Carbon Tax Revenue and the Budget Deficit: A Win-Win-Win Solution?

Abstract

Bush-era tax cuts are scheduled to expire at the end of 2012, leading to interest in raising revenue through a carbon tax. This revenue could be used to either cut other taxes or to avoid cuts in Federal programs. There is a body of economic research suggesting that such an arrangement could be a win-win-win situation. The first win—Congress could reduce personal or corporate income tax rates, extend the payroll tax cut, maintain spending on social programs, or some combination of these options. The second win—these cuts in income taxes would spur the economy, encouraging more private spending and hence more employment and investment. The third win—carbon dioxide (CO2) pollution and oil imports would be reduced. This analysis uses the MIT U.S. Regional Energy Policy (USREP) model to evaluate the effect of a carbon tax as part of a Federal budget deal. A baseline scenario where temporary payroll cuts and the Bush tax cuts are allowed to expire is compared to several scenarios that include a carbon tax starting at $20 per ton in 2013 and rising at 4%. We find that, whether revenue is used to cut taxes or to maintain spending for social programs, the economy is better off with the carbon tax than if taxes remain high to maintain Federal revenue. We also find that, in addition to economic benefits, a carbon tax reduces carbon dioxide emissions to 14% below 2006 levels by 2020, and 20% below by 2050. Oil imports remain at about today’s level, and compared to the case with no carbon tax, are 10 million barrels per day less in 2050. The carbon tax would shift the market toward renewables and other low carbon options, and make the purchase of more fuel-efficient vehicles more economically desirable.