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Tax Reform: The Case for Pollution Taxes

J. Mijin Cha

Regardless of whether you think taxes should be increased or decreased, there is one point in which most people agree: Our current tax system is too complex and in desperate need of reform.

The solution, however, is not to get rid of taxes but to shift what we tax. Our current tax system taxes a lot of things that are good, like work and wealth creation. Instead, a larger portion of our tax revenue should come from taxing things that are bad, like pollution and overusing natural resources. If pollution was taxed, for example, it would accomplish two things: one, it would create a revenue source to help offset the economic damage caused by pollution. Two, it would create a financial incentive to decrease pollution. Decreasing pollution could then have a ripple economic effect. It would make our air and water cleaner, which would decrease mitigation costs and cleaner air and water would make people healthier, which in turn would decrease health care costs. In short -- more revenue, fewer costs to individuals.

So far, this simple logic hasn't gotten much traction in the United States. Among OECD countries, the U.S. gets the least amount of revenue from environmental-related taxation. As shown in the graph below, we receive just under 3 percent of our revenue from environmental taxes, while strong economies like Germany receive twice as much.

Source: OECD

Recent reports from the European Environment Agency (EEA) highlight the benefits of environmental tax refroms (or ETR). Such taxes, say the agency, play an important role in spurring innovation -- both by making it more cost effective to innovate and by generating funds to support innovation. The EEA also found that environmental taxation cut employer pension costs in Germany and created an estimated 250,000 jobs.

As part of their reports, the EEA modeled the impact of environmental taxation with revenues going toward cutting social security payments and income taxes and funding innovation. The model found that increasing the cost of emitting one ton of carbon dioxide to 68 Euros by 2020 could create 152,000 additional jobs. The model also found that environmental taxes would help the EU meet their greenhouse gas reduction target of 20 percent by 2020 and would increase employment by more than 1 million jobs. While there was an increase in cost to households, this could be offset by targeted benefit transfers to avoid placing economic burdens on struggling households.

Carbon taxes are one form of pollution tax where a price is paid for each ton of carbon dioxide emitted. Australia recently became the latest country to adopt a carbon tax. Under it, companies will initially pay $23 AUD per ton of carbon dioxide emitted. This price will gradually increase until 2015 when it will shift to a trading scheme and let the market set the price. The revenue from the carbon tax will be used to help offset increased costs for affected companies and consumer. Because carbon taxes will result in increased prices for many goods, rebates are necessary for lower income individuals to help offset their increased costs. Finland and Sweden also have implemented a carbon tax.

In the U.S., voters in Boulder, Colorado approved the nation’s first city-wide carbon tax in 2006. Since then, there has been increasing support for a carbon tax in the U.S., including from the conservative American Enterprise Institute. Taxes could also be levied on sulfur in fossil fuels or lead in gasoline, things that create pollution and are bad for the environment and for public health.

Let's put it this way: There is something to be said about a fiscal policy that is supported by progressives and by the American Enterprise Institute. Who knew that it would be the carbon tax that brought us together?