Carbon tax shifting

Statements like this drive me nuts. This quote is from an otherwise excellent article in The Tyee by Matt Price of Environmental Defence, speculating on the meat for the climate change action bones, expected from BC Premier Gordon Campbell later this week. Price falls into the same simplistic trap a lot of environmentalists get stuck in:

On the revenue side, we need bold innovation to shift taxes away from the things we want — such as income — and onto the thing that in this case we don’t want: carbon. This must also be done in a way that does not penalize low-income citizens.

I’ve railed against this “tax shifting” argument before. People who expound it simply do not understand the economic concept of elasticities, nor the public finance concept of a revenue base. Yes, we should tax carbon, and on a growing schedule that would take carbon prices above $100 per tonne as soon as possible. But using the proceeds to provide income tax cuts is problematic, because a carbon tax will be regressive – the people most adversely affected by a carbon tax are the poor. And they pay very little income tax.

A better strategy would be to use the proceeds for income transfers to low income households (perhaps through refundable tax credits, piggybacking on the GST credit), and to finance services like expanded public transit and subsidize home retrofits and other investments that will reduce our GHG emissions. This would make much more sense given Price’s desire not to penalize low-income citizens, and if anything would give them more options.

The notion that income tax cuts are going to lead to more income is buying into a very conservative line of thought. At prevailing tax levels there is little reason to believe there will be any behavioural response (in terms of work effort or new investment) from income tax cuts. The elasticity is near-zero, and that is why income is a good revenue base for financing public services.

A carbon tax can make the price of emitting CO2 better reflect the external costs of its production, and that is a good thing. But it is not a solid revenue base, as the whole point is to get users to emit less. This would be like financing health care through tobacco taxes. If the tax works, it will eventually reduce revenues available, and it is not a good idea for policy makers to have to choose between a level of tax that maximizes revenue and one that changes behaviour.

6 comments

  • Hi Marc,

    One partial solution to the shrinking tax base problem is to put carbon (or other environmental) tax revenues into an arms-length foundation. Then instead of relying on tax revenues, which as you point out should fall over time, we draw on earnings from the accumulated revenues. The Alaska Permanent Fund is an example, albeit funded by royalties, not green taxes.

    By the way, I haven’t yet read Matt’s article, but could he mean to include other protections for the poor, like social program spending or guaranteed minimum income?

    Cheers,
    Dave

  • Dave, thanks for commenting. Arms length funds are certainly an interesting option, though I think they probably make more sense for non-renewable resource revenues than for carbon taxes.

    A carbon tax that actually succeeds in reducing emissions is going to be pretty high — much higher than anything I’ve seen floated by the Greens (who are the best politically) or NGOs — like $100-200 per tonne, if you take the Jaccard modelling seriously.

    My point was that this will definitely have a big hit on the poor if we do not build in mechanisms to compensate. I’m not sure where Matt is going in this regard, though it is notable that he does flag the issue. I just think a lot of people who fall into a knee-jerk “tax shift” answer need to probe deeper than that.

  • Excellent points, Marc! I had made a few similar points on a blog that I co-author before reading your posts and The Tyee article. I discussed mostly the Green Party of Ontario’s (not Canada’s) carbon tax proposal. But many of the issues with the two parties’ positions are the same.

    The Ontario party Leader, Frank de Jong, told me on September 20, 2007 on live radio that once the carbon tax phases out carbon emissions, we could increase consumption taxes on food, clothing and shelter. In other words, first they’d tax your carbon, and then they’d tax your shirt. The regressive nature of this approach did not seem to bother him.

    For a transcript sound file and discussion, please see my blog post at http://climatechangecdn.blogspot.com/2007/09/first-they-tax-your-carbon-and-then.html

    (Comments are welcome there!)

    On a related note, The Tyee article advocates both cap-and-trade and carbon taxes, but I like cap-and-trade much better, for reasons that I mention in my blog post. I would love to see more debate about cap-and-trade vs. carbon taxes.

    In the meantime, I have updated my post to link to your entries.

    Please keep up the good work!

  • ydzabelishensky, I must agree that the Green party comments you mention were not the most well thought-out! In general, Canadian Green parties have never impressed me as being terribly astute in policy areas other than environment (unlike in Europe, where PR has meant that they have more seats and more sophisticated candidates and policy analysts).

    However, getting to your point: there are already taxes on your shirt – and your food and your shelter. So why exactly would shifting taxes toward pollution, and away from clothing, food and shelter, be a bad thing – even if it were only temporary?

    And if it were temporary (i.e. if we did actually stop carbon emissions), that would be an outcome truly worthy of global celebration!

    Of course, we aren’t going to stop carbon emissions completely, and so the tax base is not going to disappear entirely. And for green taxes that could actually acheive their environmental goals and thus eliminate their base, I know of no reason why an arm’s-length foundation, inflation protected, wouldn’t make for a revenue stream that is perfectly sustainable.

    But the bigger and more interesting point here is regressivity. I’m not saying ydzabelishensky or Marc are in this camp, but one does often hear the claim that green taxes are – always, and intrinsically – regressive. Quite simply, they aren’t; it all depends on instrument design.

    You can easily design a green tax to be neutral or even progressive (which is one reason elites oppose green taxes). And you can easily design a green tax to be regressive.

    Green taxes, per se, are neutral with respect to distributional impacts. This being the case, it seems to me a more strategic approach than railing against them in principle (and in error) would be to get inside the design debate, making sure that the green tax policies being proposed are progressive. The signs are that green taxes are coming; better to be in the driver’s seat.

  • Dave T, thanks for your response. Unfortunately, the current Green “tax-shifting” proposals would not reduce the current taxes on food, clothing and housing while increasing taxes on carbon. They would leave the current consumption taxes (GST/HST/PST/RST/QST) in place. Some of the current taxes have some exemptions for necessities, but the Green proposals would not expand these exemptions. To compensate for carbon tax revenues, they would reduce income taxes instead.

    In fact, the price of necessities may increase to reflect the carbon tax on their components — an indirect consumption tax.

    In the long term, how do you know that “we aren’t going to stop carbon emissions completely”? If the Greens’ own goal of an economy based on 100% renewable energy is reached, then carbon emissions would go down to zero, by definition — and so would carbon tax revenues. This is the internal contradiction in their plans.

    Many in the climate-change field advocate a 50% reduction in carbon emissions. This would mean a 50% reduction in carbon tax revenues.

    So I still ask what would replace the lost revenues. Would we _increase_ the PST on food, clothing and shelter, as Frank de Jong seemed to suggest? Would we raise income taxes back to their former levels? Neither option would be politically easy to implement.

    An arms-length foundation that is protected against inflation sounds nice. But it would require all carbon tax revenues to be invested at a rate of return that consistently exceeds inflation. Where would those types of returns on investment come from — and how can you guarantee that they would always be that high?

    As for turning Green taxes into progressive taxes, I’d love to know how this would work. Details or links to studies, please.

  • “Many in the climate-change field advocate a 50% reduction in carbon emissions. This would mean a 50% reduction in carbon tax revenues.”

    Yes, but this will hardly happen overnight, and how much of an impact year to year declines in fossil fuel consumption would have is hard to predict. In the short to medium term, I don’t see why it’s not possible to program carbon tax rates to produce a constant revenue.

    Similarly, there are many ways of mitigating the regressive nature of carbon taxes – increased support for core services (transportation, hospitals, schools, etc.), direct subsidies, higher child tax credits, changes in marginal income tax rates, etc. etc. This is an adaptive process – get carbon taxes in place with some plausible plan for progressive compensation, and as a reduced fossil fuel economy unfolds, shift tax policy to assist those who are most affected.

Leave a Reply

Your email address will not be published.