January 28, 2015

A Carbon-for-Corporate Tax Swap

Most Congressional representatives at least say that they favor general tax reform, even if a discussion of what exactly “tax reform” meant would reveal some predictably deep divisions. Among Democrats, that would mean mostly closing tax “loopholes” that supposedly benefit the rich. Among many Republicans, a big part of tax reform would mean lowering corporate income taxes.

One idea that has floated around Washington for a while is the possibility of a carbon tax coupled with some corporate income tax relief. The carbon tax would appeal to most Democrats, whom have embraced climate change as an issue, and the corporate income tax relief part would appeal to most Republicans, whom have embraced corporate competitiveness as an issue

A 2013 paper by 
Donald Marron and Eric Toder was one of the first to explore this idea seriously, using a household-level model developed by the Tax Policy Center. Marron and Toder  modeled the effects of a carbon tax on five pre-tax income quintiles, unsurprisingly finding that a carbon tax alone was income-regressive. They then layered on top of that a policy distributing all carbon tax proceeds to reduction in corporate income tax rates, assuming — this is an important assumption — that 20% of the corporate income tax burden is borne by capital owners not in their capacity as shareholders, 20% by labor, and 60% by the corporation. (This assumption contrasts with Gregory Mankiw’s assertion, based on a 2006 Congressional Budget Office study, that labor bears 70% of the corporate income tax burdenThere is a fair amount of controversy on this point, but this is a respectable starting point.

A carbon tax and a lower corporate income tax, Marron and Toder unsurprisingly find, is more regressive than a carbon tax alone. But then, if just one-quarter of the carbon tax proceeds are distributed in a lump-sum household rebate, the burden is shifted to those in the middle three quintiles, with the highest quintiles best off and the lowest at least better off. Marron and Toder close by noting how hard it is to design the “perfect tax swap,” one that is progressive, reduces the distortions caused by high statutory U.S. corporate income tax rates, and taxes carbon. 


While a carbon-for-corporate tax swap signifies a potentially important political bargain, the underlying political motivations may be a bit simplistic. Not all Republicans are fixated on corporate income tax relief, and not all corporate income tax reform advocates are Republican. The President has expressed support for lowering corporate income tax rates as part of a tax reform packageMany Republicans are nervous about corporate tax reform if it means that special interest provisions will be sacrificed to reduce statutory rates, as Rep. Dave Camp’s frustrations last year demonstrate. On the Democratic side, there are Democrats in coal country or energy country (not that many anymore) that would oppose a carbon tax. All that is just to say that it may be oversimplifying a bit to suggest that carbon-for-corporate tax swap contains a carrot for Republicans and one for Democrats.