Could a Carbon Tax Save the Build Back Better Agenda?

Democrats in Congress may have to shrink the size of the proposed spending package, the Build Back Better Act, to get the Senate votes necessary to pass it under budget reconciliation. The Washington Post reports that officials in the White House are facing the choice of paring the budget bill down to fewer fully articulated programs or maintaining its full scope but reducing the size of each program. This could have implications for the climate provisions in the bill, which amount to nearly $700 billion in spending and tax credits.

It’s unlikely that climate provisions would be dropped entirely, but policymakers may be looking for ways to get more climate bang for fewer bucks. It is not certain they can meet the topline spending demands of Senators Manchin and Sinema, as well as the energy priorities of Senator Manchin, without scaling back on climate ambition. In the past few weeks, a carbon tax has been floated as a way to triangulate three key desires: avoid increases in corporate taxes, prioritize other spending, and reduce greenhouse gas emissions. In all three areas, it is clear that a carbon tax could help break the apparent impasse, and the tax mechanism fits nicely in the budget reconciliation process.

On emissions, a carbon tax will cause reductions when it is high enough to drive behavioral or investment decisions toward low-carbon options. Modeling from Resources for the Future shows that a carbon tax starting at $15 per ton and rising to $30 per ton in 2028 would reduce economy-wide emissions by 44 to 45 percent against the 2005 reference value by the end of the decade. If that same tax was applied along with the subsidies for low-carbon energy and electric vehicles in the proposed package, then emissions predictions would fall below 52 percent of the reference, exceeding the president’s goal of a 50 percent reduction by the end of the decade. If a carbon tax were raised at a meaningful level, there is little doubt that it would add to the efficacy of the current package.

It may even serve as a concession to low-carbon fossil fuels. The incentives for clean power in the House do not include gas generation, which Senator Manchin supports. A carbon tax, however, would incentivize switching from coal to gas-fired generation as early as the first year it was implemented because of the higher CO2 emissions from coal-fired plants. While that too might draw Senator Manchin’s skepticism, a full suite of policies will likely be necessary to save coal and gas in a path to net zero. The National Petroleum Council’s 2019 report on carbon capture in the United States found that combined economic incentives above $90 per ton would be necessary in the coming 15 years to scale carbon capture technology. A carbon tax that credits carbon-capturing facilities for their part of the carbon tax, in combination with tax credits for carbon capture and storage and utility incentives for clean power, could be enough to allow companies to scale up carbon capture on a sustainable basis. This will be critical for gas as well since, as CSIS’s Nikos Tsafos recently wrote, reducing emissions from natural gas generation by half is as important to meeting the president’s goals for decarbonizing the power sector as reducing coal emissions.

It is unlikely that a late-to-the-negotiation carbon tax would displace other climate provisions that have already won political support, but it could allow for some of them to achieve the same outcomes for less spending. For example, the Build Back Better Act would spend up to $150 billion paying utilities to generate more clean power year-over-year. With a carbon tax also incentivizing cleaner power, the scale of that program might be reduced without missing climate targets down the line. Other grant programs, or tax credits, could similarly be scaled back where the carbon tax would be high enough to drive emissions reductions and maintained where a carbon tax is unlikely to drive significant emissions reductions (as with vehicle electrification) or where the carbon tax would help accelerate private investment around new government programs (as with new funding for green banks or loans to high-risk low-carbon industries). With climate spending in the House bill accounting to up to $700 billion, increasing efficiency might allow Democrats to save hundreds of billions in outlays. Any savings through such a rebalancing would allow for Democrats to maintain other pieces of their agenda.

Regardless of its final size, the president and congressional Democrats have said the Build Back Better plan should be paid for with tax increases. The proposal in the House of Representatives would increase the corporate tax rate to 26.5 percent from 21 percent, but such a tax increase is looking less likely to survive the Senate. Senator Manchin prefers a maximum rate of 25 percent and Senator Sinema is reportedly reluctant to support corporate tax increases as well (that reluctance reportedly raised a carbon price in these negotiations). Even under the president’s ambitious targets for U.S. emissions, a carbon tax starting at $5 per ton would raise something like $150–$200 billion, depending on design and Congressional Budget Office scoring, more than the $100 billion that the Joint Committee on Taxation estimates would come from increasing the corporate rate by 1 percent. If congressional negotiators want to hold the increase in corporate taxes to 23 or 25 percent, then even a modest carbon tax could maintain spending while still incentivizing emissions reductions.

The politics of pricing carbon have not been easy and will remain a challenge here. Unlike corporate taxes, the carbon tax has clear price impacts on gas and electricity. To offset those increases, carbon tax proposals canonically use carbon tax revenue to fund a dividend or targeted tax reductions for households. Doing so in this case would reduce revenue available for the other programs Democrats want to see pass. An alternative under consideration would be exempting gasoline from the carbon tax, where price increases are particularly salient and unlikely to drive large emissions reductions this decade. Doing so might reduce carbon tax revenue by 30 percent according to Resources for the Future’s modeling. There are clearly tradeoffs here.

What a carbon tax could add to the negotiations is more options for the Democrats to achieve policy goals. The imposition on consumers and households will be real, so the question is if the whole package of other clean energy incentives and grants, along with substantial increases in social spending, would do enough to ameliorate political risks. From a policy standpoint, a carbon tax could address the concerns about raising the corporate tax rate and the total size of the spending package. It could secure climate gains even with a smaller basket of investments. And procedurally, it would be allowed to extend beyond the 10-year budget window under the rules of budget reconciliation, since it raises revenue. If it were to work, it might be the most lasting part of the whole package.

Joseph Majkut is director of the Energy Security and Climate Change Program at the Center for Strategic and International Studies in Washington, D.C.

Commentary is produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).

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Joseph Majkut
Director, Energy Security and Climate Change Program