In Carbon Tax Shifts and the Revenue-Neutrality Dilemma, Rory Gillis deconstructs the concept of revenue neutrality as applied to Pigouvian carbon taxes. These carbon taxes are, of course, price instruments, and their behavioral effects—the raison d’être of the taxing scheme—generally don’t depend on the specific use of any funds generated. But, as Gillis notes, the political viability of these carbon taxes often hinges on (typically vague) promises of “revenue neutrality,” which means (somewhat naïvely) that every dollar raised by a carbon tax will be offset by one dollar of tax cuts elsewhere. Gillis challenges this “standard definition” as “conceptually unclear,” then distinguishes two competing understandings of revenue neutrality.
In Gillis’s terms, “backwards-looking” revenue neutrality adheres to an enactment-year revenue baseline and effectively straightjackets future revenue increases. By contrast, “sideways-looking” revenue neutrality looks to a hypothetical—and frequently unknowable—current-year baseline calculated as if the carbon tax had never been promulgated.
For Gillis, neither understanding is particularly attractive. Backwards-looking neutrality is “normatively undesirable but [more easily] enforceable,” while sideways-looking neutrality is “normatively preferable, but relatively unenforceable.” Gillis suggests that, instead of delving deeper into the revenue neutrality boondoggle, carbon tax advocates should earmark new revenue to either specific spending projects (probably green) or direct transfers to individuals—so-called carbon tax dividends.
One of Gillis’s major contributions is a compelling series of four case studies that elucidate his critique of revenue neutrality in the carbon tax context. British Columbia and the United Kingdom enacted carbon taxes under the auspices of revenue neutrality, only to repudiate the concept within a decade. On the other hand, Washington State and Canada are the dogs that didn’t bark. Each jurisdiction saw carbon tax proposals fail, sometimes with collateral political consequences, and proponents’ promises of revenue neutrality proved important in these failures. Gillis treats these case studies as cautionary tales, and they aptly illustrate the conceptual incoherence of revenue neutrality.
From my perspective, however, there’s room for optimism in Gillis’s case studies: British Columbia and the United Kingdom retain substantial and effective carbon taxes, even after abandoning revenue neutrality. In this sense, the underlying “good” policies survived, while their “bad” (but politically expedient) corollaries died relatively quickly and quietly. Standing alone, this progression represents an unqualified win. Therefore, the true costs of renouncing revenue neutrality must lie elsewhere, either in lost political capital to enact other “good” policies within the jurisdiction or in popular mistrust that causes revenue-neutral carbon taxes to fail in other jurisdictions. Accounting for these second-order costs would move us towards a more comprehensive understanding of the political economy of climate policy.
In addition, Gillis’s critique of revenue neutrality revives strands of the Bittker-Surrey debate over tax expenditures and a comprehensive income tax base. Channeling some of Bittker’s pointed nihilism (but, sadly, without his graceful prose), one might conclude that of course revenue neutrality lacks a concrete conceptual foundation. But Surrey’s side might shed more light on the political economy that Gillis describes. Surrey recognized that persuading the public was an essential element of the tax expenditure project. In Treasury’s inaugural 1968 attempt at tax expenditure analysis, the grand list of pernicious provisions failed to include imputed income from owner-occupied housing, an omission that was entirely intentional. Surrey hoped that taxpayers eventually might accept a more complete understanding of income, but he also knew that ordinary folks would balk—and hard!—at certain inclusions, even if technically correct. Similarly, a rhetoric of revenue neutrality might bridge gaps between popular opinion and expertise on climate issues, at least for certain populations and at certain times. Further specification of these conditions is warranted.
Finally, it seems worth noting that any definition of revenue neutrality fails to account for the full cost of a Pigouvian carbon tax to current voters. By factoring externalities into private costs, carbon taxes cause individuals to switch from high-externality goods and services to lower-externality substitutes. In many cases, these individuals will be worse off after switching, at least in the near term. It would take a particularly expansive definition of revenue neutrality to encompass these welfare losses; indeed, compensating individuals for these losses could erode the carbon tax’s effectiveness. These switching costs, as well as very real distributional concerns, may help explain the depth of popular skepticism toward revenue neutrality in the carbon tax context—and also may point to other reasons to prefer (progressive) earmarks when designing carbon taxes.
Overall, Gillis’s excellent and informative article represents a significant contribution to the literature on carbon taxes. By challenging the conceptual underpinnings of “revenue neutrality,” Gillis opens new perspectives, and introduces valuable prescriptions, for academics and policymakers interested in environmental issues.