A tax on carbon could be the answer to corporate tax reform

Tax reform may be the last big initiative we will see out of Washington this year. Republican leaders have laid out an ambitious mission to make taxes “simpler, fairer, and lower” for American families, while also lowering tax burdens on small businesses and corporations so they can be more competitive. On the latter front, as the chief negotiators recently outlined in a joint statement, “The goal is a plan that reduces tax rates as much as possible, allows unprecedented capital expensing, places a priority on permanence, and creates a system that encourages American companies to bring back jobs and profits trapped overseas.”

Yet as they embark on this project in earnest, Republican leaders have already made an important decision that will make it harder to pay for corporate tax reform. They abandoned a plan to levy a so-called border adjustment tax (BAT) on imports. This had proved to be controversial, but it would have raised roughly $1 trillion over 10 years while arguably spurring domestic production and jobs. Tax negotiators cited the “many unknowns associated with it and have decided to set this policy aside in order to advance tax reform.”

This creates a quandary. Congress must find an alternative source of funding if it is going to ensure that tax reform significantly reduces America’s 35 percent corporate tax rate (one of the world’s highest) and strengthens key incentives such as expensing of investments in capital equipment and the research and development tax credit (which drive innovation, productivity, and competitiveness) without adding to the deficit.

{mosads}Luckily, there is an alternative that replaces the revenue a BAT would have raised and makes for great policy: According to a recent report by the Congressional Budget Office, imposing a tax of $25 per metric ton on most greenhouse gas emissions would raise almost $1 trillion over 10 years, with the tax rate increasing two percentage points faster than the rate of inflation.

A carbon tax has at least three major advantages in addition to the revenue it would raise to pay for corporate tax reform. First, it taxes activity that is known to impose large social costs. Regardless of how much of the climate change problem you think is due to human activity, almost no one doubts that the Earth’s atmosphere is in fact warming to our collective detriment. Moreover, carbon emissions are closely associated with emissions of fine particulates, and there is growing evidence that exposure to even small amounts of these can have serious health effects.

Second, a carbon tax could substitute for regulatory action to reduce carbon emissions. Whereas regulations take a lot of effort to put in place, impose large efficiency costs, and then remain static, a carbon tax would exert a continuous incentive to reduce emissions associated with burning fossil fuels but give industries flexibility in how to respond. A carbon tax would also help maintain U.S. leadership in the development of cleaner, more efficient sources of energy. 

Third, a carbon tax can also help restore U.S. moral leadership in the world. Over the past several years, relative economic decline, foreign adventurism, a lack of engagement, and hubris have caused both our allies and our adversaries to put less faith in what we do or say. The most relevant example is America’s recent withdrawal from the Paris agreement to control emissions.

The idea of swapping a carbon tax for cuts in the corporate rate should not be a controversial idea among conservatives. In fact, the R Street Institute, the Alliance for Market Solutions, and the American Action Forum have all proposed something similar.

Such a plan would enable the reduction of the effective tax rate for corporations, especially those that compete internationally and invest in research and high-value manufacturing. This is one of the most important policies Congress can put in place for the economy. 

A primary objection to carbon taxes, is that they are somewhat regressive, because the poor and middle class spend a higher proportion of their incomes on carbon-intensive products. But costly and complicated regulations also can be regressive. And Congress can include other policies in tax reform that would ensure progressivity while helping to pay for corporate tax reform, including taxing capital gains and dividends as normal income.

For many reasons, not least the enormous promise of new energy technology and improved efficiency, the future lies in cleaner energy. A carbon tax can accelerate that progress by spurring further innovation in energy markets. Using the proceeds to reduce corporate taxes will improve competitiveness and increase investment more broadly.

Joe Kennedy is a senior fellow at the Information Technology and Innovation Foundation (ITIF), a leading science and technology policy think tank based in Washington, D.C. He was previously the chief economist at the U.S. Department of Commerce.

The views expressed by contributors are their own and are not the views of The Hill.