Hidden benefits and dangers of carbon tax

Abstract

Many scholars argue that revenue from carbon taxes should be used to replace other taxes, such as taxes on capital or labor, in order to minimize economic damage or compensate for the regressive nature of carbon tax. Advocates of this approach argue that the carbon tax could produce a “double dividend,” reducing emissions while also increasing GDP by allowing other taxes to be lowered. This paper suggests caution before adopting this approach, for two reasons. First, the scholarly literature systematically understates the benefits of carbon taxes, and overstates their costs, by simply ignoring the possible environmental benefits of carbon taxes. The result is a one-sided scholarship that exaggerates the damage from carbon taxes and should be understood as providing a lower bound for the benefits of the tax, not a rigorous guide to policy. Second, carbon taxes, unlike other taxes, will produce less revenue as technologies improve and cleaner-burning fuels develop. Thus, if carbon taxes replace other taxes, over time the tax base of the state will wither, and the programs those taxes pay for will be threatened. This paper elaborates these claims and then discusses carbon tax policy designs that would take both points into consideration.