Would a Carbon Tax and Corporate Tax Reform Taste Great Together?

By :: February 11th, 2013

Two great tastes often taste great together. Chocolate and peanut butter. Oreos and milk. Popcorn and butter. Could the same be true of carbon taxes and corporate tax reform? Done right, each could be flavorful. But would they be even tastier together?

My Tax Policy Center colleague Eric Toder and I explore that question in a new paper. We find that using a carbon tax to help pay for corporate tax reform has several attractions and one big drawback. A well-designed tax swap could combat climate change, make our corporate tax system more competitive, and reduce long-term deficits, but would be quite regressive, increasing tax burdens on most Americans while cutting them on those with the highest incomes.

Let's start with the good news. Putting a price on carbon dioxide and other greenhouse gases would be an efficient way to reduce future emissions, encourage greener technologies, and reduce future risks of climate change. A carbon tax would make real the adage that you should tax things that you don't want--like pollution--rather than things you do.

A carbon tax could also raise substantial revenue. One common proposal, a $20 per ton tax rising at 5.6 percent annually, would raise north of $1 trillion over ten years. That money could help reduce future deficits, pay for offsetting tax cuts, or a combination of both.

Which brings us to corporate reform. Just about everyone wants to cut America's corporate tax rate, now the highest in the developed world. President Obama wants to lower the federal rate from 35 percent to 28 percent. Many Republicans, including House Ways and Means Chairman Dave Camp, hope to get down to 25 percent or even lower. But they are all having a hard time finding a way to pay for such rate cuts. It's easy to talk about closing "loopholes" and "special interest" tax breaks in the abstract, but in practice it's difficult to cut back enough to make such large rate cuts.

Enter the carbon tax. A reasonable levy could easily pay for cutting the corporate tax rate to 28 percent or even lower. In fact, such rate cuts would require only a fraction of carbon revenues if lawmakers also identify some significant tax breaks to go after. The remaining carbon revenues could then finance deficit reduction or other policies.

Cutting the corporate tax rate would boost the U.S. economy, reduce many distortions in our existing code, and weaken multinationals’ incentives to play accounting games to avoid U.S. taxes. The resulting economic gains might even be enough to offset the economic costs of the carbon tax. That's a tasty recipe.

Except for one missing ingredient: fairness. Like other consumption taxes, a carbon tax would fall disproportionately on low-income families. Cutting corporate income taxes, on the other hand, would disproportionately benefit those with higher incomes. A carbon-for-corporate tax swap would thus be quite regressive.

Eric and I used TPC's tax model to measure this regressivity for a stylized carbon tax that would raise revenues equal to 1 percent of American's pre-tax income. As illustrated by the light blue bars in the chart below, that carbon tax would boost taxes by more than 1 percent of pre-tax income for households in the bottom four income quintiles—1.8 percent, for example, in the lowest fifth of the income distribution. The increase would be smaller at higher incomes. Folks with the highest incomes would bear a significantly lower relative burden—just 0.75 percent of their pre-tax income, for the top 20 percent of households.


Pairing a carbon tax with an offsetting cut in corporate taxes would make things more regressive (dark blue bars). Lower corporate rates would benefit taxpayers at all income levels, workers and investors alike. But the biggest savings would go to high-income households. Cutting corporate taxes offsets less than a third of carbon tax burden for households in the first three income quintiles, but more than offsets the carbon tax burden in the highest-income group. The net effect would be a tax cut for high-income taxpayers, and tax increases for everyone else.

That regressivity is a serious concern. A carbon-for-corporate tax swap may be a recipe for environmental and economic improvement, but it isn't a complete one. As Eric and I discuss in the paper, lawmakers should therefore consider other policy ingredients—per capita credits, for example—that could help protect low-income households and potentially make a carbon-for-corporate tax swap a more balanced policy option.



  1. Walter Cohn  ::  2:09 pm on February 11th, 2013:

    An alternative approach to offsetting the regressive nature of a carbon tax would be to use part of the incremental revenues to reduce payroll taxes. I suggest part, rather than all, since some of the revenue may have to be used to reduce corporate taxes and reduce the deficit in order to garner support for a carbon tax.

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  3. Michael Bindner  ::  5:57 pm on February 12th, 2013:

    I have a different swap that I have been asking you to consider for a while now. Swapping the personal income tax at lower levels for a Net Business Receipts Tax with VAT-like functions and social offsets. The social offsets would include a robust refundable child tax credit (though basic wages would be taxable), health care insurance or costs (including mental health care provided in lieu of corrections), Social Security, education costs provided at all levels (elementary, secondary, post-secondary, remedial (again, with a stipend) and vocational. Indeed, the only thing not provided as a tax benefit would be defense, which would be taxed via a VAT with no exemptions (except at the border). Only high tax individuals would pay income tax in order to pay down the debt and fund foreign wars and operations. I expect the distribution on this would be more than fair, would indeed end the argument on the need to raise taxes on the rich and would result in the kind of social service sector that liberals can only dream of now. Whether it affects the environment or not is up in the air. China is a bigger player on that scale anyhow. The Administration is already going on an enforcement track rather than the economist favored taxation track – the only way back on an economics track is if the GOP realizes that carbon-producing interests are in real danger under the new regime.