Testimony of Robert Greenstein, Executive Director, Center on Budget and Policy Priorities at the Hearing on the Tax Aspects of a Cap-and-Trade System, Senate Committee on Finance

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April 24, 2008

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Strong and effective measures are needed to reduce greenhouse gas emissions and prevent costly and potentially catastrophic environmental and economic damage as a result of climate change.  The Center on Budget and Policy Priorities’ area of expertise is not in environmental policy per se but in the impacts that climate-change policies can have on the budgets of American families — especially those of modest means — and on the federal budget.

Congress can develop climate-change policy that is environmentally and economically sound and fiscally responsible, treats low-income families equitably, and avoids increases in poverty and hardship.  To achieve these objectives, the policy will need to be well designed.  This means, in part, that the policy will need to generate sufficient resources to address the requirements and challenges of sound climate-change policy and to mitigate the impact on vulnerable populations, especially people with low incomes.   If Congress decides to adopt a cap-and-trade approach, it will be important to auction off most or all of the emission allowances, to devote an adequate share of the proceeds to assisting low- and moderate-income consumers, and to make wise use of the other proceeds.  As explained below, this has important implications for tax policy.

My testimony covers the following matters:

  • Significant increases in the prices of energy and energy-related products will necessarily occur as a result of the enactment of effective policies to reduce greenhouse gas emissions.

  • Households with limited incomes will be affected the most by these higher prices, because they spend a larger fraction of their budgets on energy and energy-related products and because they are less able to afford investments that could reduce their energy consumption (such as a new, more fuel-efficient heating system or car).

  • A relatively modest percentage of the total value of the tradable emissions allowances that would be created by a cap-and-trade program — we estimate about 14 percent — would be sufficient to fund a climate rebate program that would preserve the purchasing power of the poorest 20 percent of the U.S. population and provide significant relief to people in the next poorest 20 percent.

  • Making sure that sufficient resources are available to shield low-income households from increased poverty and hardship is a necessary — but not a sufficient — step to avoid increases in poverty.  It also is essential to design measures that are effective in actually reaching low-income people, are efficient (with low administrative costs), and are consistent with energy conservation goals.

  • The tax system, including the Earned Income Tax Credit, has an important role to play in the design of such policies.  For example, a “climate rebate” could be added onto the EITC to help maintain the purchasing power of low-income working families.  At the same time, such assistance cannot be provided entirely through the tax system.  Many low-income consumers (including low-income elderly individuals, poor individuals with disabilities, and some of the poorest families in the nation) do not fall within the scope of the income tax system and will need to be reached through other means.

  • This can be done; policymakers can tap other existing mechanisms to identify eligible low-income households and efficiently deliver a climate rebate to low-income consumers who are not reached by the EITC.  As explained below, this can be accomplished efficiently and effectively through the electronic benefit transfer (EBT) systems that state human service agencies already use to provide various types of assistance to millions of poor households. 

  • The impact of climate-change policies on low-income consumers goes well beyond the direct effect of higher energy prices on their utility bills; more than half of the increased costs that low-income households would face would be for goods and services other than utilities.  This is one reason that relying on utility companies and expansions in the low-income home energy assistance program as the main ways to deliver low-income relief (an approach some climate-change proposals take) would not be especially effective or efficient, and why a rebate type of approach is more advisable.

In addition to issues relating to low-income consumers, my testimony makes the following points about the allocation of emissions allowances to meet crucial priorities:

  • Arguments that a large fraction of the allowances should be given away for free to existing emitters do not stand up to careful analysis.  The Congressional Budget Office has estimated that only 15 percent or less of the value of the allowances would be needed to offset the net financial losses that shareholders in companies affected by these policies would otherwise face.

  • If most (or all) of the permits were auctioned, Congress would secure sufficient resources to also mitigate impacts on middle-income consumers (as well as to address various other important needs related to climate change).  Later in this testimony, I describe one promising way to provide relief to middle-income consumers through a new climate-change tax credit.  This would be much more effective in protecting middle-income consumers than a reduction in individual income tax rates.

  • The higher prices for energy and energy-related products that would result from a cap on emissions would create strong incentives for energy conservation and private-sector investments in clean-energy technologies.  Proposals for additional tax incentives (or other federal subsidies) to promote alternative technologies and conservation should be carefully examined to ensure that resources are used only for cost-effective activities that would not take place anyway,in response to the higher energy prices that a cap-and-trade policy will generate.

  • I would suggest that the Finance Committee consider asking the Congressional Budget Office or other appropriate entity to undertake a comprehensive review of existing energy tax-incentives and subsidies to determine which incentives and subsidies would no longer be necessary or appropriate under a cap-and-trade regime that leads to higher prices for carbon-intensive energy sources and thus creates market incentives for investing in alternative energy sources and other means of reducing emissions.  Under a cap-and-trade system, the private market will provide much more robust incentives for such activities to be undertaken, and preferential tax treatment should no longer be necessary in some cases.  Eliminating current incentives that would be wasteful or redundant under a cap-and-trade system could free up resources to fund a substantial fraction of worthwhile new investment and conservation incentives that would complement the cap-and-trade program’s price signals.

The remainder of my testimony elaborates on these points.

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