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As many news outlets are reporting, the Obama administration’s proposed budget presumes about $75 billion in annual revenue from the sale of carbon allowances (even though a cap-and-trade bill has yet to be implemented). While this is certainly an interesting move, and perhaps a way to exert pressure on Congress to move forward with cap-and-trade legislation, what caught my eye is what Obama is proposing to do with the majority of the revenue from auctioning the permits to pollute - give it back to Americans in a tax cut that will help offset the increase in energy costs that will result under such legislation. The remainder of the funds, about $15 billion a year, will go towards energy R&D. 

The use of carbon-derived funds in this manner is a concept usually advocated by supporters of a carbon tax. One of the most well-known policy proposals that advocates this idea is the “Green Employment Tax Swap” from Tufts University economics professor Gilbert Metcalf. Metcalf’s proposal, which Al Gore embraces wholeheartedly (see below), suggests pairing the implementation of a carbon tax with a reduction in the payroll tax. Why? The increased costs of energy that result from a carbon tax (or a cap-and-trade system where allowances have a cost) will be passed on to the end-user, and will disproportionately affect low-income folks since the tax is not tied to income and is regressive. By reducing the payroll tax, which is also regressive, Metcalf shows that “While the carbon tax in isolation may be regressive, a carbon tax reform need not be regressive.” In fact, Metcalf’s paper shows that a well-designed carbon tax policy can be “revenue-neutral and distributionally neutral” - or in layman’s terms - if set right it won’t raise the tax burden on any American, regardless of income level. Conservative economists, like Gregory Mankiw, have also voiced support for this tax-swap concept.

Obama’s budget embraces this concept but applies it to a different policy aimed at creating a carbon-constrained economy. But the reality is that a cap-and-trade system in which the ability to pollute is auctioned off at a price, like Obama proposes, has essentially the same price impact as a tax. This fact, and the stated plans for what to do with the revenue raised, should theoretically lead to support for Obama’s policy even among economists and politicians that have historically advocated for a carbon tax instead of a market-based approach. Time will tell if this is the case or not, but these proposed tax cuts should bolster the chances of carbon legislation passing despite the current economic situation.

Are you a carbon policy wonk? Just want to learn more? Check out the following articles and reports:

Is a Carbon Tax Really Simpler? (The New Republic)

Carbon Taxes vs. Carbon Markets (Reason Magazine)

Thirteen Plus One: A Comparison of Global Climate Policy Architectures (Warning: 39-page pdf)