Common Tragedies

Thoughts on Environmental Economics

Sure, cap and dividend. But let’s not get crazy

Posted by Rich Sweeney on June 12, 2008

Writing on Grist yesterday, cap and dividend ringleader Peter Barnes proposes a “revenue neutral” program. However, what he appears to suggest is a 100% dividend of permits, which would be far from revenue neutral for the government. That’s because after we put a price on carbon, government expenditures go up and tax revenues go down. Terry Dinan of the CBO has looked at this extensively. Here’s an excerpt from a 2003 CBO study on the burden of cap and trade,

However, recent research has demonstrated that a significant share of that revenue might be needed to offset increases in government spending and declines in tax revenues caused by the program.

Using auction revenue to offset those effects could be viewed as compensating the government, but failing to do so would require the government to raise taxes if it wanted to keep its net revenues at their baseline levels (while holding spending constant). A tax increase could boost the cost of the cap-and-trade program.

A carbon trading program would affect government outlays and tax receipts in several ways. First, it would cause the government (like other consumers) to pay higher prices for carbon-intensive goods. Second, because the payments of some government programs, such as Social Security, are indexed to changes in the overall price level, higher prices could result in greater spending on those payments. Third, a cap-and-trade program for carbon emissions would lead to a decline in economic activity and a corresponding decrease in tax collections.

Researchers estimate that together, those effects could account for more than 30 percent of the total value of allowances.

Thus, at a very minimum, a revenue neutral program would involve the government taking a 20-30% haircut. Not sure if Barnes intends these dividend to be taxable, but even that would only get us part of the way there.

As for investing in R&D and transport, I find Barnes’ comments more reasonable but equally as unhelpful. He says,

“To be sure, we’ll need public money to fight climate change. But some of that money can come from shifting current expenditures, and if we need more, we can raise and allocate it later.”

Well then. Since you put it like that.

So the main point of this post is to say now that we’re in the red zone on climate policy, let’s not lose sight of little things like the national debt and government services.

One Response to “Sure, cap and dividend. But let’s not get crazy”

  1. In my view, the dividends would be taxable as ordinary income. Thus, high income people would pay at the top marginal rate, low-income people would pay nothing, and middle-income folks would pay in between. The revenue generated from taxing the dividends would approximately offset the revenue loss that Terry Dinan anticipates.

    BTW, most economists project a slight slowing of GDP growth after carbon is capped, not a GDP decrease. If government revenues are in line with GDP, they should grow at a slightly slower rate, but not decline. Also, I would hope the government would take measure to conserve on energy – not just rely on tax increases to stay whole. It could start by cutting back on the occupation of Iraq.

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