Would it be possible to design a carbon tax that the public would enthusiastically support? That would be progressive, rather than regressive, imposing greater costs on the rich than the poor? Is it politically possible to strictly limit the total amount of carbon emitted, without rewarding past polluters with windfall emissions permits? Yes, it is. And it's fun! Politicians — Here's an opportunity to give money to your constituents, and save the world too! It works like this:

First, enact a carbon tax. Nothing fancy here, just your usual I'm-Greg-Mankiw-Wanna-Join-My-Club? "Pigouvian" carbon tax. Embedded in what drivers pay at the pump, added as yet another surcharge to heat and utility bills, would be a new Federal tax on carbon sold or used as fuel. That was easy.

Unfortunately, a carbon tax is regressive. It imposes disproportionate burden on the poor, as the higher cost of driving to work and heating a home takes a much bigger bite out of a burger-flipper's paycheck than a hedge-fund manager's "capital gain".

But, here's a trick. Just as flattish taxes are regressive, flattish subsidies are progressive. So, when we enact the carbon tax, we grant citizens the right to a refund of the tax on a fixed quantity of carbon consumed. We distribute those refunds equally among all taxpaying US citizens annually. And, we permit citizens to sell any refunds they won't need to use.

Suppose, in the beginning, we set the amount of refunds to be equal to the total expected carbon tax, given 2007 US carbon consumption. This seems dumb, right? In the aggregate, we've just created a system whereby the government collects a tax and sends it right back out again, exacting a net cost of zero from the private sector for its profligate use of carbon. All the government has done is caused transfers within the private sector. Yes. But from whom to whom? Light users of carbon end up receiving cash, from the excess permits they sell, while gas-guzzle-monsters pay up! That's likely to mean that most poorer people earn cash from their allotment, paid for by the people whose Hummers they can't see over. Moreover, note that our refunds are distributed only to taxpaying humans, not to businesses, but businesses are still subject to the tax, and can purchase refunds. That means that on net, the government will have underwritten a transfer from businesses to voters households. The vast majority of human beings will see ka-ching positive net wealth from this scheme, without any cost to the government. People who conserve more will earn more, people who conserve less will earn less, or even have to pay. Businesses will buy refunds from households, so long as the cost of the refund is less than the cost of the tax. When there are no more refunds left to buy — when aggregate carbon consumption exceeds the refund allotted — some users will have to pay the tax outright, at whatever rate the government has set.

Now of course a tax on business is indirectly a tax on households. But this is a tax businesses can minimize, by reducing their carbon footprint. That is, after all, the point, to change behavior. Plus, taxing indirectly via businesses, rather than taxing households directly, increases the progressiveness of a tax. Not all costs are passed on to consumers. Some costs take a bite out of profits, harming relatively well-off capital-owners disproportionately. (That's why we have things like corporate taxes.)

The political economy of this scheme is interesting. Since this is a tax that creates an income for most voters (earned, of course, via parsimonious use of carbon), voters might be expected to support increases in the level of the carbon tax, as this increases the value of their refunds. Increasing the tax level faster than the refund allotment makes most voters richer, and helps save the world. It also creates strong incentives for businesses to conserve carbon. As the tax level gradually grows very large, the scheme converges to a cap-and-trade, because it becomes prohibitively expensive for anyone to pay the unrefunded tax.

Would this scheme be hard to implement? Not terribly. Remember, we begin with a simple carbon tax, and we start small and build gradually, so that the refund infrastructure has time to evolve. For a while, lots of refunds would go unused. (They needn't expire quickly.) The government maintains a system of accounts, linked to taxpayer IDs, and encourages private-sector actors to implement trading systems. Carbon consumers claim refunds by submitting proof of taxes paid (bills and receipts), which the government reimburses with a deduction from the claimant's refund account. The process would be quite analogous to the value-added tax reimbursements of businesses apply for in many countries. Consumers who are too busy or disorganized to deal with the paperwork can just sell their refunds and pay the taxes (though they lose some by doing this). Initially, a small industry would spring up to ease the process of claiming refunds, in exchange for a cut. Eventually businesses would find competitive advantage in automating the process. Gas stations, for example, would have every incentive to electronically submit claims on behalf of customers, so that customers see a discount right at the pump. Fraud would be an issue, as it always is. There would be problems, scandals, and solutions.

There's been a lot of debate among the pious, which is more godly, carbon tax, or cap-and-trade? Here's a scheme that starts as a carbon tax and evolves into a cap-and-trade, that creates incentives for consumers, businesses, and politicians to reduce carbon use, that can be implemented gradually, that doesn't reward past polluters, and that leans just a little bit against inequality. What do you think?

Update: For a similar but much simpler idea, see Softening the Impact of Carbon Taxes. The paper proposes a fixed cash rebate of carbon taxes collected, rather than tradable refunds. Thanks to commenter (and author) Dan for pointing this out.

This idea was inspired by Martin Feldstein's Tradeable Gas Rights proposal, via Mark Thoma. I first suggested something like this as a comment to Mark's post.

Update History:
  • 26-May-2007, 08:35 p.m. EDT: Added update linking to Carbon Tax Center whitepaper.
Steve Randy Waldman — Friday May 25, 2007 at 10:28pm [ 7 comments | 0 Trackbacks ] permalink