CARBON TAXES AND U.S. FISCAL REFORM

Abstract

This paper examines fiscal reform options in the United States using an intertemporal computable general equilibrium model of the world economy called G-Cubed. Six policy scenarios explore two overarching issues: (1) the effects of a carbon tax under alternative assumptions about the use of the resulting revenue, and (2) the effects of alternative revenue sources to reduce the budget deficit. We examine a simple excise tax on the carbon content of fossil fuels in the U.S. energy sector starting immediately at $15 per ton of carbon dioxide (CO2) and rising at 4 percent above inflation each year. We investigate policies that allow the revenue from the illustrative carbon tax to reduce the long-run federal budget deficit or the marginal tax rates on labor and capital income. We also compare imposing a carbon tax to increasing rates of other taxes to reduce the deficit by the same amount. We find that within 25 years of adopting the carbon tax, annual CO2 emissions are 20 percent lower than baseline levels. We find that using the revenue for a capital tax cut is significantly different than other revenue recycling policies. In that case, investment rises, employment and wages rise, and overall GDP is significantly above its baseline level through year 25. Thus, adopting a carbon tax and using the revenue to reduce capital taxes would achieve the dual goals of reducing CO2 emissions significantly and expanding employment and the economy.