‘Recycling’ the Funds from Carbon Tax or Cap and Trade

Reducing the national emissions often involves a powerful policy tool such as carbon tax or emission trading. While many focus on the effectiveness of such measures in cutting carbon emissions, there have been some serious discussions on how to spend the money gained from tax or cap-and-trade auctions. We are talking about some BIG money here; for example, California is reaping over $2 million annually from its cap and trade, and the proceeds are expected to grow over time [1].

An interesting article [2] about the fiscal implications of carbon tax revenues presents a number of measures to ‘recycle’ the revenues—such as reducing a) capital, b) labor, or c) consumption taxes, or redistributing a nontaxable lump-sum payment to citizens. The proceeds from cap-and-trade auctions can be understood in the similar manner, as the economic outcomes of the two systems are akin to one another.

Setting aside the non-quantified environmental benefits, each option provides some strengths and shortcomings in economic terms. For example, a lump-sum rebate has an advantage given that it is simple and benefits every single person, while labor tax breaks can be a powerful tool to galvanize the labor market. However, from a purely economic perspective, capital tax cuts generate better outcomes for two reasons.

First, capital tax break will correct the distortion it had created, to a further extent than other kinds of taxes. Government intervention including tax tends to distort the economy, and tax rate changes bring about different effects depending on their elasticity. The article suggests that the capital tax is more distortionary compared to labor and consumption taxes.

Second, reducing capital tax has an edge over a lump-sum rebate or other tax cuts, in terms of economic growth and intergenerational effects. The report found that the capital tax scenario is the only option that yields a GDP gain, while the capital cut generate lowest cost in intergenerational terms–even though the effects themselves are not significant.

Despite these economic merits, there are considerable uncertainties to address, such as the amount of emissions reduction and the cost that should be shouldered by each household. Indeed, the article discovered that the capital tax cut scenario showed the smallest reduction, while it is unclear whether the cost of household for capital tax is lower than other options. Moreover, the benefits will largely go to the households that rely on capital assets—in other words, high-income families. This inevitably leads to an important question of equity.

In conclusion, no single metric can decide how the money should be recycled. As countries are getting more serious about adopting carbon tax and/or cap and trade, setting up their own principles and priorities as regard to spending the funds should be considered equally important.

[1] http://www.latimes.com/business/hiltzik/la-fi-hiltzik-20150613-column.html

[2] Carbone, J. et al. (2013) Deficit Reduction and Carbon Taxes: Budgetary, Economic, and Distributional Impacts: Considering a Carbon Tax: A Publication Series from RFF’s Center for Climate and Electricity Policy. Resources for the Future.

[3] Image source: Flickr.com


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