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'Revenue-Neutral' Carbon Tax: Merely Implausible or Mathematically Impossible?

By Josiah Neeley -- August 16, 2012

This summer Australia implemented a new tax on the country’s top 500 carbon emitters, which has already led to significant increase in electricity prices. Meanwhile, on August 2, Congressman Jim McDermott (D-Wash.) introduced his own carbon tax bill in the House of Representatives, which like the Australian tax is targeted at certain disfavored emitters.

Talk of a federal carbon tax has been recently revived by several conservative-leaning groups. Earlier this year Robert Inglis (former Republican Congressman from South Carolina) launched the Energy and Enterprise Institute, a new advocacy group aimed at marketing carbon taxes to Republicans. And last month rumors of carbon tax discussions at the American Enterprise Institute led AEI’s own Ken Green to reiterate his opposition to the carbon tax idea.

What sets the new conservative proponents of carbon taxes apart from traditional advocates is revenue neutrality. Instead of adding a carbon tax to existing taxes, Inglis proposes offsetting any increased revenue from a carbon tax with reductions in income and capital gains taxes. The question is: should we take the bait?

Some Carbon Tax Basics

The idea of shifting taxes away from income and investment to consumption has long been popular in conservative circles. But while revenue neutral tax swaps can make sense in theory, they are hard to achieve in practice. Even if a carbon tax is initially paired with other offsetting tax cuts, there is no guarantee that government won’t raise taxes a few years down the line and offset the offset. As economist Robert Murphy recently noted:

[W]hen the modern individual income tax was first introduced in 1913, it was touted as a relatively minor nuisance that would just affect the super rich. Indeed, the original bracket structure was very modest. Adjusting for inflation, the top rate of 7% kicked in on incomes above $11.3 million, while the bottom bracket applied to all incomes up to $453,000, with a tax rate of a mere 1%.

But oh how things changed, and quickly: Because of the government’s need for revenue during World War I, a mere five years later the top rate had skyrocketed eleven-fold to an incredible 77%, while the bottom rate (with a much lower income threshold of $59,000) had risen six-fold to 6%. Keep this history in mind when supporters promise a “revenue-neutral” carbon tax.

Maintaining a revenue neutral carbon tax would be particularly difficult because of the inherently fluid nature of the tax. If imposing carbon taxes leads to a reduction in carbon emissions, then it may be necessary to increase the tax rate to maintain the same level of revenue. If each increase in the tax leads to further reductions of emissions, it may not be possible to stabilize carbon tax revenue at a revenue neutral level.

By contrast, if a carbon tax fails to adequately reduce emissions, then it may be necessary to increase the tax to achieve desired environmental goals. So even if a revenue neutral carbon tax can be enacted in the short run, whether it will stay revenue neutral over the long run is impossible to determine.

Enter Richard Tol

Even leaving these issues aside, a new working paper by Richard Tol casts doubt on whether a carbon tax could remain revenue neutral and be successful from an environmental perspective. Tol begins by noting that there is a limit on how high a carbon tax could be and remain revenue neutral. Once carbon tax revenue reaches the total amount of revenue from all other taxes, any additional revenue cannot be offset by other tax cuts, and hence the tax cannot remain revenue neutral.

In addition to the maximum rate at which a carbon tax could be imposed while remaining revenue neutral, there is also a minimum rate at which a carbon tax must be imposed if it is to achieve desired reductions in carbon emissions. Most environmental groups, including the IPPC, have called for stabilizing atmospheric carbon at no more than 450 ppm, which climate models suggest would hold global temperatures to 2 degrees Celsius above pre-industrial levels. Tol estimates that stabilizing CO2 at 450 ppm would require a minimum initial tax of $149 per ton.

This, of course, assumes a uniform tax imposed by all countries on the planet (according to the IPPC, even a 100% reduction in carbon emissions from the United States would only forgo a few tenths of a percent of warming, so to be effective any carbon tax would have to be an international effort). For purposes of comparison, the implied price of a ton of carbon under the Europe Emissions Trading Scheme is below $10.

As it turns out, the maximum revenue neutral carbon tax is surprisingly low for many countries. The maximum revenue neutral carbon tax is $29 per ton of CO2 for China, $36 for Russia, and $45 for India. Overall, countries representing approximately 10% of current emissions have a maximum revenue neutral carbon tax level below the minimum level needed to achieve IPPC goals. Many of these countries (such as China and India) do not current impose carbon taxes at all, and are unlikely to do so at anywhere near these levels.

For the United States, the maximum carbon tax level is $223 per ton of CO2. A revenue neutral carbon tax is therefore theoretically possible, though it would require carbon taxes equal to about two-thirds of all tax revenue, which is approximately the same as the entire income tax. Given the regressive nature of carbon taxes, it is unlikely that completely replacing the income tax with a carbon tax would ever be politically achievable.

Further, the $149 per ton tax assumes a uniform tax imposed by all countries simultaneously. Should a substantial number of countries decline to impose a carbon tax (or impose it at a lower rate than $149 per ton) tax rates in the United States would have to be even higher to make up the difference.


Combining the above, it may not be possible for an effective carbon tax to be revenue neutral in either the short or long run. In the short run, Tol’s analysis shows that a revenue neutral tax may not be sufficient to meet IPPC goals. And in the long run the general uncertainty surrounding taxation makes it impossible to know whether any tax swap will remain revenue neutral.

If correct, this suggests that advocates of a carbon tax cannot simply hide behind the idea of revenue neutrality, but must accept that an effective carbon tax would require the growth of government.


  1. Floccina  

    How about not aiming for revenue neutral but for carbon neutral. That is tax co2 going into the air and pay out from the removal of co2 from the air. I have seen numbers as low as $37 per tonne to remove co2 from the air through biochar. So you aim for no net new co2 going into the air.


  2. Jon Boone  

    The if and buts accompanying carbon tax rules would make a great board game played with marbles and dice. I loved the way the words “effective carbon tax” flowed across the conclusion, and the quiet way the word “regressive” crept into the text, giving a low key register to how such “taxes” will affect poor folk, particularly the working poor.

    Since carbon is emitted in virtually every animal (to include humans) transaction, the definition of effective here can only be considered as ironic.

    There are no revenue neutral taxes. Only increased taxes or additional taxes. Revenue neutral is a term used to mask consideration of what is really going on: providing revenues to support the ever burgeoning patronage system now bloating western democracies, and thereby ensuring political control.


  3. Paul Sodieu  

    Many if not most countries such as China operate carbon subsidy schemes. So we are talking about a net reduction in subsidies rather than a tax. It i sometimes argued that the US is amongst this group, paying in the region of 100bn/year to maintain Gulf oil and gas supplies as well as many domestic fossil fuel subsidies.

    Typical carbon taxes around the world are in the $20/tonne region. a $200/tonne carbon tax is unimaginable and not feasible with the public. The cost of carbon is assessed by various commentators over a very wide range. So in practice, should the US introduce a carbon tax it would likely do so in th $10 range and compensate with cuts in taxes elsewhere to win public approval. Later the tax would be increased but it cannot be increased at the rate that income tax was as this would be infeasible. Look at VAT rates or slaes taxes in the US and Europe. They have not spiralled as income tax has. VAT maxes out at about 25%.

    People need a story and many good news compensators when a new tax is introduced because new taxes create huge resistance. Typically new taxes may be promised to be revenue neutral, to protect special groups like old and poor and to have revenue raised allocated to very good causes. All this can be changed with little more than grumbles in later years.

    Revenue neutrality is a lubricant not a policy goal.


  4. Andrew  

    “Revenue neutrality” would be determined by CBO scoring…Scoring that has never to my knowledge been correct about anything.

    Besides which, as a Republican (if sometimes feeling very alienated as one…) I am sure that if “revenue neutral” were more accurately described as a redistribution of wealth it would rather lose it’s “conservative” appeal. (BTW, it doesn’t matter who is on the “beneficiary” end, even if it’s redistributing in the opposite of the usual “direction” with respect to wealth, a tax which is uneven in it’s burden is a redistribution of wealth).


  5. Ed Reid  

    Robert N. Stavins, the Albert Pratt Professor of Business and Government, Director of the Harvard Environmental Economics Program, and Chairman of the Environment and Natural Resources Faculty Group has an excellent post up regarding carbon cap & trade.


    His discussion of the Independence Property identifies the key fallacies of the “cap and trade and tax and spend and pick winners and redistribute wealth and income” bills take up in the US Congress: Waxman-Markey, Kerry-Lieberman and Kerry-Boxer. Even in bills alleging to be “cap & trade”, the US Congress appeared to be far more interested in the potential incremental revenue than in any reduction of carbon emissions.

    If the nations of the globe ever decide that it is necessary to control carbon emissions, a simple cap, declining over time to whatever level is determined to be politic, plus the ability to trade emissions allowances, will be the only acceptable and effective choice. All else is “much sound and fury, signifying nothing”.


  6. David Bergeron  

    Sure, let’s pass a revenue-neutral carbon tax,… but first we’ll need a balanced budget amendment and a federal spending cap as a percent of GDP to insure it is indeed neutral.

    I also think such a tax would be regressive.


  7. Josiah Neeley: ‘Revenue-Neutral’ Carbon Tax: Merely Implausible or Mathematically Impossible? | JunkScience.com  

    […] MasterResource Share this:PrintEmailMoreStumbleUponTwitterFacebookDiggRedditLike this:LikeBe the first to like this. This entry was posted in Cap & Tax and tagged carbon scam, carbon tax, government cash grab, really stupid idea. Bookmark the permalink. ← Porpoise Threatening Merkel’s $48 Billion Atomic Shift […]


  8. Mark Walker  

    BC’s Carbon Dioxide tax was also sold as “revenue neutral” – which begs the question (among others)- what’s the point.

    Apart from a vain attempt to modify consumer behaviour, BC CO2 tax has proved to be costly to the province generally and some, but not all BC residents specifically.

    Built into the tax was a “rebate” for low income families and individuals. As the economy fell apart in 2008/2009, the amount of CO2 tax revenue declined while the number of individuals who qualified for the rebate rose.

    The CO2 tax moved to “revenue negative” in short order. The automatic annual increases in the tax have served to increase the price of gasoline, at the same time increasing the size of the rebate to low income earners.

    Emissions have remained steady or increased, BC industry is less competitive, and the climate is pretty much unchanged.

    But each quarter, millions of dollars in CO2 tax rebates are enjoyed by low income earners across the province.

    Redistribution at it’s “best”.


  9. Dr. James H. Rust  

    The idea of a carbon tax and making it revenue neutral is simply a ploy to put an energy tax on fossil fuels so renewable energy sources will be competitive and possilbly replace fossil fuels as energy sources. Energy is still the life blood of the U. S. economy. If the tax works and fossil fuel use drastically reduced, we will be back in the same spot as if cap-and-trade is implemented. Energy is needed to make renewable energy sources, so the carbon tax will increase their costs with an continuous spiraling up of energy costs and economic collapse for the U. S. You might call this positive feedback of a tax that will increase expenses of everything with no gain.

    If governments want revenue, why not put in a food tax. This will decrease obesity and cut down on health costs. Here is a negative feedback as far as a tax causing less dmand on society as it is implemented


  10. Fantasy Islander  

    The simplest way to make a carbon tax revenue neutral is to rebate the entire net proceeds equally to every citizen with a SSN. Assuming there is a limit to the amount of CO2 that can safely enter our atmosphere, every citizen deserves an equal rebate of taxes imposed to reduce CO2 emissions. This system would: eliminate any “concerns” about a carbon tax being regressive; provide the affluent, who have money to invest in conservation, with a greater incentive to conserve; and provide the non-affluent with cash that could (but probably won’t) be invested in conservation. Everyone could sign up for direct monthly deposit of rebates or an annual lump sum rebate when filing a tax return.

    However, one would want to first rebate the carbon tax paid on goods made or grown domestically and shipped overseas, so that domestic products wouldn’t suffer a competitive disadvantage. And one would want to come up with a system for appropriately taxing the CO2 used to make or grow imported goods. This seems horribly complicated, but the vast majority products might be handled with a flat rate based on an average energy input (kW-h) per dollar of sales and an average CO2 emission per kW-h. Businesses treated unfairly by such averages could document the carbon taxes they actually pay.

    As global temperature and perhaps sea level rise – or don’t rise – to truly dangerous levels or at dangerous rates, carbon taxes could automatically rise or not rise to appropriately punitive levels. The rates for the last 30 years are roughly 1.5 degC/century and 0.3 m/century. In 25 years, if the temperature is 0.75 degC higher (0.3 degC/decade), we probably need a carbon tax big enough to make fossil fuels prohibitively expensive for electricity generation and cars making less than 75 mpg. A carbon tax appears superior to letting politicians, environmentalists and politicized IPCC scientists, rather than the marketplace, make economic decisions. Those who believe in the IPCC’s projections will invest in low emission technologies and those who don’t will wait.


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