Carbon Taxes and Economic Growth

The Bloomberg BNA Tax Management Weekly State Tax Report filters through current state developments and analyzes those critical to multistate tax planning.

Tax Policy

Next week, Washington voters will consider Initiative 732, which would impose a tax on carbon emissions produced by fossil fuels. In this article, Dr. Frederick R. Treyz of Regional Economic Models, Inc. discusses his firm's findings using several simulations of a revenue neutral carbon tax in the state.

Dr. Frederick R. Treyz

By Dr. Frederick R. Treyz

Dr. Frederick R. Treyz is the Chief Executive Officer and Chief Economist at Regional Economic Models, Inc. (REMI). Dr. Treyz is one of REMI's original owners, and has led the company for more than a decade. He joined REMI in 1995 and was named CEO in 2000. He holds a B.A. in Economics from Princeton University and a Ph.D. in Regional Science from the University of Pennsylvania.

Chris Brown, Manager of Business Development at REMI, and Brian Boyd, a REMI associate, contributed to this article.

On Nov. 8, Washington State voters will decide if their state becomes the first in the nation to adopt a carbon tax—a concept long discussed by economists and environmentalists but never attempted in the U.S.

The proposal, Initiative 732, would impose a tax on carbon emissions produced by fossil fuels, while cutting the sales tax by 1 percentage point, reducing taxes on manufacturing, and increasing a low-income exemption. The plan is another sign of growing interest in the carbon tax as an alternative to regulations.

In 2013, Regional Economic Models, Inc. (REMI) worked on behalf of a pro-carbon tax group, Washington Environmental Tax Reform (ETR-WA), to develop several simulations related to different levels of a revenue-neutral carbon tax in the state and to produce a report on our findings.

Our firm develops economic modeling software and provides consulting services. We take no position on the ballot initiative, but we are familiar with the complex issue of carbon taxes. We have assisted in the analysis of proposals in Massachusetts and Vermont, and we also studied the issue on the national level for the nonprofit Citizens' Climate Lobby.

ETR-WA asked us to find ways to use the revenue from the carbon tax to get the most economic growth. They gave us wide latitude in developing scenarios to simulate, but they specifically wanted to help protect manufacturing and low-income families.

Methodology and Findings

In our study, we made the point of helping manufacturing by lowering the business and occupation (B&O) tax and providing relief to low-income households through the Working Family tax credit. These elements have informed the proposal being considered by Washington voters.

We assessed a possible tax on carbon-emitting fossil fuels and electricity—the scenarios included a fee at $10 per metric ton, $30 per ton, $50 per ton, and $100 per ton, phased in at $5 a year. To offset the tax, we reduced the B&O and sales taxes and increased the low-income household rebate. In total, these offsets are equal to the new revenue.

Our findings show the following results for Washington depending on the particular scenario:

  •  By 2022, the state could gain approximately 5,000 to 20,000 jobs and approximately $250 million to $1 billion (2013 dollars) in economic output, when compared to baseline.
  •  By 2035, the state could gain approximately 5,000 to 40,000 jobs and approximately $250 million to $2.75 billion (2013 dollars), when compared to baseline.

 

Generally, all things else being equal, one would expect a tax to increase prices and dampen economic growth. Revenue-neutral carbon taxes, on the other hand, present intriguing economic questions. There are two sides of these proposals—the tax increases costs for consumers and businesses, but they are fully or partially offset by cuts to other taxes or rebates.

A Tax With Moving Parts

Revenue-neutral carbon taxes are complicated policy measures with several moving parts. We used our economic model to account for both the increased costs and the “recycling” of proceeds back into the private sector. Our research suggests that matching the new tax with cuts to other taxes or a rebate can offset job loss from higher costs of energy.

So what matters most is how you handle the proceeds. In a revenue-neutral scenario, you are returning money to households that can go to other expenses.

Carbon taxes can affect regions differently, depending the underlying industry base. For states that have a large industrial base built around fossil fuels or have very energy-intensive sectors, there can be net losses in both jobs and value added.

Industries that benefit directly from household spending—such as health care, retail, and housing—stand to gain the most, since consumers are able to spend their refund on those sectors. At the same time, a carbon tax can reduce output in the capital-intensive fossil fuel extraction, pipeline, and refinery industries. Since labor-intensive sectors such as health care benefit, though, the employment picture ends up being positive on balance.

Supporters argue the carbon tax is a more efficient than imposing regulations, because it would harness market forces rather than create new layers for rules. By placing a price on carbon, a tax would account for the social cost, and send a signal that encourages companies and households to reduce their carbon emissions. The tax would provide industries with incentive to innovate and find new ways to protect the environment.

If designed correctly, a revenue-neutral carbon tax may also benefit the economy by redirecting the proceeds into other types of consumption and by offsetting costs with other tax reductions.

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