Why you just may come to like a carbon tax

Thousands rally for climate action and a carbon price

Tax reform may involve simplifying the tax code, but actually achieving such a thing promises to be a terrifyingly complicated process. The battle over how (and by how much) to reduce the various tax deductions, credits and exemptions that litter the code will be contentious enough; reaching agreement on how to divvy up the revenue generated by this exercise between reducing the debt and lowering tax rates seems almost intractable.

Republicans face a dual problem. The fiscal reality is that revenue gains from reducing tax deductions won’t be as substantial as they desire and, politically, Democrats will insist some of those gains go toward reducing the deficit.

The only way Congress can deliver the lower rates they’ve promised, given those inevitable constraints, is to find a new source for revenue. And the only one that both parties could potentially live with is a carbon tax.

The motivations for enacting tax reform are many: our tax code is a mess, we incentivize behavior that makes little economic sense, and there’s a growing belief that, in many respects, it is fundamentally unfair. This dissatisfaction is especially true for the corporate tax code, where a bipartisan coalition of congressmen is keen to cut the rate, which is among the world’s highest and serves as a disincentive to investment. Ultimately, investment in new machines, software and equipment improves worker productivity, boosts wages and creates jobs.

Some Democrats kvetch that corporations’ effective tax rate (what they actually pay once we take into account the various credits, deductions and exemptions) is relatively low and thus, we shouldn’t do them any favors. They are right that these tax expenditures drive average tax rates down while doing little for the economy. If we did away with the bulk of these provisions and used the savings to finance a lower rate, we would see more economic growth. Getting rid of all of these and using the revenue generated to offset reductions in the corporate tax rate would allow Congress to cut the corporate tax rate from the current 35 percent (the highest in the Organisation for Economic Co-operation and Development) to around 25 percent, which is what House Ways and Means Committee Chairman Dave Camp, R-Mich., has been promising the business community.

The problem arises that some those provisions have ardent defenders both inside and outside of Congress—most notably the Research & Experimentation Tax Credit, as well as provisions for bonus or “accelerated” depreciation, which lessens the cost of new investment in plant and equipment. Their constituencies include Silicon Valley and domestic manufacturers, who spend a great deal of money on capital investment. Eliminating these provisions in the context of a corporate tax reform that lowered rates across the board could result in a net tax increase for manufacturing and technology companies and a net reduction for investment banks, which may be a political impossibility.

If these two provisions remained in the tax code, then reaching a revenue-neutral 25 percent corporate rate would no longer be attainable. Even 30 percent might be difficult to deliver.

It may be possible to come up with $2 or $3 trillion of savings from reducing deductions in the personal tax code and use some of that revenue to finance a move to a 25 percent corporate rate. But any attempt to do so would easily be blown up by any member who points out the proposal would raise taxes on individuals to reduce taxes on corporations. No matter how patiently members explain to their constituencies that a lower corporate income tax would create jobs while boosting incomes, or that workers and consumers pay a portion of it, that isn’t going to fly.

So that leaves us with a corporate tax rate well above what the business community will swallow, and a dearth of ways to further reduce the rate.

Enter the carbon tax. Besides its intended purpose of reducing carbon emissions, it is politically advantageous, in that it is a tax that is relatively hidden. If phased in over a decade, the annual increase in gas prices that would result would be less than the typical annual fluctuations we already observe. And its other manifestations are also somewhat less than obvious—power bills will go up, but they’ve been inexorably increasing since time immemorial, even in places that get most of their power via natural gas.

From the corporate side, it does hit manufacturing harder than service companies, but it would be a small price most manufacturers would gladly be willing to pay for the preservation and improvement of accelerated depreciation and the R&E credit.

Some portions of the left may object that the carbon tax is not particularly progressive tax. But the inevitable result of any personal tax reform will be a marked increase in progressivity, and it’s hard to see progressives blowing up a chance at a carbon tax for that reason.

The historic Republican objection to dealing with climate change remains strong, but it is beginning to weaken—along with its opposition to both gay marriage and immigration reform, three issues that repel young people from the party. For a strong majority of young Americans, combating climate change and accepting gay marriage are non-negotiable positions for a politician to earn their support. While that may not be true in very conservative districts, Republicans with broader ambitions or who represent swing districts know they must escape party orthodoxy on these issues as soon as possible.

It is also an especially propitious time to think about a carbon tax. China’s recently announced plans to adopt a carbon tax renders moot the last legitimate excuse for ignoring climate change and provides an ostensible reason for Republicans to pivot on the issue.

The recent collapse of carbon prices in Europe—and the European Union’s inability to act in concert to fix it—means imposing a carbon tax in the United States ultimately would result in carbon reductions in Europe as well. In short, the global reduction in carbon emissions from the imposition of a U.S. carbon tax may be bigger now than at any other time over the last decade.

The odds are still long that we adopt a carbon tax. But the odds are equally long that some sort of comprehensive income tax goes through, as well. For the moment, their fates may be tied together.

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