As the midterm elections get closer, congressional Republicans are seeking to expand upon their main legislative accomplishment so far during the Trump presidency: tax reform. They have released a framework for “Tax Reform 2.0,” which proposes to make the individual tax cuts in the Tax Cuts and Jobs Act (TCJA) permanent, reform the tax treatment of different retirement savings accounts, and some kind of new preference for start-up businesses. Meanwhile, Republican representative Carlos Curbelo of Florida released a proposal for a carbon tax proposal, which would eliminate the gas tax, but still overall raise revenue. The GOP conference responded to this proposal to almost unanimously condemn even the concept of a carbon tax. This is a mistake: the carbon tax would be a useful piece of a second round of tax reform.
The GOP has a deficit problem: even when accounting for additional economic growth, the TCJA is projected to increase the deficit by roughly half a trillion dollars over the next ten years. The deficit has boomed this year, thanks to both the TCJA and the omnibus spending bill, and trillion-dollar deficits during economic booms are unheard of in American history. Furthermore, the GOP’s hypocrisy has emboldened left-wingers to make sweeping spending proposals without offering plausible pay-fors.
Another round of tax cuts (namely making the individual portions of the TCJA permanent, and ideally allowing corporations to fully expense capital investments) will further increase the deficit. Making the individual provisions of the TCJA permanent will reduce revenue by $576 billion dollars over the ten-year budget window, after taking into account economic growth. Expanding the TCJA’s full expensing provisions to include all forms of capital investment, permanently, would have a major, positive impact on long-run GDP, but even with that considered, it will probably reduce revenue by between .5 and 1 trillion dollars.
In an op-ed I wrote for RealClearPolicy two weeks ago, I suggested the GOP make another round of tax reform revenue-neutral by removing distortionary deductions, such as capping the exclusion for employer-sponsored health insurance, which favors non-monetary over monetary employee compensation. That would be an ideal reform. But that exclusion is notoriously difficult to curb politically, and the TCJA already significantly reduced many major itemized deductions, such as the deductions for state and local taxes and mortgage interest, so even if some of those other deductions were eliminated, that might not be enough to make the tax reform revenue-neutral. Enter the carbon tax.
Including a carbon tax in a larger tax reform package would help address the most common conservative complaints about a carbon tax. For example, the regressive nature of a carbon tax (namely, that a carbon tax would hurt lower-income households more because lower-income households spend a higher portion of their income on energy) would be counteracted by making the doubling of the standard deduction and child tax credit, along with lower individual income tax rates, permanent.
The economic costs of a carbon tax would be dwarfed by the economic benefits of full expensing. A carbon tax of $20 per metric ton of carbon (roughly equivalent to the $23 per metric ton that Curbelo proposed) would reduce long-run GDP by .8 percent, while raising $857 billion in GDP after accounting for economic effects. Meanwhile, the full expensing of capital investments would increase GDP by 3.1 percent, while reducing revenue by roughly the same amount a carbon tax would raise.
A revenue-neutral tax reform that featured permanent income tax cuts and the full expensing of all capital investments would more than cancel out the negative economic and distributional impacts of the carbon tax, while significantly reducing carbon emissions and paving the way for a more environmentally friendly future.