Testimony of Robert Greenstein, Executive Director, Center on Budget and Policy Priorities at the Hearing on the Fiscal Impacts of Controlling Carbon Emissions, House Budget Committee

PDF of this testimony (8 pp.)

November 1, 2007

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About the Speaker

Effective action to reduce greenhouse gas emissions is necessary to prevent costly and potentially catastrophic environmental and economic damages from climate change.  The Center on Budget and Policy Priorities is not making recommendations about how much we need to reduce emissions; that is not our area of expertise and we leave those recommendations to experts in environmental policy.  Instead, our focus is on how climate change legislation might affect 1) the budgets of American families, especially those of modest means; and 2) the federal budget.

Our analysis indicates that Congress can develop climate change policy that is environmentally and economically sound and fiscally responsible, and that treats low-income families equitably, avoiding increases in poverty and hardship.  To achieve these objectives, however, the policy has to be well designed.  This means the policy must generate sufficient budget resources to address the requirements and challenges of sound climate-change policy — including the resources needed to offset the direct impact of those policies on the federal budget — and must cushion the impact on vulnerable populations, especially people with low incomes.

Four Key Numbers on Climate Policy, the Budget, and Low-Income Families

Our analysis of the effects of climate-change policy on the federal budget and the budgets of low-income households can be summed up in four key sets of numbers.






Fortunately, the same climate-change measures that generate higher energy-related costs can also generate substantial resources to cover those costs.  CBO estimates that various recent proposals to limit greenhouse-gas emissions by establishing a cap-and-trade system would create a valuable resource — emission permits —  that would be worth $50 billion to $300 billion per year by 2020, depending on the specifics of each proposal.  That is how much revenue the government could expect to raise if it auctioned off all of the permits.  It is also how much revenue the government could expect to raise if a carbon tax with a similar effect on limiting emissions were used instead of a cap-and-trade approach.

3.  Approximately 14 percent:  share of auction proceeds or carbon tax revenues needed to fully offset the increased energy-related costs faced by low-income consumers



Well-Designed Climate Policies Can Generate the Resources Needed to Address Crucial Priorities





There are legitimate policy issues around the choice between a carbon tax and a cap-and-trade mechanism.  But we should not let misconceptions cloud the debate or create false choices.  Here is how Harvard economist Greg Mankiw, who served as Chairman of President Bush’s Council of Economic Advisers, has characterized a cap-and-trade mechanism under which the allowances are given away:

Economists recognize that a cap-and-trade system [in which the allowances are given away to emitters] is equivalent to a tax on carbon emissions with the tax revenue rebated to existing carbon emitters, such as energy companies. That is, Cap-and-trade [under which the allowances are given away to emitters] = Carbon tax + Corporate welfare.[2]

Avoiding Regressive Outcomes While Meeting Other Climate-Related Budget Priorities





Finally, economic analysis suggests that if there are instances where existing taxes have some disincentive effects that may dampen economic activity, receipts from cap-and-trade auctions or a carbon tax could be used to reduce those taxes.  This, in turn, would lower any economic cost of restricting greenhouse-gas emissions.  For example, CBO reports that the changes in economic activity required to achieve a 15 percent reduction in greenhouse-gas emissions would result in economic losses equivalent to roughly one-half of one percent of GDP in 2010 if the all the allowances were given away.   If, however, all of the emission allowances were auctioned off and the proceeds were used to cut payroll taxes or corporate income taxes, that loss could be cut substantially.  At the same time, CBO points out that using all of the auction proceeds exclusively to reduce net economic costs would itself come at a price, because those proceeds would not be available to address the regressive effects of increases in consumer costs or to make investments in basic research on clean technologies. 

It should be noted, that these calculations of net economic loss do not take into account the substantial benefits that may arise from avoiding environmental and economic damages from climate change.  Economic costs of the magnitude that have been reasonably estimated appear to be a modest price to pay to achieve the important goal of reducing greenhouse-gas emissions.  In a well-designed climate-change policy, these are necessary costs for achieving the benefits of reduced greenhouse-gas emissions.  They do not “harm” the public any more than expenditures on antibiotics to fight a serious infection “harm” a patient.  Moreover, these “side effects” in terms of economic performance are modest (analogous to losing a day or two of work a year due to the antibiotic treatment in order to avoid greater harm from failing to treat the infection).

To return to the trade-off between reducing net economic costs and equitable treatment of families facing higher costs, CBO has found that using the proceeds from auctions exclusively for tax cuts would offset only a very modest fraction of the impact of higher energy costs on low-and moderate-income households, and that cutting corporate taxes would be highly regressive.  With all of the auction receipts used for either a payroll tax cut or a reduction in corporate income taxes, the poorest 20 percent of households would have the largest net losses (as a share of income) while the richest 20 percent of households would end up with tax cuts that exceeded their increase in energy costs.  (It also should be noted that analyses by CBO and others find that reducing long-term budget deficits would do substantially more to boost the economy over time than cutting taxes and have a far less regressive impact.)

While there are tradeoffs between economic efficiency and fairness in the design of climate-change policy, one policy that fails to measure up on either ground is giving away a substantial fraction of the permits to existing emitters.  As CBO has explained,

Because giving allowances to energy producers would disproportionately benefit higher-income households and would preclude the possibility of using the allowance value to reduce taxes on capital and labor, such a strategy would appear to rate low from both a distributional and an efficiency perspective.[3]





To shield vulnerable households from higher energy costs in a manner that is both effective and efficient, we recommend that policymakers follow these six basic principles.


  6. Adjust relief to reflect changing needs.  Assistance for low-income consumers should be smaller in the beginning, when a cap-and-trade system or carbon tax is just phasing in and the impact on energy-related prices is less substantial, and larger when the system is fully in place.


The economic and distributional effects of climate-change policy will generate major new claims on the federal budget, especially the need to offset the regressive impact of higher energy prices.  But a well designed climate-change policy can also generate significant resources that can be used to avoid regressive outcomes and address other legitimate budgetary claims that arise from the new policy.  Policymakers need to recognize the importance of generating adequate revenue and addressing fairness concerns to avoid ending up with a policy that increases poverty and further widens gaps between rich and poor, increases deficits and debt, or both.

End Notes:

[1] The Congressional Budget Office has provided a figure of $680 for the average increase in cost for the bottom 20 percent of households.  It should be noted that the $680 figure is for the fifth of households with the lowest incomes, not the poorest fifth of the U.S. population.  There is an important difference.  If one simply ranks households by income, regardless of household size, then the bottom fifth of households disproportionately consists of one- and two-person households, and as a result, includes significantly less than one-fifth of the people in the United States.  Moreover, the bottom fifth of households, if measured in this manner, includes many small households that are not poor (i.e., that are above the poverty line), while missing many larger households that are poor.  (The poverty line is adjusted by household size.)  The $680 figure for the bottom fifth of households is measured in this manner.  CBO has also developed a standard methodology to address this household-size problem when dividing households into income quintiles (or income “fifths”) and uses that methodology in most of the work it conducts on income distribution issues.  We use the CBO size-adjustment methodology here to allow us to examine the poorest fifth of the population, rather than the bottom fifth of households irrespective of household size.  This produces a figure of $750 to $950 for the poorest fifth of the U.S. population.


[3] Congressional Budget Office, letter to Senator Jeff Bingaman, Chairman, Committee on Energy and Natural Resources, United States Senate, July 9, 2007, pp. 3-4.

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