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Executive Perspectives

EXECUTIVE PERSPECTIVE: A Takeaway from Paris to Washington: Tax Reform to Warm Less and Work More

Robert M. Wolcott

15 Dec 2015

The climate agreement reached in Paris is a great leap forward, but it’s widely acknowledged that it lacks specificity about how we’ll achieve the aspiration to keep global warming to 1.5 degrees Celsius. The mechanisms by which the US (and other countries) will accomplish it remain to be worked out.  While US negotiators purposefully steered clear of provisions that would require specific actions from Congress, at his press conference during the first week of the Paris climate talks, President Obama did say a carbon tax would be the most “elegant” policy solution, incentivizing business and industry to reduce costs by innovating and finding cleaner systems.

He called global warming a “market failure,” meaning that without regulation or taxes, “externalities” like air and water pollution are not paid for by their producers, but are borne by the rest of us. If you tax something, you get less of it.  Make polluters bear the cost through taxation, and pollution decreases.

But that’s just half the story of why a carbon tax could be the climate solution we need. What the President didn’t say is that the converse is also true: if you want more of something, tax it less. Nor did he say how to use the revenues.

If we spent carbon tax revenues on reducing the payroll tax – both for workers and employers – we would spur more employment.  This is what policy wonks call a revenue-neutral tax swap.  The bi-partisan, pro-employment tax policy group Get America Working! proposes swapping payroll taxes against non-labor taxes on pollution, inefficiency and waste. That would reduce the cost of hiring and retaining staff (nominally employers pay more than half of the 15+% federal payroll taxes) and give workers a pay boost. In our consumer-driven economy that means more spending and more growth and jobs. The nonpartisan Congressional Budget Office found payroll tax cuts were the tax change that would boost jobs and economic output the most.

Jobs and growth are key to the politics of climate change, because while many Republicans are skeptical about climate action, they are pretty unanimous in wanting economic growth and job creation. They point out that while today’s official unemployment rate is low, the labor force participation rate (the percentage of healthy, working age Americans who are actually working) is the lowest in 30 years. So the fact that swapping it against payroll tax cuts would create more jobs and bring more Americans back into the workforce could help get a carbon tax enacted.

Payroll taxes fund Social Security and Medicare, and swapping them against a carbon tax could also provide an elegant way to avoid cuts to those immensely popular programs. Workers and firms could get a payroll tax rebate based on the carbon revenues collected. That way, the tax would reduce what we don’t want (climate disruption and health damage from air pollution) and boost what we do want (wages for working Americans, job creation and economic growth).  We’d also help take some pressure off Medicare by promoting healthier air. Studies show burning fossil fuels not only emits carbon but other pollutants that are damaging our health like arsenic, mercury and fine particles.

Since it has relatively few key sources (mine mouths, well heads, oil terminals) carbon pollution from fossil fuels can be taxed at origin. Yes, that will raise the cost of energy. That’s how it spurs innovation and conservation. Some of the revenues (perhaps 15 -20%) will be needed for cost of living adjustments for non-working/low-income seniors and others who need assistance, so they are kept whole.

But for the great majority of working Americans, levying a carbon tax while cutting payroll taxes will be a net gain. Payroll taxes are the largest federal tax most Americans pay, and the most regressive. When billionaire Warren Buffet famously says he pays a lower tax rate than his secretary, it’s because the Social Security tax only applies to earnings up to $118,500.

You don’t need to be a climate action advocate to see the benefits of taxing carbon and cutting payroll taxes, including jobs, growth, tax fairness and health. As President Reagan’s economic policy adviser Arthur Laffer said, “I don’t know if climate change is real, but I know pollution damage is real. And it has a cost.”

But if you do favor climate action, a swap between a carbon tax and payroll taxes will help narrow the “emissions gap” between what countries agreed to in Paris, and what it will actually take to hold warming to 1.5 or even 2 degrees Celsius.  That’s why it should be part of the US climate action plan, as Obama’s former economic adviser Larry Summers argued earlier this year. It represents the best opportunity to get some bipartisan movement on specific measures to cut US emissions and expand US employment.

Robert M. Wolcott is Senior Economic Adviser to Get America Working! and Former Deputy Assistant Administrator for Policy, U.S. EPA

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