Event Recap: Fiscal Solutions to Climate Change

On May 17, the Committee for a Responsible Federal Budget hosted an event on the "Fiscal Solutions to Climate Change." The virtual event featured a conversation between Committee president Maya MacGuineas and Senator Sheldon Whitehouse (D-RI) as well as a panel discussion. The panelists included Marc Goldwein of the Committee for a Responsible Federal Budget, Jon Huntley of the Penn Wharton Budget Model (PWBM), and Catrina Rorke of the Climate Leadership Council. 

You can find a full video of the event here or below. 

The event opened with a discussion between MacGuineas and Senator Whitehouse. MacGuineas began by asking why legislative solutions are necessary to address climate change. Senator Whitehouse noted that while carbon dioxide (CO₂) emissions have fallen nearly 20 percent since 2005, the concentration of CO₂ in the atmosphere has risen. Bringing both CO₂ emissions and concentration numbers down to safe levels will ultimately require legislative action. The conversation then pivoted to legislation Senator Whitehouse proposed: the Save Our Future Act. The bill would impose a carbon tax of $54 per ton starting in 2023 and increase the tax 6 percent annually. It would raise $2.4 trillion of new revenue over ten years. It also includes carbon dividends to American households and a carbon border adjustment for trade to ensure that companies abroad are charged the same emissions fees as U.S. companies and neither gets a competitive advantage. 

Senator Whitehouse views a carbon tax as a necessary though not sufficient solution to the climate problem. He stated that investments in areas such as nuclear power, carbon capture, green technology, and the transmission of wind and solar will also be necessary, and everything needs to be on the table. The revenue from a carbon tax could be used to pay for new climate spending, carbon dividends, or to address the nation's fiscal challenges. 

The event then moved to the panel discussion. Huntley began by talking about the Penn Wharton Budget Model's analysis of the $550 billion of climate provisions in the Build Back Better Act. PWBM took a close look at every individual proposal and matched each one to the best economic research available to determine the amount of carbon abatement from each individual policy. The analysis found a huge amount of variation amongst the effectiveness of each provision. Specifically, the policies focused on natural resource management and conservation are the most cost-effective of the legislation's approaches to reduce carbon, while the policies focused on efficiency improvements, weatherization enhancements, and electric vehicle subsidies are the least cost-effective. The analysis found that policies financed with non-distortionary fees tend to increase Gross Domestic Product (GDP) while programs that are deficit-financed tend to reduce GDP because the negative economic effects of higher government debt offset the economic benefits of the climate investments themselves. 

Rorke was asked why a carbon tax is the best path forward on climate change. She highlighted the four pillars of the Baker-Shultz Carbon Dividends plan that she works on and supports. The four pillars are a $40-per-ton carbon tax that increases every year by 5 percent, a carbon dividend, significant regulatory simplification, and a carbon border adjustment. She argued a carbon tax is the most efficient, low-cost, and fastest-acting way to cut greenhouse gas emissions; the $40-per-ton carbon tax in the Baker-Shultz plan would cut U.S. greenhouse gas emissions in half by 2035. A carbon dividend would ensure American households, particularly those at the low end of the income spectrum, are better off financially while addressing climate change. Regulatory simplification would ensure the uncertainty and unpredictability in the rulemaking process is addressed while also giving markets clarity over what they need to do to compete and win. The carbon border adjustment would allow the U.S. to consider the international dimension and its ability to hold emitters accountable no matter where they are. There's no climate solution if emissions at home fall but emissions abroad rise. 

Goldwein then discussed the Committee's recent paper "Can a Carbon Tax Fund Climate Investments?" The paper looked at the effects of implementing the Build Back Better Act's proposed $550 billion climate provisions and imposing a carbon tax. With modeling help from Energy Innovation, the paper finds that implementing the Build Back Better Act's climate provisions alone would reduce emissions by 17 percent by 2030, while imposing a $20- to $40-per-ton carbon tax, indexed to grow 1 to 5 percent faster than inflation per year, would raise $650 billion to $1.6 trillion of new revenue over ten years and reduce U.S. greenhouse gas emissions by 14 to 21 percent by 2030. A $20-per-ton carbon tax with 1 percent annual growth would be more than enough to pay for the Build Back Better Act's climate provisions and would drive down emissions by 25 percent by 2030. A $40-per-ton carbon tax with 5 percent annual growth coupled with the Build Back Better Act's climate provisions would reduce budget deficits by $900 billion over ten years and reduce greenhouse gas emissions by 30 percent by 2030. This push-pull approach, Goldwein argued, would help reduce U.S. greenhouse gas emissions in a fiscally sustainable way. 

The panelists were then asked how climate solutions should be managed with the current state of the economy. Goldwein noted that there's a tradeoff: when we transition from some of the things we're doing now to new measures, such as a carbon tax, to manage climate change, there's going to be some economic costs. These costs can be minimized by removing inefficiencies. He noted that the reason why a carbon tax is so efficient is that it would let the economy and markets decide what the most efficient way to reduce emissions is. Huntley mentioned that climate investments are just like any other investments. Moreover, climate investments and investments in the economy are not mutually exclusive. Investments in projects that yield the highest returns are going to yield the best economic outcomes. In the climate space, this would be investments in natural resource management or wind electricity generation. 

In a similar vein, the panelists discussed the impact of climate policies on inflation. Goldwein noted that in ordinary times a carbon tax wouldn't have much of an effect on inflation because the Federal Reserve could offset it to some degree. But since the Federal Reserve is behind the curve and inflation is at a 40-year high, any policy solutions require extra thought and care. On the spending side, subsidies that push markets past their potential aren't appropriate right now. On the tax side, a carbon tax could be implemented at a really low rate to prove its effectiveness with a schedule for it to increase over time as inflation comes down. Rorke mentioned a carbon tax would have a mild inflationary impact when it's introduced, and Goldwein said it would push down demand but increase consumer inflation because of higher prices. 

The panelists then fielded a series of audience questions. One viewer asked how a carbon tax would affect the fiscal outlook. Goldwein mentioned that depending on its size and scope, a carbon tax could raise anywhere from a few hundred billion dollars to a couple trillion dollars of new revenue over ten years. This would be enough to reduce debt-to-GDP by at least 7 percentage points. Goldwein would like to see the revenue raised go toward deficit reduction but noted it'd likely go toward funding a carbon dividend, paying for the Build Back Better Act's climate investments, or tax cuts, and any remaining funds should go toward deficit reduction because even the slightest reduction in debt-to-GDP would be preferable to the unsustainable path the national debt is currently on. Huntley noted that any reduction in debt-to-GDP would crowd in investment since some of the money that would've gone to government debt could now be used instead on private investment. 

Another viewer asked if a carbon dividend would offset any additional costs to households and how it would be administered. Rorke noted that lower-earning American households stand to benefit the most from a carbon dividend; research shows that the average household in the bottom eight income deciles would come out ahead with a carbon dividend. Since lower-income households tend to spend more of their income on energy-intensive goods and services than wealthy households, an equal per capita carbon dividend would allow them to come out most ahead. 

A third viewer asked if the U.S. could impose a carbon border adjustment without a federal carbon tax. Rorke said it's easiest to introduce a carbon border adjustment with a carbon tax. In order to impose the adjustment, we'd need to know how much carbon is coming into the U.S. and how much it costs. She noted that addressing imported emissions with a carbon border adjustment would allow the U.S. to have a substantial effect on emissions at home and abroad and that if the U.S. was able to import goods as carbon-intensive as its own, domestic emissions would be reduced by 600 million tons. 

Another viewer asked what the mechanism is for making a carbon tax work. Rorke said it's competition and noted that imposing a carbon tax is an alternative to either doing nothing or doing something that's less efficient. Coupling a carbon tax with a carbon border adjustment would allow American industries to be more competitive since U.S. industries are currently more carbon-efficient than their global counterparts. 

The event concluded with the panelists offering their final thoughts. Huntley mentioned that the Build Back Better Act is a collage of smaller policies that need to be thought of separately because each one is different. No two policy proposals are created equal, and some are more cost-efficient and economically efficient than others. Rorke noted that there's no silver bullet to address climate change and no one policy is going to do the part of reducing greenhouse gas emissions. The solution is going to be a suite of policies, some of which will be enacted at the same time and some which will be enacted in one large legislative package. She reiterated her view that a carbon tax is the single most effective instrument to address carbon emissions in the U.S. – it's an indispensable tool in the toolbox, both because it would allow the U.S. to address climate change in a meaningful way and because of its fiscal implications. Goldwein noted that climate change and the U.S. fiscal outlook have a lot in common: both have long-term threats that accumulate over time, both can reach a dangerous tipping point, neither are easy to solve, and addressing them requires adjustments today. A carbon tax would offer a unique opportunity to get a two-for-one deal: the revenue raised from a carbon tax could be used to pay for climate investments while the tax itself would reduce U.S. carbon emissions. 

The Committee for a Responsible Federal Budget wishes to thank all those who participated in and attended the event.