A U.S. Carbon Tax and the Earned Income Tax Credit: An Analysis of Potential Linkages

A U.S. Carbon Tax and the Earned Income Tax Credit: An Analysis of Potential Linkages Aparna Mathur and Adele C. Morris June 30, 2017 This paper examines, individually and jointly, an excise tax on carbon and an expansion of EITC benefits to childless workers. We estimate how an illustrative tax of $32 per ton of CO2 from fossil fuel combustion would burden households differentially across the income distribution, how it could affect worker benefits from the existing EITC program by lowering wages, the share of the revenue that would be necessary to fund an EITC expansion to childless workers, and the further resources policymakers would need to target to low income households to hold them unburdened on average from a carbon tax. We find that although in principle a carbon tax that lowers wages could affect EITC benefits and thus impact low-to-moderate income households, the likely magnitude of the effects is very small. We find that far more important to the distribution of burden is the extent to which the carbon tax passes through to raise retail prices, a decidedly regressive outcome, versus lowering wages, which is distributionally much more neutral. Using emissions and other data from 2013 and 2014, we also find that the revenue from the carbon tax could be enough to expand the EITC to childless workers and hold other low income households harmless, combining a regressive tax with progressive benefits. We find that such a policy package could create net benefits for on average for the lowest income deciles while improving incentives to work and providing environmental benefits. Keywords: Carbon tax, tax swap, EITC, distributional issues Adele Morris gratefully acknowledges support for her work from the Laura and John Arnold Foundation. We thank program participants at the 2015 National Tax Association Meetings for their comments. We gratefully acknowledge Nicholas Montalbano, Cody Kallen, and Adele Hunter for their excellent research assistance and Donald Marron for his helpful comments. The views expressed in the paper are those of the authors and should not be interpreted as reflecting the views of any of the above organizations or of the institutions with which the authors are affiliated.The findings and conclusions contained within are those of the author and do not necessarily reflect positions or policies of the Tax Policy Center or its funders. TAX POLICY CENTER | URBAN INSTITUTE & BROOKINGS INSTITUTION 1 1. INTRODUCTION Economists have long argued that a price on carbon, such as through a carbon tax, is a critical component of efforts to stabilize greenhouse gases (GHGs) in the atmosphere. One concern about the policy, however, is its negative effect on low income households, both in absolute terms and relative to higher income households. A carbon tax would be regressive because lower income households tend to spend a higher percentage of their income on energy and other goods whose relative prices will increase under a carbon tax. A number of analysts have noted that policymakers could target some of the revenue to benefit low income households so that on average they bear no net burden from the tax. Recent proposals in the United States, such as Stone (2015), call for channeling carbon tax revenues to low income households through a portfolio of existing social safety net programs, including refundable tax credits like the Earned Income Tax Credit (EITC). Households that file a federal tax return could receive tax credits in an amount on par with an estimate of the burden they bear from the carbon tax. Stone (2015) suggests that this approach, along with supplements to social security payments and state-run food stamp benefits for non-filers, could ensure that about 95 percent of households with incomes below 150 percent of poverty levels would be no worse off under a carbon tax than they would be without it.1 Entirely independent of the context of the carbon tax, policy advocates have called for the expansion of the EITC to boost the income of childless workers, married or single. Members of both political parties support the expansion to childless workers.2 Progressives like the additional income support for low-income workers and conservatives like the work incentive that comes with an EITC benefit. But without an obvious way to pay for the benefits, the potentially bipartisan proposal has stalled. Thus the question arises how policymakers might combine a carbon tax and an EITC expansion, pairing a regressive tax with progressive benefits. Background on the EITC The EITC is a tax credit program that provides money to low- and moderate-income working people in proportion to their earned income. The EITC is fully refundable, meaning that the credit is available to eligible participants whether they owe income taxes or not. It is one of the largest anti-poverty programs in the United States, and the largest such program implemented through the tax system. Its ef