A carbon tax is an example of Pigouvian tax. It comes with limitations such as becoming regressive and de-incentivising the public’s willingness to contribute to climate action. Revenue neutrality is a solution to both of these challenges that governments can implement through taxes.
Carbon taxes have been known to be a classic example of a Pigouvian tax – a tax to eliminate the negative social impacts, or, more technically speaking, an externality, by incentivising a lack of the usage of goods that cause social detriments.
The tax on carbon emissions has been a longstanding and straightforward solution to offset their negative impact. However, the study of economics is largely based on ideals and the outcome of carbon taxes is not without its fair share of limitations. More broadly, the limitations are those of a Pigouvian tax.
One of the main concerns is that the tax will become regressive in nature, meaning that the burden of the tax will asymmetrically affect those that belong to lower-income groups. A prime instance of this is the market effect on pull and push factors that lead to an increase in costs as a result of levying carbon taxes on corporations. The burden of increases in production costs can be very easily shifted to consumers by increasing prices. In addition to this, carbon taxes are often a small price to pay for large corporations in proportion to the profit they make, thus not ensuring the absolute effectiveness of Pigouvian taxes in eradicating carbon emissions.
From the two limitations of carbon taxes, it is evident that a common denominator in them is the tax burden on consumers, which consequently de-incentivises the public’s willingness to contribute to climate action.
A solution to such a problem that can ensure efficiency to a large extent, if not absolutely, is making carbon taxes revenue neutral. This essentially means that the government retains little, if any, of the revenues raised by taxing carbon emissions. To offset the burden and successfully eliminate the negative externalities, the revenues are returned to the public, with only small amounts utilised to assist communities dependent on fossil fuel extraction and processing to adapt and convert to low- or non-carbon economies. The revenue neutrality of carbon taxes in such a manner optimally targets both the above-mentioned challenges: it prevents taxation from becoming regressive while also giving corporations the resources to evolve their infrastructure in a climate-friendly way. This then brings up the question of the methods by which governments can implement revenue neutrality through taxes.
Two ways in which this has been implemented are through the fee and dividend system in the United States and tax shifting in British Columbia, Canada.
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The Fee and Dividend System in the US
The premise of the dividend and fee system is the redistribution of the tax burden to compensate low-income families that are most affected by carbon taxes. In the specific case of the US, partisanship plays an integral role in policy decisions. The partisan nature of the government and the electorate is especially heightened when taking environmental politics into account. Despite Republicans being at odds with carbon taxation as of 2018, 97% of the House Republicans on the floor voted against carbon taxes. Nonetheless, in 2019, after being advocated for almost a decade, Republicans and Democrats came to consensus on the dividend and fee system, the aim of which is to offset the regressive nature of carbon taxes by providing cash back and rebates to low-income families.
On the opposite end of the spectrum lies the anti-carbon tax argument that these taxes negatively impact the economy by increasing government expenditure. However, as per the Stanford Energy Modelling Forum (EMF) project, the “revenue recycling” process involved in this system will require little to no additional government expenditure in providing rebates.
This policy is administered by returning 100% of the net fees back to households as a monthly dividend after initially holding them in a Carbon Fees Trust Fund. If implemented correctly and consistently, this policy is projected to bring carbon emission levels to 52% below 1990 levels in two decades, as well as prevent over 230,000 premature deaths over the same period from improved air quality. While there is potential for carbon taxes to slow down economic growth in a minuscule manner, the benefits that accompany the minimisation of global warming and greenhouse gas emissions will arguably overturn this slowdown.
Canada’s Tax Shifting
As per the 2017 policy report by the Grantham Research Institute on Climate Change and the Environment, individuals generally express support for the use of tax revenues to ease the impact of the tax on low-income households. While this sentiment is seen as a common consensus, inhibitions towards carbon taxes still prevail. Such aversions, however, can be countered via a gradual phasing out of the taxes levied on carbon emissions. Taxpayers are more likely to be on board with a tax rate increase after seeing the initial success of the propositions made by the government. An outcome-based shifting of the tax will then, as the survey suggests, be the best way to get individuals to express general support for tax redistribution as well. A slower increase in taxes allows tax-paying individuals to understand the costs and benefits of paying said tax, especially if they belong to higher-income households and are to pay a larger proportion than low-income families.
A mechanism like this was implemented in British Columbia, Canada, in 2008. This tax is levied on the sale and use of fossil fuels and accounts for approximately 70% of the province’s greenhouse gas emissions. A coordinated national carbon pricing system was established by the federal government in 2019, and it was increased to CA$50 per tonne (US$36.68 per tonne) as of April 1, 2022.
On July 1, 2022, the Climate Action Tax Credit increased from $174 to $193.50 for adults and from $51 to $56.50 for children. As of 2023, the government of British Columbia established that the taxes will gradually be increased, with an ultimate goal of reaching $170 per tonne (US$124.72 per tonne) in 2030. These increases are put in place on a legislative level, wherein there are set times laid out for an increase in taxes from the onset of the policy’s launch. The revenue generated is then utilised for redistribution purposes. The credit, which is given four times a year by the Canada Revenue Agency, aids in reducing the burden of the carbon taxes that low- and moderate-income people and families pay. The government also provides a number of carbon tax programmes for local governments and corporations to facilitate sustainable, long-term, environmentally friendly infrastructure.
Considering the limitations of Pigouvian taxes, there are substantial considerations to make when implementing a carbon tax. However, maintaining revenue neutrality, as laid out in this article, is a foolproof solution to this shortcoming. While the solution is evident, its implementation is far overdue.
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