January 14, 2009

Revenue Recycling

Word seems to be coming down the pike that comprehensive action on climate change is going to be delayed, possibly to next year: Nancy Pelosi has gone on record saying a cap-and-trade bill is unlikely to be passed in 2009, and incoming OMB director Peter Orszag has suggested that health care is the Obama administration's top agenda item, rather than energy and climate change, as Obama had said earlier.

I hope that's not the case -- though getting health care reform passed would a fantastic development. But further delay on mitigation, the global economic downturn notwithstanding, just makes it harder to do anything meaningful to reduce carbon emissions and the dangerous increases in global average temperatures that they entail. Moreover, as John Whitehead recently noted, now would actually be a good time to start instituting a cap-and-trade system or a carbon tax, as a way to begin shifting incentives away from fossil fuel consumption, if only incrementally.

I don't, however, agree with this comment by Whitehead (emphasis added):
One reason why it might be difficult to enact climate legislation during 2009 is that raising broad-based taxes during a recession is not a great idea (see Keynes). However, one of the features of carbon taxes and cap-and-trade with auctioned permits is that revenue is raised for the government in addition to achieving reductions in pollution. The typical next line in this story is that these new revenues could be used to offset cuts in income, capital gains, business and other distorting taxes while keeping the government budget situation at least as sound as it was when we started. I've argued in the past that revenue recycling is a separate policy and should not be paired with a carbon tax in the minds of decision makers (since this second policy might not take shape). But during a recession we're already talking about cutting taxes. Indeed, during the 2009 recession we're talking about cutting taxes and increasing government spending so that the budget deficit is bigger than ever (as a percentage of GDP) while the budget debt is as big as ever. A new revenue source would help offset deficit risks.
Carbon pricing and revenue recycling may be separate policies conceptually, but with respect to building legitimacy for carbon regulation, I think they need to be paired. Assuming Congress creates a cap-and-trade system that auctions off its permits (if they're smart -- I know, I know), what happens to the money raised is going to be a big question; likewise with a carbon tax. And in a time when how federal money is spent is under intense scrutiny, we had better make sure that it's spent in a way that 1) isn't wasteful, and 2) helps compensate low-income households for any potential energy price increases from carbon pricing. If the majority of Americans perceive climate change regulations as merely jacking up their energy bills with no tangible benefits, even something benign like increased funding for renewable energy deployment, that could undermine the long-term viability of efforts to reduce carbon emissions and bring us back from the brink of runaway climate change.

This is why I'm coming around a bit to the cap-and-dividend proposal that's garnered some endorsements lately, including Ezra Klein and James Hansen. True, funding for things like renewables and mass transit is really important, and there's reason to believe that a carbon permit auction or carbon tax could raise enough revenue to offset most or all energy price increases for the poor and middle class, with enough left over for energy R&D and the like. But I think the value of having a tangible return on investment in a stable climate -- which is essentially what cap-and-dividend is -- shouldn't be underestimated. Getting Americans to accept tax increases is a fairly difficult exercise, particularly on energy; a carbon dividend would make it clear that the purpose of carbon emissions regulation is not to raise taxes, but to shift economic activity away from fossil fuel consumption and toward more sustainable purposes.

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