. While enhancing the progressivity
of the overall tax system may be attractive from an equity perspective, lump-sum rebates to
households offer limited potential for gains in overall economic efficiency. If carbon tax revenues
are instead used to offset other distortionary taxes in the economy (i.e., payroll, income), the costs
associated with a carbon tax may be reduced or eliminated.
Studies that examine the distribution of a carbon tax rely on a number of modeling assumptions.
Metcalf (2007), for example, assumes that the costs of the carbon tax are related to energy
expenditure patterns across income groups. An alternative approach is to look at the distribution
of the carbon tax, assuming that the carbon tax reduces returns to factors of production: labor,
capital, and fossil fuel resources.83 Under this approach, the regressivity of a carbon tax is
reduced. If the burden of the carbon tax falls more heavily on owners of capital, as opposed to
labor, the carbon tax affects higher income households that tend to derive more of their income
from capital. Further, lower income households that receive a larger share of their income from
transfer payments (e.g., social security), would be less affected by a carbon tax. While the
“baseline” distribution of a carbon tax (i.e., the distribution of a carbon tax absent revenue
recycling) differs under various modeling assumptions, the general conclusions regarding
different policy choices for uses of carbon tax revenues often remain the same. Lump-sum
83 Studies that use this approach include Sebastian Rausch, et al., “Distributional Impacts of Carbon Pricing: A General
Equilibrium Approach with Micro-Data For Households,” Energy Economics, vol. 33, no. 1 (March 2011) pp. S20-S33
and Sebastian Rausch, et al., “Distributional Impacts of a U.S. Greenhouse Gas Policy: A General Equilibrium
Analysis of Carbon Pricing,” in U.S. Energy Tax Policy, ed. Gilbert E. Metcalf (Cambridge University Press, 2011), pp.
52-107.
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redistribution of carbon tax revenues tends to be more progressive, while policies that reduce
payroll taxes tend to be less regressive than those that reduce taxes on income or capital. 84
Address Economy-Wide Costs
Some are concerned about potential economy-wide costs that a carbon tax would impose.
Economy-wide costs, or macroeconomic costs, are often measured in terms of changes in
projected gross domestic product (GDP) or another societal-scale metric, such as efficiency cost
or welfare changes.
A tax on carbon would likely lead to increased energy costs, which could reduce GDP growth.85
However, most measures of economic costs imposed by a carbon tax do not consider the climate
change benefits or ancillary benefits86 that a carbon price would provide. The ultimate economic
effects would depend on a number of factors, including the magnitude, design, and use of
revenues of the carbon tax.
Economic studies indicate that using carbon tax revenues to offset reductions in distortionary
taxes—labor, income, and investment—would be the most economically efficient use of the
revenues and yield the greatest benefit to the economy overall. Studies also conclude that using
tax revenues to lower the federal deficit would yield an economy-wide benefit, because of the
reduced need to impose distortionary taxes in the future.87 But this benefit would be delayed and
its realization assumes policymakers would, sometime in the future, address the deficit by raising
taxes.
Using carbon tax revenues to offset other distortionary taxes is sometimes described as revenue
recycling, a fiscal strategy that may yield a “double-dividend:”88
1. reduced GHG emissions, achieved through the new carbon price, and
2. reduced market distortions, achieved through lower taxes on desirable behavior.
84 Sebastian Rausch, et al., “Distributional Impacts of a U.S. Greenhouse Gas Policy: A General Equilibrium Analysis
of Carbon Pricing,” in U.S. Energy Tax Policy, ed. Gilbert E. Metcalf (Cambridge University Press, 2011), pp. 52-107.
85 Although often used as an economy-wide measurement, GDP is an imperfect measure of the economy or society’s
well-being. A classic example is that an epidemic may increase measured economic activity because of higher
expenditures on health care, while reducing well-being. See also Organisation for Economic Co-operation and
Development. How’s Life?: Measuring Well-Being. Paris, 2011; Mack Ott, “Limitation of NIA as a Gauge of Welfare”
in The Concise Encyclopedia of Economics: National Income Accounts, Library of Economics and Liberty, at
http://econlib.org/library/Enc/NationalIncomeAccounts.html.
86 For example, a reduction in GHG emissions from certain sectors may also entail a reduction in hazardous air
pollutants, which could provide health-related benefits.
87 Ian Parry and Robertson C. Williams III, Moving U.S. Climate Policy Forward: Are Carbon Taxes the Only Good
Alternative? Resources for the Future, 2011; Warwick McKibben et al., The Potential Role of a Carbon Tax in U.S.
Fiscal Reform, The Brookings Institution, 2012.
88 For further information, see Ian Parry, “Fiscal Interactions and the Case for Carbon Taxes over Grandfathered
Carbon Permits,” in Climate Change Policy (Dieter Helm, editor), 2005; and Lawrence H. Goulder, “Environmental
Taxation and the Double Dividend: A Reader’s Guide,” International Tax and Public Finance, vol. 2, no. 2, 1995, pp.
157-183.
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According to a 2011 study,89 economic literature90 generally finds that revenue recycling may
reduce the economy-wide costs imposed by a carbon tax intended to reduce GHG emissions, but
may not eliminate them entirely.91 However, the same 2011 study and a 2012 study both provide
scenarios in which a carbon tax and revenue recycling would produce a net increase in Gross
Domestic Product.92 In other words, these studies found that, in certain situations, that the
economic improvements gained by reducing existing distortionary taxes would outweigh the
costs imposed by the new carbon tax.93 In both studies, the potential benefits of reduced GHG
emissions were not part of the calculation, largely because these estimates carry considerable
uncertainty.
For example, the 2012 study94 projected a net reduction in GDP and employment—a measure of
economy-wide costs—when carbon tax revenues where used to (1) reduce the deficit, (2) provide
lump-sum transfers to households, or (3) reduce payroll taxes. However, when carbon tax
revenues were used to reduce marginal tax rates on capital income (e.g., the corporate tax),
employment and GDP increased relative to the baseline. While using carbon tax revenues to
reduce tax rates on capital may enhance economic efficiency, such policies would not offset the
increased burden imposed by a carbon tax on low-income households.95
Assist Carbon-Intensive, Trade-Exposed Industries
Carbon-intensive, trade-exposed industries would likely face disproportionate impacts within a
U.S. carbon tax system. This issue received considerable attention during the debate over H.R.
2454 in 2009 (the 111th Congress) and would likely receive similar attention if Congress were to
consider establishing a carbon tax system.
An industry’s carbon intensity is a function of both direct CO2 emissions from its manufacturing
process (e.g., CO2 from cement or steel production) and indirect CO2 emissions from the inputs to
89 Ian Parry and Robertson C. Williams III, Moving U.S. Climate Policy Forward: Are Carbon Taxes the Only Good
Alternative? Resources for the Future, 2011.
90 For example, the following reports found that a price or tax on carbon would have a small, but negative, impact on
GDP growth: U.S. Energy Information Administration, Energy Market and Economic Impacts of H.R. 2454, the
American Clean Energy and Security Act of 2009, Report #: SR-OIAF/2009-05, August 4, 2009, http://www.eia.gov/
oiaf/servicerpt/hr2454/background.html and Congressional Budget Office, The Economic Effects of Legislation to
Reduce Greenhouse-Gas Emissions, Washington, DC, September 2009, http://www.cbo.gov/sites/default/files/cbofiles/
ftpdocs/105xx/doc10573/09-17-greenhouse-gas.pdf.
91 This is referred to as the “tax-interaction effect” in economic literature. See, e.g., Ian Parry, “Fiscal Interactions and
the Case for Carbon Taxes over Grandfathered Carbon Permits,” in Climate Change Policy (Dieter Helm, editor), 2005.
92 See, e.g., Ian Parry and Robertson C. Williams III, Moving U.S. Climate Policy Forward: Are Carbon Taxes the
Only Good Alternative? Resources for the Future, 2011; Warwick McKibben et al., The Potential Role of a Carbon Tax
in U.S. Fiscal Reform, The Brookings Institution, 2012.
93 Note that this net economy-wide gain does not include benefits achieved by reducing GHG emissions.
94 This study assumed a tax of $15 per ton of CO2, with the tax rate rising at 4% above inflation each year through
2050. See Warwick McKibben et al., The Potential Role of a Carbon Tax in U.S. Fiscal Reform, The Brookings
Institution, 2012
95 For an analysis of the distribution of federal taxes, including corporate taxes, see Congressional Budget Office, The
Distribution of Household Income and Federal Taxes, 2008 and 2009, Washington, DC, July 2012,
http://www.cbo.gov/sites/default/files/cbofiles/attachments/43373-06-11-HouseholdIncomeandFedTaxes.pdf. The
corporate tax is progressive, with 87.4% of the corporate tax burden attributable to the top two income quintiles. Since
carbon taxes are regressive, and corporate taxes are progressive, using carbon tax revenues to reduce corporate taxes
would tend to reduce the progressivity of the overall tax system.
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the manufacturing process (e.g., electricity, natural gas). In general, trade-exposed industries are
those that face considerable international competition. A carbon tax would present a particular
challenge for these industries. Compared to other domestic industries, they would be less able to
pass along the tax in the form of higher prices, because they may lose global market share (and
jobs) to competitors in countries lacking comparable carbon policies.96
To address these impacts, policymakers could distribute a portion of the carbon tax revenues to
these industries. As one point of reference, under H.R. 2454 (111th Congress) such industries
would have received approximately 15% of the emission allowance value—analogous to 15% of
carbon tax revenue—through 2025, steadily decreasing to zero thereafter. At the time, some
questioned whether this allotment was sufficient.97 Regardless, the data and administrative
resources necessary to implement such a program would be substantial.
Alternatively, policymakers could supplement a carbon tax scheme with a border adjustment
mechanism that would essentially apply a tariff to carbon-intensive, imported goods. Such a
mechanism was included in H.R. 2454 (111th Congress). Under that proposal, EPA would have
required importers of energy-intensive products from countries with insufficient carbon policies
to submit a prescribed amount of “international reserve allowances,” for their products to gain
entry into the United States. Implementation of this approach would present substantial
administrative challenges, particularly in terms of data from other nations.
In addition, either the revenue distribution or border adjustment approach would likely raise
concerns of trade complications. These issues are beyond the scope of this report. For further
information, see CRS Report R40914, Climate Change: EU and Proposed U.S. Approaches to
Carbon Leakage and WTO Implications.
Concluding Observations
Carbon taxes, or fees on emissions of some or all GHG emissions, have been proposed for many
years by economists and some Members of Congress. A new carbon price would help reduce
GHG emissions contributing to climate change and ocean acidification, and tax revenues could
support a range of policy objectives, including deficit reduction.
Carbon tax revenues would depend strongly on the scope and rate of the tax and multiple market
factors, which instill uncertainty in revenue projections. A $20/mtCO2 carbon tax on U.S. CO2
emissions would generate approximately $90 billion in its first year. If applied toward deficit
reduction, carbon tax revenue (of this magnitude) could have some impact on projected budget
deficits, but impacts vary considerably depending on which budgetary baseline is assumed.
Regardless, if policymakers established a carbon tax, they would likely face pressure from
multiple stakeholders seeking a portion of the carbon tax revenues. Households would be
96 During debate over H.R. 2454 (in the 111th Congress), the Energy-Intensive Manufacturers’ Working Group on
Greenhouse Gas Regulation provided detailed testimony on the energy intensity and trade intensity of the U.S.
manufacturing sector. Testimony of John McMackin for the Energy Intensive Manufacturers’ Working Group on
Greenhouse Gas Regulation before the House Committee on Ways and Means (March 24, 2009).
97 For further details, see CRS Report R40914, Climate Change: EU and Proposed U.S. Approaches to Carbon
Leakage and WTO Implications.
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expected to bear a large portion of burden imposed by a carbon tax. Lower-income households, in
particular, would face a disproportionate impact if revenues were not recycled back to them in
some fashion. In addition, specific industries may experience disproportionate impacts. Carbon
tax revenues that are used to offset the burden imposed on various sectors or specific population
groups would not be available to support other objectives, like deficit reduction.
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Appendix. Carbon Tax and Carbon Pricing
Proposals in the 111th Congress
In the 111th Congress, policymakers introduced at least 9 stand-alone, market-based proposals that
sought to reduce GHG emissions.98 These bills included carbon tax, cap-and-trade, and hybrid
approaches. Of the bills that specified a distribution formula for carbon tax revenue or emission
allowance value,99 only three (and one draft bill) would have allotted allowance value or tax
revenue that would explicitly support deficit reduction (listed in order of proposed date):
• H.R. 2454 (Waxman-Markey), introduced May 15, 2009: 0.2% of emission
allowance value in 2016-2026, zero in subsequent years.
• S. 1733 (Kerry-Boxer), introduced September 30, 2009: 10.3% of emission
allowance value in 2016, increasing to 30% in 2030.
• S. 2877 (Cantwell), introduced December 11, 2009: 25% of emission allowance
value (subject to the appropriations process) to a fund, which could be used to
support a myriad of policy objectives, including deficit reduction.
• Kerry-Lieberman draft legislation, released May 12, 2010: 6.8% of emission
allowance value in 2016 and 2030.
Author Contact Information
Jonathan L. Ramseur
Molly F. Sherlock
Specialist in Environmental Policy
Specialist in Public Finance
jramseur@crs.loc.gov, 7-7919
msherlock@crs.loc.gov, 7-7797
Jane A. Leggett
Specialist in Energy and Environmental Policy
jaleggett@crs.loc.gov, 7-9525
98 See CRS Report R40556, Market-Based Greenhouse Gas Control: Selected Proposals in the 111th Congress, by
Brent D. Yacobucci, and Jonathan L. Ramseur.
99 Allowance value allocation includes both the use of auction revenues and distribution of allowances to entities (e.g.,
industry or non-covered parties) at no cost.
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