I was once on a panel about tax policy where a fellow panelist, a veteran Washington budget expert, made a smart and succincent case that America should adopt a carbon tax. It was a total masterclass in fiscal wonkery — which I then summarily dismissed as utter political fantasy. And I apparently did so with such fervor that in every subsequent panel on which we've appeared over the years, she has humorously prefaced her support for a carbon tax with something like, "Now, I know James sees this is a total non-starter, but ... " (Well, I think she's being humorous, at least.)
But the carbon tax may finally have its moment thanks to West Virginia's Joe Manchin and Arizona's Kyrsten Sinema, the two Democratic senators currently giving their party fits as it attempts to pass President Biden's expansive economic agenda.
The problem isn't only that both want to spend a lot less taxpayer money than many of their fellow Democrats. Manchin also strongly opposes the centerpiece of the Biden climate plan, a $150 billion program that would reward utilities for switching from fossil fuels to wind, solar, and nuclear energy. Meanwhile, Sinema has been telling lobbyists she doesn't want to finance Biden's social spending and climate plan by raising tax rates on businesses, high-income individuals, or capital gains.
Neither senator, however, has definitely ruled out a carbon tax, with Sinema staying particularly opaque about what she would support. The White House also hasn't ruled it out, and from this political chaos could emerge an incredible policy opportunity — if Democrats choose to seize it.
But it's an opportunity that comes, as all opportunities do, with a trade-off. The carbon tax is an elegant, seemingly win-win policy economists love. It would put an explicit price on carbon emissions from burning fossil fuels, and the goal is to nudge businesses and consumers to change their behavior in ways big and small. Higher gas prices, for instance, might encourage more carpooling or use of public transit. A carbon tax would also create incentives for entrepreneurs to find clean-energy alternatives. Markets, rather than government, would decide which options — solar, wind, nuclear, geothermal — make the most sense.
And while all this behavioral change and innovation was happening, the tax would be raising revenue. Now, given that I'm no fan of the Biden social spending agenda, I would prefer a carbon tax be used to pay for the bipartisan infrastructure bill also languishing in Congress. That said, Democrats could cover the social tab if they sub out their income and corporate tax ideas for a carbon tax.
The Tax Foundation finds that a carbon tax levied on all energy-related carbon emissions at a rate of $50 per metric ton and an annual growth rate of 5 percent would generate nearly $2 trillion in additional federal revenue over the next 10 years. Or a smaller carbon tax could be combined with other tax hikes — such as taxing unrealized capital gains or a minimum corporate tax — that Sinema might accept.
But this win-win policy plan does have a political downside, or at least a challenge, for Democrats. While folks on the left often stress the existential threat from climate change, my impression is there's a lot more energy around the issues of wealth and income inequality. For example: Even though polls show Democrats say addressing climate change is extremely important, their tax plans are focused on inequality. That's a pretty big tell. Embracing a carbon tax would mean, at least for now, abandoning high-profile income and corporate tax hikes
That isn't to say a carbon tax would mean ignoring inequality. Carbon tax revenues could be used to reduce income inequality, and Sen. Ron Wyden, an Oregon Democrat, has been working on a carbon tax proposal that could start at $15 to $18 per ton and increase over time. A new Harvard University study finds that a tax around that size, when combined with an extension of various renewable electricity production and investment tax credits, would reduce power sector emissions by 80 percent by 2030, relative to 2005.
Wyden stressed in a New York Times interview that his plan would include tax rebates for lower-income Americans, especially those currently working in the fossil fuel sector. "You've got to show workers and families, when there's an economy in transition, that they will get their money back," he said. "They will be made whole." It's also worth remembering that economic research suggests a corporate tax is also, to some extent, a tax on workers via lower wages.
Even with those possibilities, I realize the political odds still favor options other than a carbon tax. But I would love for my long-time skepticism to be finally proven wrong.
