Swapping The Corporate Income Tax For A Price On Carbon
Catrina Rorke, Andrew Moylan and Daniel Semelsberger, December 23, 2016 (R Street0
The corporate income tax and domestic carbon policy are two areas of concern in dire need of reform. In both cases, protracted political infighting has inhibited progress on legislative solutions. The tax code remains as voluminous and convoluted as ever. The outgoing administration spent eight years expanding its authority to reduce greenhouse gas emissions without ever receiving congressional authorization.
Progress on tax reform has been stymied by clear revenue needs. Though there is growing consensus on the need to reduce the U.S. corporate income tax, the available policy tools to achieve that goal – such as a European-style Value Added Tax or broad-based taxes on consumption—remain politically unpopular. Meanwhile, political fissures and a lack of motivation to find bipartisan agreement continue to block progress on greenhouse gas emissions.
Though it would no doubt be politically adventurous, there is a way to pair these two policy areas to yield an economically optimal tradeoff: an orchestrated swap of existing taxes on stuff we like for new taxes on stuff we don’t. This swap could take any number of forms. Policy analysts and advocacy groups have in the past advanced proposals to use the proceeds from a tax on carbon emissions to reduce taxes on labor, on capital or on some combination thereof.
Despite the political baggage associated with the climate debate, lawmakers could soon discover—as they attempt to slay the corporate tax code’s many sacred cows—that a price on carbon just might be the easiest way to finance substantial tax reform. Moreover, the combination of a price on carbon with deep reductions in corporate tax rates would reduce government interference in the private market and in the energy market, in particular.
Given the salience of those goals, this paper proposes a politically feasible and revenue-neutral plan to use a price on carbon emissions to eliminate the U.S. corporate income tax completely.
Trading Carbon For Capital
The economic literature suggests that taxes on capital, which are broadly distributed throughout the tax code, are the most distortionary form of taxation. Efforts to reduce taxes on capital thus rank among the best ways to induce economic growth. Alas, systematically ferreting out the many ways the existing rules tax capital would require radical changes to the code and a lengthy period of transition, and likely would prove politically impossible.
A simpler approach to achieve many of the same goals would be to eliminate the corporate income tax. Of course, this idea would face political challenges of its own, given that the corporate income tax is quite popular. Roughly 70 percent of Americans say they want companies to “pay their fair share” of the tax burden.1 President Barack Obama marshalled this sentiment earlier this year, when his Treasury Department proposed a set of rules to combat corporate tax inversions, suggesting companies that incorporate abroad are “gaming the system” at the expense of the middle class.
What isn’t controversial among tax policy economists is that the corporate income tax is highly distortionary, costing roughly $140 billion annually in compliance costs. It’s also highly inefficient. Though the United States has the highest nominal corporate rate among Organization of Economic Cooperation and Development nations, the corporate tax manages to bring in just 10 to 12 percent of federal tax revenue. Moreover, as demonstrated in a prior R Street policy short, the burden of taxes on corporate income actually falls on a combination of employees, customers and shareholders.3
The good news is that broad bipartisan agreement for corporate tax reform has been building for several years. This appears to be, at least in part, a consequence of mounting evidence that exceedingly high U.S. corporate taxes are pushing jobs, investments and companies themselves overseas. The wave of inversions—in which U.S. companies move their legal domiciles to lower-tax nations—has brought attention to the problem, while the lingering lackluster recovery from the last recession is seen to reflect underinvestment in the domestic workforce…
Corporate Income Tax Repeal…Carbon Tax Receipts…Pro-Growth Design…
Tax Swap Summary
In this paper, we have elucidated a path to eliminate the corporate income tax outright and instead impose a direct price on carbon. This is a combination specifically designed to promote economic growth and strengthen domestic job creation. It requires conceding two points. First, the corporate income tax—politically popular though it may be—is paid by workers, customers and investors, not by companies themselves. Second, price signals and market forces will go further at lower cost to reduce greenhouse gas emissions in the energy economy.
It is no understatement to say that eliminating the burden of the corporate income tax would be a huge boon to job creation, income growth and investment. While most tax reform proposals suggest modest reductions in the corporate rate to better align it with the tax rates of OECD nations, outright elimination of the corporate income tax is a more radical approach that would establish the United States—with clear rule of law, a well-trained workforce and abundant intellectual and natural resources—as the ideal place to do business. High U.S. corporate taxes have fueled an exodus to lower-tax jurisdictions like Ireland and others. Eliminating the corporate income tax would reverse that exodus immediately
This revenue-neutral swap must also be used to shrink the footprint of government in the energy sector. In the absence of congressional legislation to address greenhouse gas emissions, the executive branch and the states have proliferated a number of policies that take the place of a comprehensive national plan. We expect that a robust price on carbon at the federal level justifies not just rolling back redundant federal policies, but also would encourage states to abandon efforts to create a patchwork of carbon policies.
This would mean backing away from interstate carbon credit trading programs like the Regional Greenhouse Gas Initiative and iterative policies that mandate certain percentages of energy come from renewable sources. At a minimum, we expect that systems that trade in carbon credits will no longer be binding; the federal price on carbon will be more significant and durable than the carbon markets have been. In an ideal scenario, we would eliminate state policies that make investments and energy trade across the states more difficult.
This revenue-neutral swap also would serve as an excellent model for other nations. Policies like the European Union Emissions Trading System are perfect examples of overdesigned and unsuccessful carbon policies. Directly pricing emissions is an elegant approach that leaves all further decision-making on pathways, investments and innovation to a private sector that would be motivated by a predictable price signal. Directly pricing emissions also allows, as we see here, significant changes in existing tax structures that hold back growth.
Expectations across the carbon pricing literature suggest that a carbon tax with an increasing rate of taxation would bring in higher levels of receipts year-over-year until emissions reductions outweigh rate increases and receipts begin to drop. It is a feature, not a bug, of a carbon tax that it eventually would take in no revenue. A carbon price is a policy specifically designed to put itself out of business. By setting the benchmark that lower taxes are wise policy and that specific policy outcomes can be achieved while simultaneously shrinking the government’s footprint, this proposal could serve as a model for policies that reduce the size of government broadly.
It is possible to achieve dramatic reform in the corporate income tax structure and in our approach to carbon emissions simultaneously. Of course, this proposal has its limits. Corporate income taxes remain popular, and calls to make sure companies “pay their fair share” will make it difficult to enact such ambitious policy change. A direct price on carbon emissions remains unpopular on the center-right and the center-left remains focused on a regulatory commandand-control model to reduce emissions. It will be difficult to break through these walls of opposition.
Moreover, this proposal only goes so far. Broad reductions in taxes on capital across the tax code would do the most to spur domestic investment. This version of a carbon price addresses only emissions related to energy usage, an area in which the private sector has had dramatic success even without government policy. To address the many diverse sources of emissions would require policy changes outside the scope of this proposal.
We posit the proposed tax swap’s greatest strength is that it accepts that we simply don’t know how to shape investment in the corporate sector or how to dictate carbon emission reductions in the energy sector. By curbing the influence of special interests to dictate corporate tax structures and the constantly expanding regulatory state, we can leave decision making about the future of the economy to the markets, not the limited imagination of bureaucrats. This will make the United States a better place to do business.
Finally, the proposal outlined in this paper relies on simplistic back-of-the-envelope constructions to pursue an interesting idea: eliminating the corporate income tax and the abundant energy regulatory burden. We hope this proposal inspires efforts to model this exchange with far greater granularity, particularly to explore the extent to which corporate income tax elimination will be self-financing and to identify a carbon price that would ensure revenue neutrality