A simple way to reduce carbon tax regressiveness

Don Fullerton, Garth Heutel, and Gilbert Metcalf have a paper out, Does the Indexing of Government Transfers Make Carbon Pricing Progressive? There is a widespread perception that carbon pricing is regressive (meaning that it hurts poorer individuals and household more than rich ones), even among economists that study carbon pricing and think about regressiveness. This is almost certainly true to at least some extent, but this recent paper casts a new light on the question: what if we took into account where the poorest Americans get their income from? The answer is, for the poorest quintile, government transfers. The insight in this paper (and an earlier paper addressing this same question) is that when government benefits are indexed to inflation, increases in energy costs that would be disproportionately borne by poorer individuals and households are offset by the benefit increases. For many of those that derive almost all of their income from indexed programs, there is no net increase in burden. That is not a complete answer, of course. As Fullerton, Heutel and Metcalf point out, not all federal US programs are indexed for inflation. For those that are recipients of government benefits that are not indexed to inflation, the regressiveness problems still stands. Which raises the obvious question: what if we just indexed all low-income government benefit programs for inflation? That would go a long way towards solving the regressiveness problem for carbon pricing for the lowest quintile (or maybe the lowest quartile, now).

I raise a couple of other questions about the regressiveness of carbon pricing. First, what exactly do we mean by "regressive"? Do we demand that every quartile, quintile, or decile be progressively better off relative to each quartile, quintile, or decile above it? Second, what do we use to measure wealth? Relying solely on income is problematic, as it fails to account for vast differences in income at different ages -- rich retirees are often wealthy, but have little income, and students often have little current income but prospects of high future incomes (think medical students, business students, and some law students). Third, focusing on direct energy costs exaggerates the impact on poor individuals and households. Low energy prices are embedded in a wide variety of goods and services, and substituting away from many of these goods and services would be invisible to poor individuals and households (think production processes).

This is not to trivialize the impacts of carbon pricing on the poor. But this is a call to avoid yielding to sympathy entrepreneurs that exploit the issue for political gain.