How a $20 carbon tax could cut America’s deficit in half

Climate Progress

Over the last year, there’s been increasing talk in Washington political circles – including conservative ones – about how to use a carbon tax as a deficit reduction tool. However, with an election season in full swing and a large number of Congressional Republicans campaigning against climate action, the current likelihood of getting a price on carbon is officially zero.

In theory, if Obama gets re-elected in November, there could be an opportunity to pass a carbon tax as part of a deficit reduction plan. With Bush-era tax cuts set to expire and Republicans talking a big fiscal game, Obama might have some leverage to play hardball with Congress and push for carbon pricing as part of a larger package.

It’s a long shot. But a new report from the Congressional Research Service released today illustrates why it’s such an enticing prospect. According to the CRS analysis, a modest carbon tax of $20 per ton that rises 5.6 percent annually could cut the projected 10-year deficit by 50 percent — from $2.3 trillion down to $1.1 trillion.

The CRS report models two scenarios — one based on current law (the blue bar below) and one based on an alternative scenario (gray bar below) that assumes a much greater increase in the deficit due to extension of tax cuts and the avoidance of automatic spending cuts through the Budget Control Act. While the two scenarios vary widely, they show that a price on carbon starting in 2013 could fill in a sizable chunk of the federal budget gap:

Here’s how CRS explained the two scenarios:

The possible contribution of a carbon tax to deficit reduction would depend on the magnitude and scope of the carbon tax, various market factors and assumptions about the size of the deficit. In August 2012, CBO released updated budget projections for fiscal years 2012 to 2022. Under current law, CBO estimated the 10-year budget deficit at $2.3 trillion, or 1.1% of GDP. However, using an alternative fiscal scenario, CBO’s projected a larger deficit—$10.0 trillion, or 4.9% of GDP.

Enacting the carbon tax options discussed in the previous section could reduce future budget deficits. As illustrated in Figure 4, a $20/mtCO2 price on carbon (increasing by 5.6% annually) would have a considerable impact on budget deficits using CBO’s August 2012 baseline projection.

• The 10-year budget deficit could be reduced from $2.3 trillion to $1.1 trillion, or from 1.1% to 0.5% of GDP.
• Overall, a $20/mtCO2 price on carbon would reduce the 10-year budget deficit by more than 50%.

• Under CBO’s alternative fiscal scenario, the same carbon tax would have a smaller impact on budget deficits.
• The deficit would be reduced from $10.0 trillion to $8.8 trillion, or from 4.9% to 4.4% of GDP.
• Overall, a $20/mtCO2 price on carbon would reduce the 10-year budget deficit by about 12%.

In the first year alone, CRS estimates that a $20 per ton carbon tax could generate $90 billion.

But here’s the catch: As the analysis points out, not all revenues from a carbon tax would go toward deficit reduction. Some revenues might need to be “recycled” back to groups of people that would disproportionately bear the costs of a carbon price; some might be offset by lowering the payroll tax; some might go back to industry to help companies invest in new technologies and make a low-carbon transition; and some might go into government clean energy deployment programs.

There are many possibilities that policymakers and economists need to consider. So simply saying that a carbon tax would reduce the deficit by specific amount doesn’t show the full picture. Still, this report offers a framework showing that a modest price on global warming pollution would be a significant revenue generator — and thus a possible bargaining chip in future conversations on deficit reduction.

The political climate for a carbon tax is not good. But polls show that Americans support such a policy by a fairly wide margin. According to a George Mason University poll from April, 61 percent of Americans say they would be more likely to vote for a candidate who supports a “revenue neutral” tax on fossil fuels that would be used to reduce federal income taxes. That’s not the same as reducing the deficit, but it shows support for using a carbon tax to make changes to fiscal policy.

That same poll showed that 75 of Americans broadly support regulating carbon dioxide as a pollutant.