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

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.

5 thoughts on “Would a Carbon Tax and Corporate Tax Reform Taste Great Together?”

  1. CAGW (catastrophic anthropogenic global warming) is a theory that has yet to be proven. There is much uncertainty regarding how much of climate change is natural and how much is anthropogenic. Most of the predictions of CAGW are based upon computer models. Computers can be programmed to provide most any answer that is sought. For CAGW to occur, CO2 induced temperature change must be amplified by positive feedbacks. It is those feedbacks that are programmed into climate models that produced projected CAGW, not just the rise in CO2. There are some very prominent climate scientists who think that the feedbacks will in fact be negative, i.e., they will reduce the warming produced by CO2. This seem to be the case as, despite large increases in CO2 produced by the burning of fossil fuels since 1998, global temperatures seemed to have flat lined. In addition, warmer global temperatures and more atmospheric CO2 has conferred benefits. Longer growing seasons and faster more robust plant growth. Horticulturalists pump warm CO2 into their greenhouses to promote faster plant growth.

    To learn more about climate, the science and the controversies surrounding CAGW I recommend the following blogs: “wattsupwiththat.com”, judithcurrycom, and CO2science.com. In addition, I recommend you Google the following names of scientists who are active skeptics (skepticism is the normal attitude that should be held in all matters of science) when it comes to CAGW: Dr. Richard Lindzen, retired professor at MIT; Dr. William Happer, professor of physics at Princeton University; “Dr. David Evans AGO”, worked in the Australian Greenhouse Office. There are so many more who you will learn about if you have an interest in learning more about the real uncertainty regarding CAGW.

  2. I’m no economist, so this may be a silly question. Would raising the tax rate on capital gains help offset the regressive nature of a combined carbon tax and lower corporate tax rate?

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