Warming Up to a Carbon Tax

With a growing national debt, heightened concern about global warming and continual debate over federal tax reform, might a carbon tax lie in our future?

November 29, 2007
by Annette Nellen, CPA/Esq.

Reports made by the United Nations and other groups over the past year have concluded that global warming is a certainty (United Nations Intergovernmental Panel on Climate Change, Pew Center on Global Climate Change and others). Greenhouse gases (GHG) trap heat in the atmosphere that slowly warms the earth. The primary greenhouse gas is carbon dioxide (CO2) generated from the burning of fossil fuels, such as oil, coal and natural gas.

The U.S. is the largest emitter of greenhouse gases (November 2007 report (PDF) from the Climate Change Science Program). Increased world attention to climate change will likely put pressure on the U.S. to reduce its GHG emissions. In addition, many state and local governments have taken actions to address global warming. They will also push for national remedies.

In January 2007, the Senate Committee on Energy and Natural Resources held a hearing on a proposed cap and trade system (a cap and trade system involves a government set limit on GHG emissions for particular industries. Companies are then issued certificates indicating how much they are allowed to emit, with allowances decreasing each year. If a company needs to emit more than allowed, it will need to either find a way to reduce its emissions or purchase certificates from others. This system employs market forces to encourage companies to determine their best reduction strategy.). In November 2007, the Senate Committee on Environment and Public Works held hearings on a climate security proposal (S. 2191).

In addition to discussions at both the federal and state levels on a cap and trade system to reduce GHG emissions, taxes have also been proposed by Congressmen Pete Stark (D-Calif.), John Dingell (D-Mich.) and others.

U.S. Budget and Tax Challenges

A $158 billion budget deficit is projected for 2007 (Congressional Budget Office, Budget and Economic Outlook (PDF), August 2007). If the 2001 and 2003 tax breaks are not renewed when they expire after 2010, a surplus is projected for future years. However, desire to extend all or most breaks and repeal the individual AMT will require new revenues and/or spending cuts. A possible source of revenue is a carbon tax imposed on certain activities that produce GHG emissions.

In addition, continued discussions on federal tax reform could include replacing a portion of the current income tax or payroll tax with an environmental tax, such as a carbon tax.

Carbon Tax Logic

The base of a carbon tax would be the carbon content of coal, oil and natural gas.

Benefits of a carbon tax include:

  1. The increased cost of fossil fuels will lead many taxpayers to reduce usage and consider alternative energy sources.
  2. The tax would cause the price of fossil fuels to include costs to society of pollution, GHG emissions and depletion of a natural resource that is associated with the burning of fossil fuels. If such a tax is designed to be visible to the end user, it would increase awareness of what activities cause global warming.
  3. The rate could be increased regularly to encourage taxpayers to continue to reduce their use of fossil fuels.
  4. Transitional rules could be included to provide time for people to find ways to reduce their use of fossil fuels. For example, utility companies will not be able to alter their energy sources overnight.
  5. The revenue could be used to fund development of renewable energy, environmental clean-up, tax reductions and/or to improve the operation of other taxes.

Disadvantages of a carbon tax include:

  1. For simplicity and effective administration, a carbon tax would likely be imposed on producers or retailers, rather than the final consumer. Thus, the tax may not be visible to the end-user and the intended behavioral change may not occur to the desired extent.
  2. While a carbon tax can help cover costs of burning fossil fuels, it is unlikely to be effective in helping the government reach a specific GHG emission reduction target.
  3. It may be difficult to determine how best to use the funds generated.

Design Issues and Proposals

Many design questions exist in the creation of a carbon tax. Who should the tax be imposed upon and at what level (extractor, refiner, distributor, retailer and/or consumer)? Should any taxpayers be exempt? What relief can and should be provided to address the regressivity of the tax? Should the tax be part of a larger federal tax reform effort?

While these questions have not been vetted in tax-writing committees, a few proposals have been introduced in the 110th Congress. In addition carbon tax examples exist because some countries, such as Sweden, have had them for several years and the City of Boulder, Colorado enacted one in 2006.

Congressman Dingell has proposed a $50 tax per ton of carbon content of coal, petroleum and natural gas to be phased in over five years. He would also increase the tax on gasoline and jet fuel by 50 cents per gallon. Congressman Stark proposes a tax of $10 per ton of carbon content of fossil fuels, increasing $10 each year until a specified level of GHG emissions is achieved (H.R. 2069).

Congressman John Larson (D-Conn.) proposes a $15 per ton of carbon content of fossil fuels (H.R. 3416). The funds collected would be used for research and a payroll tax refund. Use of a tax to reduce another tax is referred to as a “tax shift.” Congressman Larson describes his proposal as “an important move toward shifting taxes away from positive things, like labor, and onto negative things, like pollution” (August 2007 press release).

The carbon tax used in Boulder is added to utility bills. Most of the city’s electricity is generated from coal. The tax is estimated to be about $1.33 per household per month and almost four dollars per month for businesses (City of Boulder, 11/8/06).


A carbon tax would increase the cost of doing business for everyone given the pervasive use of fossil fuels in the U.S. While taxpayers seem to prefer a tax shift in order to recoup a portion of their carbon tax through another tax, given revenue needs, a carbon tax is likely to be used to prevent or reduce an income tax increase. A tax or other type of market-based remedy (such as cap and trade) is inevitable given the need to reduce GHG emissions. Businesses should consider working with their respective industry associations to encourage implementation of incentives along with any proposed carbon tax to assist in efforts to reduce reliance on fossil fuels. Such incentives might include rapid depreciation of renewable energy devices and tax credits.

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Annette Nellen, CPA, Esq., is a tax professor and Director of the MST Program at San José State University. She is also a fellow with the New America Foundation. Nellen is an active member of the tax sections of the AICPA and ABA. She has several reports on federal and state tax reform and a blog.