Beware the trap of paying for Climate Infrastructure with Corporate Taxes
But the politics are at odds with the economics of the issue. The conventional wisdom of many climate-hawk politicians involves taxing corporations or high-income Americans to pay for climate initiatives. This approach is evidenced in President Biden’s initial infrastructure proposals, which included corporate income tax hikes and more climate spending. Unfortunately, in this kind of armchair economics, policymakers should understand that there may be unintended consequences for both the economy and the environment.
The problem lies in the failure to appreciate the role of the private sector in the development and deployment of relevant clean energy technologies. Recent research from the R Street Institute highlighted that private sector research and development (R&D) for energy and environment outdoes public spending by about seven to one. Beyond that, the research noted that changes from the 2017 tax reform, which lowered corporate tax rates and allowed for full expensing of R&D costs, are the most likely explanation for a 12 percent increase in annual private sector energy and environment R&D—more than double the previous largest single-year increase. The prior 5 years had an average annual increase of a mere 0.5 percent.
Could this same outcome be achieved by taxing corporations and increased spending on environmental priorities? Probably not. It is an unfortunate and pervasive myth among politicians that taxing corporations, or other activities traditionally associated with high-income Americans, creates a tax treatment that is isolated to the point of incidence. This ignores that, whenever possible, taxed entities will try to pass on or diminish their tax liabilities. It is not corporate CEOs that pay corporate income taxes, but rather the investors, employees and customers of corporations. The way a tax manifests throughout the economy beyond its point of incidence should always be considered, and the recognition that taxes on corporations could be impacting productivity growth and wages was the reason that President Barack Obama proposed cutting corporate taxes in 2015.
Economic sectors tied to clean energy or environmental endeavors are no different than the rest of the economy; pushing for a tax code that weakens the incentives to work and invest in the United States will harm productivity even in the very economic sectors that policymakers are trying to buoy. The retort, though, is always that public spending can make up the difference, redirecting economic resources from one economic sector to the politically preferred initiatives. But again, such arguments miss the mark on the economics for two reasons.
The first is that the private and public sectors fulfill fundamentally different roles in the research, development and deployment of clean energy technology. The ideal role of the public sector is to fund opportunities that have scientific or economic merit but are not easily funded by the private sector. For example, new technologies that may not be profitable for decades do not make for attractive investment opportunities. By contrast, the private sector prioritizes opportunities that are profitable today, and that immediate profit motive drives the private sector to reduce costs and expand market share. This makes the private sector better suited to deploy mature technology than government spending that bears no risk of failure.
The second is the global nature of environmental challenges like climate change. Public spending to subsidize or promote clean energy can stimulate emission abatement and clean energy deployment through subsidies so long as healthy and wealthy economic sectors can be taxed to pay for said subsidies. In developing nations with rising greenhouse gas emissions, it is the unsubsidized cost of technology that matters. Popularizing green infrastructure hinges on cost reduction and global, open markets. The free market, with its capacity for competition and incentives for private actors to risk their capital on innovation, promotes technological transition in a way that cannot be replicated by government action.
These ideas are buttressed by empirical analysis. A recent comparison of environmental quality relative to economic freedom has shown that free market economies perform twice as well in environmental sectors than their centrally planned counterparts. Such findings are consistent with past analysis, even back in the early 1990s.
The lesson to be had is that policies which improve economic outcomes can also support environmental outcomes, and encouraging environmental progress is all the more challenging with a weaker economy. Policymakers should avoid the siren’s call of raising taxes on politically unpopular entities to pay for favored initiatives, and instead think holistically about the outcomes that will ensue from their policies.