The Effects of Climate-Change Policies on the Federal Budget and the Budgets of Low-Income Households
An Economic Analysis
 See Congressional Budget Office, Statement of Peter R. Orszag, Director, “Approaches to Reducing Carbon Dioxide Emissions,” before the Committee on the Budget, U.S. House of Representatives, November 1, 2007, and Letter from Peter R. Orszag, Director, Congressional Budget Office, to Senator Jeff Bingaman, July 9, 2007
 More accurately, limiting or offsetting the amount of carbon-equivalent emissions released into the atmosphere is the key. Fossil fuels can be burned without contributing to the buildup of greenhouse gases in the atmosphere if there is a way to directly “capture and sequester” or to indirectly “offset” the carbon dioxide released from burning fossil fuels so that there is no net increase in atmospheric concentrations. Other greenhouse gases would also have to be accounted for in a comprehensive policy.
 An allowance must exist for each ton of carbon ultimately released into the atmosphere. For practical reasons, it is easier to require that energy producers have an allowance for each ton of carbon they introduce into the economy whether or not they are the ones that actually do the burning. For example, an oil importer would be required to have an allowance even though most of the carbon in a barrel of oil is not released into the atmosphere until it is burned as gasoline or another fuel.
 The government could also set a floor on the price of emission allowances by purchasing any surplus allowances that became available at the floor price. That would maintain price incentives for conservation and alternative-energy development when energy demand declines (such as during a recession). By setting both a floor and a ceiling, the government could limit destabilizing fluctuations in allowance prices in both directions.
 Congressional Budget Office, Budget Options, February 2007, p. 331.
 The intended effect of the policy is to reduce carbon emissions, and the more effective the tax is in encouraging emissions reductions, the smaller the base on which the tax will be collected. Thus, a very high tax rate (or very tight emissions cap) could raise substantial revenue at the beginning, but as the economy adapted to the high cost of energy over time, emissions (and hence tax revenues) would fall.
 A tax of $55 per ton of carbon is equivalent to a tax of $15 per ton of carbon dioxide, because burning a ton of carbon results in 44/12ths tons of carbon dioxide.
 See Gilbert E. Metcalf, “A Proposal for a U.S. Carbon Tax Swap: An Equitable Tax Reform to Address Global Climate Change,” The Hamilton Project, The Brookings Institution, October 2007, p. 12.
 Congressional Budget Office, testimony, op. cit.
 The 15 percent figure is a net figure and includes some offsetting gains, such as those that companies producing “clean” energy would secure. Such companies would benefit from higher prices without incurring new costs. (In addition, some energy companies could incur losses in some areas and gains in others.)
 The government would receive some revenue from the taxation of those windfall profits, but the amount collected would be far less than the full value of the permits.
 Climate-change policy increases the price of energy relative to the price of other goods and services, but the overall inflation rate will be determined by the monetary policy actions of the Federal Reserve, which should be able to keep overall inflation within its target range. In addition, while climate-change policy will reduce output and employment in some industries, in the long run there should be compensating increases in output and employment in other industries.
 Standard measures of economic activity, such as the gross domestic product (GDP), measure market activity and do not capture the non-market benefits of conservation or non-market costs such as environmental damage. In the long run, however, even conventionally measured economic activity could be higher than it would have been without action to address climate change, because some of the costs of climate change that would be avoided are economic costs that would be captured in measured GDP.
 In the environmental economics literature, this is called the “tax interaction” effect. Higher energy prices that raise the price of consumer goods lower the reward to working or saving and may thereby increase any pre-existing disincentives to work or save. There is controversy over the size of these pre-existing distortions. If they are small to begin with, any additional cost to the economy will be small as well.
 The Center’s methodology differs from CBO’s in an important respect. CBO’s figure is for the one fifth of households with the lowest incomes, not for 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 U.S. population. 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.)
CBO has developed a standard methodology for how to address this problem when ranking households by quintile, so that one can examine the poorest fifth of the population, rather than the bottom fifth of households irrespective of household size. CBO uses that methodology in most work it conducts on income distribution issues. The $680 figure for the bottom fifth, however, was not calculated using this preferred methodology.
The income limits for the top and bottom fifths cited in this paragraph are based on the Census Bureau’s standard definition of “money income” (i.e., cash income), with households ranked using CBO’s size-adjustment methodology.
 The exact percentage would depend not only on the precise size of the cost impact but also on the precise way that income is measured in the denominator.
 The price incentives created by a cap-and-trade system or carbon tax will encourage profitable investments in clean-energy technologies and technologies for sequestering greenhouse gases, but there may be other investments with a high social rate of return whose benefits cannot be fully captured by private investors. Government subsidies or direct public investment can be justified in such cases, where the returns are not fully “appropriable.” Such investments tend to be in basic research or pre-market development rather than in commercial development.
 These losses are what economists call “deadweight” or “welfare” losses from the changes in economic activity induced by the emissions-reduction policy. Such losses are not always reflected in measures of output such as GDP. To the extent that people purchase additional clothes to keep them warm when they cut back on home heating in winter, for example, their economic welfare is lower but there may be no corresponding reduction in GDP.
 Testimony of CBO Director Orszag, op. cit..
 Congressional Budget Office, letter to Senator Jeff Bingaman, Chairman, Committee on Energy and Natural Resources, United States Senate, July 9, 2007, pp. 3-4.
 Greg Mankiw, “Greg Mankiw’s Blog: Random Observations for Students of Economics,” August 2, 2007.