The Biden administration has set ambitious goals to decrease US carbon emissions. Starting in 2022, the Inflation Reduction Act granted clean energy tax credits to businesses in hopes of encouraging a greener economy.
Kyle and Shuting Pomerleau see a carbon tax as a superior approach. To offset any regressive effects, they propose a revenue swap, using the income from the tax to directly finance an expanded child tax credit. Today on Political Economy, I talk to the Pomerleaus about their innovative policy proposal, and why a carbon tax might be a powerful, multifaceted solution.
Shuting Pomerleau is the deputy director of climate policy at the Niskanen Center. She has previously worked at the Cato Institute and the American Council on Renewable Energy.
Kyle Pomerleau is a senior fellow at AEI, where he studies federal tax policy. He was previously chief economist and vice president of economic analysis at the Tax Foundation.
What follows is a lightly edited transcript of our conversation. You can download the episode here, and don’t forget to subscribe to my podcast on iTunes or Stitcher. Tell your friends, leave a review.
Pethokoukis: Kyle and Shuting, welcome to the podcast.
Shuting Pomerleau: Thank you for having me.
Kyle Pomerleau: Thank you.
Is the point of this proposal, is it to promote the child tax credit and find a way to pay for it, or is the point of this to pass a carbon tax and slap a child tax credit on to kind of put a little sugar to help the medicine, help the tax, go down? Which way are you coming at this from, or is it more you’re coming at it from both sides simultaneously?
Kyle: I think what motivated this proposal, or this paper, was a couple things: So first is that, when there was a discussion of the expansion of the child tax credit, I think it was entirely divorced from the reality that you need to pay for government spending. So if you’re going to expand spending by $100 billion dollars a year, that needs to come with tax increases, and there are a whole lot of ways to do that, and we thought, well, what would be a good contribution to this debate? Well, what if we paired an expansion of this credit with a broad-based tax such as the carbon tax? From there we were able to show what we thought were the true trade-offs of such a policy. You can say a lot about the effects of the child tax credit on poverty, household wellbeing, work incentives in isolation, but that’s only half the story, you also then need to pair it with what the taxes would be, and what the taxes would have on poverty, household wellbeing, and work incentives.
So these are two policies that, of all else equal, you both think are good ideas.
Kyle: It depends, and you can talk about the carbon tax, and I’ll talk about the child tax credit.
The example I think of, it’s like peanut butter and chocolate, two great tastes that go great together, is that what it is?
Kyle: I think that, in the context of tax policy, the child tax credit, for the longest time, prior to the Tax Cuts and Jobs Act, was seen more of a middle-income support, and it was meant to offset maybe the decline in the value of the personal exemption that occurred over a number of years, and over time, the credit has expanded. In the Tax Cuts and Jobs Act, the expansion there was meant as a replacement for the personal exemption. So is expanding the child tax credit a good idea? Well, it depends on the context of the rest of tax reform.
Shuting: Yeah, I would add that I would think of this as a policy analysis exercise. Ultimately, it’s up to the democratic process, it’s up to politicians, whether they have the willingness to gather enough support for this to go. The major goal of this report is to really look at, if, miraculously, we have a carbon ta in the economy to incentivize fast and wide decarbonization, there’s a big pot of money, how can we use the revenue? And, historically, economists, tax policy and fiscal policy experts have looked at different ways of utilizing the revenue, for example, giving rebates to households, cutting corporate income taxes or individual income taxes. The goal of that is to mitigate the regressive impact of a carbon tax, and we thought it would be interesting to look at, what if we pair it with a tax policy of a child tax credit and look at what the distributional outcome could be if we used the revenue to fund the child tax credit.
So one function of this exercise, as you mentioned, is highlighting trade-offs. Obviously, we hear a lot of policy ideas, people who promote ideas don’t like talking about the trade-offs of those ideas, they just like talking about the primary thing that idea is supposed to do, or the upside, and they won’t talk about what are the downsides, whether those downsides are paying for it, or whether those downsides are distributional. So you talk about two policies that get talked about—well, I’m not sure how much they’re talking about carbon tax, economists like talking about a carbon tax, but certainly a child tax credit is a policy that is in the general conversation; so, to me, the fact that that’s something people are talking about, to me makes this more than just kind of an instructional thought experiment, but, hopefully, get people thinking about how to pay for something, and what is an efficient way of paying for it. Because a carbon tax is also a kind of a consumption tax, and generally, economists tend to like consumption taxes, right?
Kyle: Right, and I think it has broader implications for policy debates outside of just the child tax credit and the carbon tax. Say we’re facing a fiscal cliff in 2025 with the expiration of the individual provisions of the Tax Cuts and Jobs Act. There’s going to be a big push to extend those, but what are the costs of that? What are the benefits of that? And you also ultimately need to think of ways to finance those expansions. The federal government has spending priorities it needs to accomplish, but if federal revenues are too low to do that because of income tax cuts, revenue has to come from somewhere or spending needs to come down to match revenue at some point.
Why do economists get excited about the notion of a carbon tax? Why is that a policy that always comes up as an efficient policy if you’re concerned about climate change? What is the selling point, the elevator pitch, for a carbon tax, generally?
Shuting: That’s an excellent question, I think generally economists are very supportive of a carbon tax as a quote-unquote “stick approach,” as opposed to a carrot, like the expensive provisions, clean energy credits in the Inflation Reduction Act [IRA].
Right now we’re all carrot. We seem to be doing a lot of carrots.
Shuting: Yes, a lot of it, and I think one major reason that stands out is the efficiency argument, that it’s efficiently incentivizing consumers and businesses to find the most flexible and least-costly ways to decarbonize. You just have to determine the price per ton of emissions and you’re pricing emissions directly. It’s up to the businesses to find the easiest and least costly way to decarbonize, as opposed to the clean energy tax credits, in the Inflation Reduction Act. A lot of work needs to be done on the regulator side. It might need to be done sector by sector, the technology types that are used to requalify for certain tax credits, or to look at the performance standards that would incentivize businesses to improve their decarbonizaion efforts. So it’s much more direct than tax credits, than carrots. Also, it can move really fast economy-wide. Compared to the tax credits, you really have to do it sector by sector and be very prescriptive.
With the passage of the Inflation Reduction Act, a lot of time was spent figuring out which technologies, are they going to favor these technologies, is this tax credit going to be technology-neutral, which lends it to the criticism that, ultimately, you’re having legislators, and staffers, and bureaucrats figuring out which are the “good” technologies, which are the “bad” technologies, where, under this system, it’s “may the most efficient technological fix win.”
Shuting: You hit a really, really important point, Jim. The technology-neutral is a key part of why a lot of economists are so fond of a carbon tax, as opposed to tax credits, because when you’re pricing per ton of emissions directly, regardless of the way—it could be hydrogen, it could carbon capture, it could nuclear, as long as you get there, it makes sense for businesses’ long-term investment plan, you can do it; versus the tax credits, it’s basically regulators cherry picking winners and losers, deciding, “Oh, this technology, we think it’s more promising than the other ones.
How big is the carbon tax that you guys are talking about here?
Shuting: $35 per ton.
And you have a number of child tax credit options?
Kyle: Yeah, it’s a number of options, those options are loosely based on proposals that have been put forth over the last couple of years, and those roughly offset one another, so this is a budget-neutral proposal where the government neither increases nor decreases the budget deficit.
Of course, if I were a little cynical or skeptical, I’d see, well, we’re starting off at 35, and we’re going to start off at 35, we’re going to pay for this, but maybe tomorrow it will be 40, or 50, and then that would be more revenue that I guess you could use for whatever, you could use it to pay for a tax cut, you could use it to reduce the deficit. It would be your expectation that whatever it starts at, it’s not going to end at that.
Kyle: Sometimes by design, so a lot of carbon tax proposals, they start at a certain rate, and then they ramp up. One, they need to keep up with inflation, so they clearly need to increase the dollar value there, but there’s also an argument in favor of increasing the real tax rate over time, as well, get the economy moving faster towards decarbonization over time. Now, from a scoring perspective, or a revenue perspective, those are somewhat offsetting: The rate’s going up, but carbon emissions are going down, so one thing that’s not discussed very much in this paper is that, what do you do in the long run? So carbon tax is great for a short-run or medium-term increase in federal revenue that could be used for all sorts of good things, including tax cuts, but in the long run, that source of revenue, by design, dries up.
And we’ll worry about that when we get to it? What’s the long run here? Let me phrase it like this: What is the relationship, to the best we know, between a carbon tax and the goal of cutting emissions? How big does the carbon tax have to be to get emissions down by 25 percent, or 50 percent by a certain year, or whatever the current Biden administration target is?
Shuting: I think that’s a great question. There have been some studies previously that came out before the IRA passed. So I think, after the IRA passed, you would have to look at whether you’re repealing all of the IRA tax credits and then put in place a carbon tax instead, or are you putting a carbon tax on top of it? For our study, we’re looking at on top of the IRA tax credit. If we get a $35 per ton of carbon tax, what would that be?
On top of the IRA subsidies?
Kyle: Yes.
That’s kind of like a CBO [Congressional Budget Office] thing, where you assume the current policy stays in place.
Kyle: Right, because there’s a whole host of other options. You can replace existing regulations, replace existing credits, and those have different implications for both the carbon tax, but also the rest of the federal budget.
So if you were to get rid of all the IRA subsidies, that carbon tax would have to be significantly . . .
Shuting: Higher.
Kyle: It would need to be higher in order to get the same amount of decarbonization
Beyond just the exercise, that, to me, doesn’t seem like a crazy scenario, because there might be some assumption that if Republicans get in power, they’re going to be very eager to get rid of these subsidies, but a lot of this clean energy stuff—the manufacturing, the batteries, the cars—that’s happening in states that are red states. I realize this isn’t a political exercise, but, to me, it wouldn’t be crazy that the IRA, to some great degree, stays in place. I mean, how long have Republicans been talking about getting rid of the Affordable Care Act? Still there. I think it’s, to me, more likely IRA ends up being more like the Affordable Care Act rather than something. . . or do you disagree?
Kyle: I don’t necessarily disagree.
You look skeptical, Kyle. You look very skeptical of my thesis.
Kyle: On the other hand, Republicans have a tax bill coming up. They’re facing potentially a $5 trillion tax bill, that’s how much they would increase debt over a 10-year period, and those IRA credits, depending on how you score them, repealing all of them could raise close to a trillion dollars over the same period. So if you’re thinking from a budgeting perspective and putting together a tax bill, it’s a lot of money there that could be used for priorities that are higher on the list for Republicans.
Or they could adopt the “why not both.” Right? We’ll vote for your thing, we’ll vote for this centerpiece of the Biden administration. I think there’s a meme like that, like the “why not both” meme, and given the lack of interest, it seems like, in the parties in reducing the deficit, that’s not the craziest option.
Kyle: Yes. There is a question whether this time around there’ll be more consideration to debts and deficits. Back in ’17, when they initially passed the Tax Cuts and Jobs Act, the 10-year treasury was closer to 2.5 or 3 percent; now we are north of that, so the cost of additional debt is higher than it was in the past, so additional borrowing more quickly crowds out other government spending. Lawmakers, I think, they’re going to need to pay attention to that, and we’ll see if that translates into a different approach when they get to putting a tax bill together.
Shuting: I think I’m more with Jim on this, agreeing with his thesis. In my opinion, I think it’s probably unlikely that Republicans will be able to repeal all of the clean energy tax credits. I mean, that’s the way it goes with tax credits, once people or companies are receiving the money, receiving the checks, it’s hard to get rid of them. And then, you mentioned that a lot of the red states are benefitting from the tax credits: They’re seeing jobs, they’re seeing manufacturing investment. It might be difficult for the politicians to go back to their constituents and say, “Hey, want to take back what we gave you.”
I recall one time I was invited to a group that was interested in a carbon tax, I may have written something positive, and they said, “Why don’t you come to our meeting?” and the meeting was in a secretive location, in a basement somewhere, behind a loose brick, and you could sneak in there. It was not a very popular policy.
Where is the popularity level of the carbon tax? I might assume that it’s very unpopular, going nowhere. For people who do not like the Inflation Reduction Act, for people who think it looks like central planning, has that lent any new energy? I mean, I hope this proposal adds some new energy, but even beyond that, has there been any new interest in a carbon tax from people who are concerned about the climate, and something that’s not the Inflation Reduction Act?
Shuting: Yes, definitely. I’ve heard a lot from representatives, specifically from the business community, corporate executives, saying that they really support a carbon tax because of the policy certainty. Once you have a carbon tax passed by Congress, presumably it’s going to be 10 years, and they know, per ton of emissions, the price, and they can incorporate that into the investment long-term planning, as opposed to all of the clean energy tax credits that’s in the IRA. The domestic content rules have drawn a lot of criticism from both folks at home and abroad, and there’s a lot of uncertainties of when consumers or businesses would be able to qualify to use those tax credits, when they would be able to distribute the money investments locally to have those infrastructure in place, or development of certain clean energy technology. So there’s definitely interest in carbon tax; I would caveat, though, carbon tax continues to be politically challenging.
Interest coming from a low level, interest is up by 300 percent, but it’s . . . it seems to have a little bit of. . . the kids say, a little bit of “rizz,” a little bit of pizazz about it going on. So what is the reaction you’ve gotten? People have said, “This is a crazy idea,” or they’re like, “Oh, finally someone’s maybe figured out how to kind of crack the puzzle?”
Kyle: Going back to your previous question a little bit, I think there’s also, on the legislative side, if you broaden out and talk about it more as carbon pricing, there seems to be some interest there. Now, I’ll caveat this by saying that a lot of the proposals aren’t necessarily well-structured. I think there’s also a tendency for a lot of people that are pro-carbon pricing in general to latch on to other policy fads that are going on; for example, trade protectionism. There’s a movement to enact carbon pricing at the border, so just enacting a price on carbon just on imports, so latching on to this push from the Trump people that we should have taxes on imports; well, why not just tax the carbon content of imports? Both Republicans and Democrats have been pushing proposals like that. There seems to be legislative interest in pricing in general, and their hearts are in the right place, but the policy design . . . a little iffy.
So the reaction that you guys have been getting, I assume there’s been some?
Kyle: There has been some. Some of it’s a traditional reaction to carbon taxation.
Is it like a “usual suspects,” or has any of the reaction said, “Oh, that’s not the kind of the reaction I normally expect from that person or that group?”
Kyle: I think it’s more of your usual reactions. I think people, in general, are very set in their opinions on the carbon tax. You’re either for it, or very strongly against it.
The point, as you see it, of an expansion of a child tax credit is to do what, exactly? Is it to help middle class families? Is it to help reduce poverty? Is it to provide an incentive to have more kids? As you’re seeing it, why would this be a good idea, or what is the point of it?
Kyle: I think there are two strong arguments in favor of having a child tax credit or expanding a child tax credit. One is a traditional tax policy justification that, if you have a system where your taxation is based on the household unit, you need some mechanism to adjust for the size of the household. So if you have two households both earning $40,000 a year and one is just a single individual and the other is a family of four, your tax system could adjust for how far that $40,000 can go. $40,000 doesn’t go as far for the household of four, so a child tax credit in the current tax code adjusts, in a way, for the number of children in the household.
The second justification is just the traditional alleviation of poverty, and I’d say this is the weaker of the two justifications that I’m putting forth, but this is a way that the current federal tax and spending system gets some money into the hands of low-income households.
The IRS [Internal Revenue Service], for better or for worse, has been tasked with doing all sorts of things. One of its tasks is to do a little bit of social policy through transferring money to low-income households through the refundable portion of the child tax credit. In an ideal world, maybe this would be under the purview of the Social Security Administration or some other administration, but in the US system, the tax code takes care of some of that. And this is similar to how other countries throughout the world transfer some money to low-income households with children, is through child benefits. The other justifications I’m less sold on. I think that, at the margin, an additional $2,000 or $3,000 a year is not going to tip in favor of having one more child. I think that, on the financial side, you’d have to transfer a whole lot more money to create an additional incentive there.
One more thing on the carbon tax: How is this issue discussed in other rich countries right now, if at all?
Shuting: I would say, in terms of carbon pricing policy, the United States seems to be an outlier compared to other OECD [Organisation for Economic Co-operation and Development] countries. It seems to be strongly favoring a carrot-centered approach, as opposed to pricing emissions. The EU is really leading the carbon pricing. They will start to implement their carbon border adjustment from 2026. Now, by carbon border adjustment, this policy means they will slap an import tax on certain imported goods under six sectors, mirroring what domestic producers are subject to under the emissions training system, and the goal is to alleviate the economic and competitive concerns, use the carbon border adjustment under the EU ETS [European Union Emissions Trading System] to replace the current free allowances that they’re giving to certain carbon-intensive industries, so they’re kind of phasing in the EU CBAM [Carbon Border Adjustment Mechanism] and phasing out the free allowances.
In some of my previous analysis, I point out that’s not a standard carbon border adjustment, it’s just an import tariff because it doesn’t have an export rebate component. If regulators or governments are really concerned about their domestic producers’ competitiveness against foreign producers—in the climate policy world, we call it “carbon leakage”—it’s saying that producers have a tendency to move their production facilities to another jurisdiction with a more lax environmental standard. The carbon leakage could happen in both ways: It happens in imports; it also happens in exports. That’s why you need to have export rebates in carbon border adjustments so that you’re really taxing the carbon content based on consumption of the goods and services, not based on the production. With an import tax and export rebate, producers will be indifferent to where their production facilities are located, as long as they want to sell to consumers in the EU.
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