A Fee and Dividend but Without the Dividend—How Good Ideas Turn Less Good

March 7th, 2017 <-- by Paul Higgins -->

The fee and dividend put forward by conservative thought leaders recently would cause a reduction in greenhouse gas emissions and provide us with a more stable climate system. It would also help most low-income families and take the sting out of any increase in energy and transportation prices, if they happen. We know all of that from basic economics and from decades of intensive research on the climate system (and also my posts here and here).

One of the key obstacles the idea will face is that an emission fee without the dividend would provide a new revenue stream. That revenue stream is highly alluring to those who want to create new federal programs, particularly if they can’t win a more direct argument to obtain the federal funding they need to finance those programs.

To examine the idea of exchanging the dividend for funding for new federal programs we need to consider two separate issues. The first is whether it makes sense to use the revenue from an emission fee to increase federal revenue. If so, the second issue is figuring out what the revenue from an emission fee would be best used for.

Let’s take those issues in reverse order. If it makes sense to treat the emission fee as a new source of revenue, what should that revenue go towards?

Proponents of climate protection typically want to apply revenues from carbon pricing to renewable energy, research and development of low emission technologies, and climate change adaptation.

Such investments might make sense. Renewable energy could help replace fossil energy sources, help address traditional forms of air pollution, and help protect the climate system. Research and development of low emission technologies could create new job opportunities, make it possible to reduce our impact on the climate system without reducing our energy usage, and accelerate innovation. Some impacts of climate change are inevitable and we might avoid much suffering by building our resilience to the climate impacts that lie ahead.

As these examples illustrate, using the revenue from an emission fee could make possible additional approaches to climate change risk management. These would be entirely additional to the risk management that would follow from the emission fee itself.

However, we could use any source of revenue for such initiatives. We could redirect funds that currently go to existing programs, we could increase taxes to generate the necessary funds, or we could borrow money to finance them. Why not use the regular appropriations process to provide the funding that these programs need, if they are worthwhile?

Similarly, we could use the revenue from an emission fee for anything. Other new federal programs might make as much, or more, sense as those described above. For example, the revenue from an emission fee could increase research on cancer, or make pre-K education possible for all. It could be used to strengthen border security, to fund additional basic research, or to deploy missile defense systems. Of course, it could also be used to reduce the federal deficit or to lower existing taxes on sales, income, or investments.

If the current federal budget accurately reflects the nation’s priorities, then it makes sense to use the revenue somewhat more consistently with how we use other sources of revenue. Alternatively, it might make sense to have a broader national discussion about priorities to determine what the new revenue, if used, should go toward.

The key point is that the source of revenue (an emission fee in this case) does not necessarily (and typically does not) drive what that revenue is used for. Why should it in this case?

This brings us to the broader issue of whether it makes sense to use the revenue from an emission fee as a new source of federal revenue.

There are four options for the money from the carbon fee. We could: 1) fund new federal programs, 2) reduce existing taxes (i.e., hold federal revenue constant), 3) reduce the federal budget deficit, or 4) return the money to the people directly (e.g., through the dividend). There are arguments for each of these four options.

Returning the money directly to the people would help take the sting out of increasing energy and transportation prices, if they occur. That would reduce the potential for a political backlash if electric bills or prices at the pump increase. It would also largely take care of the potential for the emission fee to disproportionately harm low-income families (as I described in this post).

People would be less likely to mobilize against higher energy and transportation prices if they receive a nice sized dividend check every few months. Equivalently, people would be willing to accept a larger emission price if they receive those dividend check. So the dividend makes it possible for the fee to be higher and it is more likely to remain in place than it would otherwise be. That translates directly into increased climate protection.

Each of the other three options would also have obvious advantages: we could lower our taxes, reduce the federal budget deficit, or create new federal programs. But each of those options must come at the expense of the dividend checks. That means we would all feel the direct effects of any increase in energy and transportation prices while the benefits of the fee would be more diffuse. That makes emission pricing less likely to succeed or requires that the emission fee be lower than it would be with a dividend.

It would also likely be more difficult to enact a fee without a dividend in the first place. Expanding government simply doesn’t fly for most conservatives. That is a big reason why the conservatives who came up with this implementation of the fee included the dividend. So the dividend appears to increase the potential for broader political support.

To be effective, an emission fee must be first enacted and then sustained over the full length of time that it takes to fully reduce our emissions—probably several decades. That means the policy approach needs to withstand potential backlashes that could occur if energy and transportation prices rise. That is part of the genius of the dividend checks because those dividend checks will rise right along with expenses on energy and transportation.

Instead, we could use the revenue from an emission fee and there could be benefits of doing so. As is always the case with policy, there are no unambiguous answers and people can disagree.

But the dividend allows an emission fee to be as high as possible and to be as politically sustainable as possible. Those are very significant advantages. Giving up the dividend would make an emission price harder to enact, harder to sustain over time, and less effective than it could otherwise be. Ultimately, that would weaken the climate protection offered by an emission fee. That isn’t worth it.

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