No, Working Families Won’t Benefit from a Carbon Tax

Before the Curbelo bill dropped (see my analysis here), the big carbon tax news was the launch of the group “Americans for Carbon Dividends,”which was a spinoff of the older Climate Leadership Council (CLC). The New York Times headline predictably touted the new group’s “conservative credentials,” as they include some former GOP officials and academics.

The proposal sets the initial carbon tax at $40/ton, which would—by design—make gasoline and electricity more expensive. But don’t worry: As the NYT story reports: “To offset the higher prices, the tax revenue would be returned to consumers as a ‘carbon dividend.’ The group estimates that the dividend would give a family of four about $2,000 in the first year.”

This claim is extremely misleading. It makes it sound as if the average household is going to benefit financially from the proposed carbon tax, on top of enjoying less global warming to boot. But no, this is totally wrong. On average, of course, Americans don’t benefit from getting their own tax dollars returned to them.

And even for that portion of the population that are net recipients, they will still alter their behavior in light of the carbon tax, which reduces their standard of living. After all, the government could levy a $10,000 annual tax on owning a car. If most Americans decided to get rid of their vehicles and take the bus, the tax wouldn’t “cost them” but it would still make them miserable.

The Office of Tax Analysis (OTA) Report

The websites of Americans for Carbon Dividends and the Climate Leadership Ccouncil are not designed for academic use, but my best guess is that they derive their “$2,000 for a family of four” figure from this 2017 Office of Tax Analysis (OTA) study of a hypothetical carbon tax. Specifically, the OTA study “estimated the 10-year revenue effects of a carbon tax that started at $49 per metric ton of carbon dioxide equivalent (mt CO₂-e) in 2019 and increased to $70 in 2028” (p. 3). This initial carbon tax rate translates into a 44-cent increase in gasoline prices per gallon, more than $21 per barrel of crude oil, and $2.60 per mcf of natural gas (see Table 1 of the study).

As far as revenue, the OTA study estimated this carbon tax “would raise $2,221 billion in net revenue over the 10-year window from 2019 through 2028” (p. 10). The OTA study eventually considers the distributional impact of higher energy and transportation costs, first showing the results before the carbon tax receipts are distributed:

The table above shows just how large the raw impact of a carbon tax would be on many poor households. For example, consider families whose cash income places them in the 20 to 30 percent decile. (There are 17.2 million such families.) As of the tax code in January 2017, such families paid an effective federal tax rate of 1.4%. Yet with the proposed carbon tax, they would be paying 2.7% in tax, for a whopping 98.1% increase. In absolute dollar amounts, these relatively poor households would be paying $332 extra in taxes, for an aggregate payment of $5.7 billion a year to Uncle Sam. Overall, their total after-tax income would fall by 1.4%.

In contrast, as the table shows us, the top decile of families (i.e. those in the 90^th to 100^th percentile) would pay, on average, an extra $4,111 per year in taxes, which works out to $70.7 billion total. In the OTA’s modeling, the top 10% of families (by income) consume far more goods and services, and hence pay far more in total carbon taxes. However, notice that their total tax liability only goes up by 3.6%, and their total after-tax income only drops by 1.5%.

Now in this context, what happens if the government takes the total carbon tax recipients and returns them, lump sum, to each citizen equally? That would translate into a $583 per person dividend. In that case, Table 6 from the OTA analysis shows us:

Table 6. Distribution of $49/ton Carbon Tax Using $583 Per Person Dividend

Source: OTA study, p. 26.

Table 6 above makes it clear what is happening when a carbon tax dividend “benefits” poorer families. Because households with lower incomes don’t spend as much as richer households, they obviously pay a lower total dollar amount in carbon taxes—even though energy and transportation expenses are often higher fractions of a poorer household’s budget.

Therefore, if the federal government does nothing with incoming carbon tax receipts except cut lump-sum checks to every citizen, then obviously the poorer households “make money” while the richer household “lose money.” This has nothing to do with a carbon tax per se; we would see the same pattern from a tax-and-rebate scheme enacted on pizzas or purple shirts. If poor households pay in fewer total dollars than rich households, and then the government sends everybody an equal check, the poor households get back more dollars on net than they put in, while the rich households get back fewer dollars than they put in.

So first of all, let’s realize that the carbon tax proposal isn’t making Americans richer on average. Even if the enforcement were costless, it would just be a giant shell game, rearranging money among Americans. If some of them “gained” money, then others would “lose” money by exactly the same amount.

But of course, the enforcement of a giant new carbon tax wouldn’t be free. Companies have to devote manpower to computing their liability, and the government would need to use manpower to do the same.

The Economic Cost of a Carbon Tax Isn’t Simply the Flow of Dollars to Washington

However, the true economic cost of a tax isn’t simply the flow of dollars out of households and into the coffers of the Treasury. Rather, by altering the (after-tax) prices of goods and services, the carbon tax would force households to change their behavior in ways that made them worse off, if we consider the direct impact (i.e. not the possible effects on climate change).

For example, because gasoline will be immediately 44 cents per gallon more expensive, poorer households in particular might drastically reduce their consumption of gasoline, whether through driving less and/or buying a lighter vehicle. We know that this makes these households worse off in direct terms, because they had the option of driving less and/or buying a lighter vehicle before the carbon tax. Because the carbon tax makes energy more expensive, it reduces households’ options, making them worse off.

Notice that depending on the specifics, a household could be worse off, even if it is a net recipient of money from the carbon tax program. To see why, consider an extreme example: Suppose the government levied a $10,000 annual tax on owning a motor vehicle. Most poor households would presumably comply with this new tax by getting rid of their personal cars and trucks. Thus, they wouldn’t pay any vehicle tax into the new program. Rich households (and businesses) would still retain some cars and trucks, and so they would contribute funds into the new program. When the money was distributed lump-sum, that would mean poor households would get “free money” as a dividend. But unless the checks were quite large, most of the poor and middle class households would be worse off. They would gladly forfeit the monthly rebate check, in exchange for being able to afford a car or truck again. (And obviously, the rich households and businesses who paid the vehicle tax would be worse off because of it.)

Warren Buffett and the Milkshake Tax

Just to make sure my basic point goes through, let me use an even more exaggerated analogy: Suppose in an effort to crack down on obesity, the federal government levied a $325 million tax on milkshakes, to be enforced with draconian severity. Clearly, just about nobody in America would drink milkshakes anymore. However, suppose that every year, Warren Buffett (perhaps as part of a publicity stunt, or just to be funny) bought and drank one single milkshake on national television, and paid the huge “milkshake tax” afterwards. The government would then take the milkshake tax revenue, and send an equal dividend check of $1 to all 325 million Americans.

Now in this exaggerated example, defenders of the tax could truthfully say: “The average family of four will gain $4 every year from the milkshake tax.” This is because they wouldn’t pay any of the tax (since they would buy 0 milkshakes), and each person in the household would get $1 from Warren Buffett’s annual contribution.

But clearly, most Americans would not be happy with this scheme. In exchange for “gaining” $1 per year, they would never again get to enjoy a milkshake.

Obviously I am exaggerating the situation to make the point, but a similar principle holds for a carbon tax. Even households who “make money” off of it might prefer the status quo, because the whole country alters their behavior to reduce how much carbon tax they are paying into the kitty. Rather than a financial windfall, over time the whole scheme just ends up making more and more people worse off because they have fewer options when it comes to energy and transportation.

Conclusion

A steep carbon tax would significantly raise the price of energy, which would impose hardship especially on poorer households. It’s true that the blow could be cushioned if all of the revenue were returned to citizens, rather than used to fund higher government expenditures. (Note that the recent Curbelo bill does not devote much money at all to relief—it spends the lion’s share on government infrastructure and other projects.)

However, when members of the CLC tell the public that average households will “make money” off of their proposed carbon tax and dividend plan, Americans should keep in mind two things. First, the public on average doesn’t get rich when the government rearranges dollars; any household that “wins” is necessarily doing so at the expense of somebody else who is a net loser.

Second and more important, even those households that receive more in dividends than they pay in explicit carbon taxes can be worse off, because they have to change their lifestyle in light of more expensive energy (and other carbon-intensive goods and services). If Americans want to reduce their material standard of living in order to mitigate the threat of climate change, that’s one thing. But they shouldn’t let the boosters of the CLC convince them that they’ll be personally “profiting” from the scheme as well.