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The US Has Hit Record High Fiscal and Trade Deficits

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A.  Introduction

The final figures to be issued before the election for the federal government fiscal accounts and for the US trade accounts have now been published.  The US Treasury published earlier today the Final Monthly Treasury Statement for the FY2020 fiscal year (fiscal years end September 30), and earlier this month the BEA and the Census Bureau issued their joint monthly report on US International Trade in Goods and Services, with trade data through August.  The chart above shows the resulting fiscal deficit figures (as a share of GDP) for all fiscal years since FY1948, while a chart for the trade deficit will be presented and discussed below.  The figures here update material that had been presented in a post from last month on Trump’s economic record.

The accounts show that the federal fiscal deficit as a share of GDP has reached a record level (other than during World War II), while the trade deficit in goods (in dollar amount, although not as a share of GDP) has also never been so high.  Trump campaigned in 2016 arguing that these deficits were too high, that he would bring them down sharply, and indeed would pay off the entire federal government debt (then at over $19 trillion) within eight years.  Paying off the debt in full in such a time frame was always nonsense.  But with the right policies he could have at least had them go in the directions he advocated.  However, they both have moved in the exact opposite direction.  Furthermore, this was not only a consequence of the economic collapse this year.  They were both already increasing before this year.  The economic collapse this year has simply accelerated those trends – especially so in the case of the fiscal deficit.

B.  The Record High Fiscal Deficit

The federal deficit hit 15.2% of GDP in FY2020 (using the recently issued September 2020 estimate by the CBO of what GDP will be in FY2020).  The highest it had been before (other than during World War II) was 9.8% of GDP in FY2009, in the final year of Bush / first year of Obama, due to the economic collapse in that final year of Bush.  In dollar terms, the deficit this fiscal year hit $3.1 trillion, which was not far below the entire amount collected in tax and other revenues of $3.4 trillion.

This deficit is incredibly high, which does not mean, however, that an increase this year was not warranted.  The US economy collapsed due to Covid-19, but with a downturn sharper than it otherwise would have been had the administration not mismanaged the disease so badly (i.e. had it not neglected testing and follow-up measures, plus had it encouraged the use of masks and social distancing rather than treat such measures as a political statement).  By neglecting such positive actions to limit the spread of Covid-19, the only alternative was to limit economic activity, whether by government policy or by personal decision (i.e. to avoid being exposed to this infectious disease by those unwilling to wear masks).

The sharp increase in government spending this year was therefore necessary.  The real mistake was the neglect by this administration of measures to reduce the fiscal deficit during the period when the economy was at full employment, as it has been since 2015.  Instead of the 2017 tax cut, prudent fiscal policy to manage the debt and to prepare the economy for the risk of a downturn at some point would have been to call for a tax increase under such conditions.  The tax cut, coupled also with an acceleration in government spending, led fiscal deficits to grow under Trump well before Covid-19 appeared.  Indeed, they grew to record high levels for periods of full employment (they have been higher during downturns).  As the old saying goes:  “The time to fix the roof is when the sun is shining.”  Trump received from Obama an economy where jobs and GDP had been growing steadily and unemployment was just 4.7%.  But instead of taking this opportunity to reduce the fiscal deficit and prepare for a possible downturn, the fiscal deficit was increased.

The result is that federal government debt (held by the public) has jumped to 102% of GDP (using the CBO estimate of GDP in FY2020):

The last time the public debt to GDP ratio had been so high was at the end of World War II.  But the public debt ratio will soon certainly surpass that due to momentum, as fiscal deficits cannot be cut to zero overnight.  The economy is weak, and fiscal deficits will be required for some time to restore the economy to health.

C.  The US Trade Deficit is Also Hitting Record Highs in Dollar Terms

In the 2016 campaign, Trump lambasted what he considered to be an excessively high US trade deficit (specifically the deficit in goods, as the US has a surplus in the trade in services), which he asserted was destroying the economy.  He asserted these were due to the various trade agreements reached over the years (by several different administrations).  He would counter this by raising tariffs, on specific goods or against specific countries, and through this force countries to renegotiate the trade deals to the advantage of the US.  Deficits would then, he asserted, rapidly fall.  They have not.  Rather, they have grown:

Trump has, indeed, launched a series of trade wars, unilaterally imposing high tariffs and threatening to make them even higher (proudly proclaiming himself “Tariff Man”).  And his administration has reached a series of trade agreements, including most prominently with South Korea, Canada, Mexico, Japan, the EU, and China.  But the trade deficit in goods reached $83.9 billion in August.  It has never been so high. The deficit in goods and services together is not quite yet at a record high level, although it too has grown during the Trump period in office.  In August that broader deficit hit $67.1 billion, a good deal higher than it ever was under Obama but still a bit less than the all-time record of a $68.3 billion deficit reached in 2006 during the Bush administration, at the height of the housing bubble.

The fundamental reason the deficits have grown despite the trade wars Trump has launched is that the size of the overall trade deficit is determined not by whatever tariffs are imposed on specific goods or on specific countries, nor even by what trade agreements have been reached, but rather by underlying macro factors.  As discussed in an earlier post on this blog, the balance in foreign trade will be equal to the difference between aggregate domestic savings and aggregate domestic investment.  Tariffs and trade agreements will not have a significant direct impact on those macro aggregates.  Rather, tariffs applied to certain goods or to certain countries, or trade agreements reached, may lead producers and consumers to switch from whom they might import items or to whom they might export, but not the overall balance.  Trade with China, for example, might be reduced by such trade wars (and indeed it was), but this then just led to shifts in imports away from China and towards such countries as Viet Nam, Cambodia, Bangladesh, and Mexico.  Unless aggregate savings in the US increases or aggregate investment falls, the overall trade deficit will remain where it was.

Tariffs and trade agreements can thus lead to switches in what is traded and with whom.  Tariffs are a tax, and are ultimately paid largely by American households.  Purchasers may choose either to pay the higher price due to the tariff, or switch to a less desirable similar product from someone else (which had been either more expensive, pre-tariff, or less desirable due to quality or some similar issue), but unless the overall savings / investment balance in the economy is changed, the overall trade deficit will remain as it was.  The only difference resulting from the trade wars is that American households will then need to pay either a higher price or buy a less desirable product.

It is understandable that Trump might not understand this.  He is not an economist, and his views on trade are fundamentally mercantilist, which economists had already moved beyond over 250 years ago.  But Trump’s economic advisors should have explained this to him.  They have either been unwilling, or unable, to do so.

Are the growing trade deficits nevertheless a concern, as Trump asserted in 2016 (when the deficits were lower)?  Actually, in themselves probably not.  In the second quarter of 2020 (the most recent period where we have actual GDP figures), the trade deficit in goods reached 4.5% of GDP.  While somewhat high (generally a level of 3 to 4% of GDP would be considered sustainable), the trade balance hit a substantially higher 6.4% of GDP in the last quarter of 2005 during the Bush administration.  The housing bubble was then in full swing, households were borrowing against their rising home prices with refinancings or home equity loans and spending the proceeds, and aggregate household savings was low.  With savings low and domestic investment moderate (not as high as a share of GDP as it had been in 2000, in the last year of Clinton, but close), the trade deficit was high.  And when that housing bubble burst, the economy plunged into the then largest economic downturn since the Great Depression (largest until this year).

Thus while the trade deficit is at a record level in dollar terms (the measure Trump refers to), it is at a still high but more moderate level as a share of GDP.  It is certainly not the priority right now.  Recovering from the record economic slump (where GDP collapsed at an annualized rate of 31% in the second quarter of 2020) is of far greater concern.  And while expectations are that GDP bounced back substantially (but only partially) in the third quarter (the initial estimate of GDP for the third quarter will be issued by the BEA on October 29, just before the election), the structural damage done to the economy from the mismanagement of the Covid-19 crisis will take substantial time to heal.  Numerous firms have gone bankrupt.  They and others who may survive but who have been under severe stress will not be paying back their creditors (banks and others), so financial sector balance sheets have also been severely weakened.  It will take some time before the economic structure will be able to return to normal, even if a full cure for Covid-19 magically appeared tomorrow.

D.  Conclusion

Trump promised he would set records.  He has.  But the records set are the opposite of what he promised.

Trump’s Attack on Social Security

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Trump famously promised in his 2016 campaign for the presidency that he would never cut Social Security.  He just did.  How much is not yet clear.  It could be minor or it could be major, depending on how he follows up (or is allowed to follow up) on the executive order he signed on Saturday, August 8 while spending a weekend at his luxury golf course in New Jersey.  The executive order (one of four signed at that time) would defer collection of the 6.2% payroll tax paid by employees earning up to $104,000 a year for the pay periods between September 1 and December 31 (usefully straddling election day, as many immediately noted).

What would then happen on December 31?  That is not clear.  On signing the executive order, Trump said that “If I’m victorious on November 3rd, I plan to forgive these taxes and make permanent cuts to the payroll tax.  I’m going to make them all permanent.”  He later added:  “In other words, I’ll extend beyond the end of the year and terminate the tax.”

The impact on Social Security and the trust fund that supports it will depend on how far this goes.  If Trump is re-elected and he then, as promised, defers beyond December 31 collection of the payroll tax that workers pay for their Social Security, the constitutional question arises of what authority he has to do this.  While temporary deferrals of collections are allowed during a time of crisis, what happens when the president says he will bar the IRS from collecting them ever?  The president swore in his oath of office that he would uphold the law, the law clearly calls for these taxes to be collected, and a permanent deferral would clearly violate that.  But would repeated “temporary” deferrals become a violation of the statutory obligations of a president?  And he has clearly already said that he wants to make the suspension permanent and to “terminate the tax”.

There is much, therefore, which is not yet clear.  But one can examine what the impact would be under several scenarios.  They are all adverse, undermining the system of retirement benefits that has served the country well since Franklin Roosevelt signed the program into law.

Some of the implications:

a)  Deferring the collection of the Social Security payroll taxes will lead to a huge balloon payment coming due on December 31:

The executive order that Trump signed directs that firms need not (and he wants that they should not) withhold from employee paychecks the 6.2% that goes to fund the employee share of the Social Security tax.  But under current law the taxes are still due, and would need to be paid in full by December 31.

Suppose firms did decide not to withhold the 6.2% tax, and instead allow take-home pay to rise by that amount over this four-month period straddling election day.  Unless deferred further, the total of what would have been withheld will now come due on December 31, in one large balloon payment.  For those on a two-week paycheck cycle, that balloon payment would have grown to 54% of their end of the year paycheck.  It is doubtful that many employees would be very happy to see that cut in end-year pay.  Plus how would firms collect on the taxes due on workers who had been with the firm but had left for any reason before December 31?  By tax law, the firms are still obliged to pay to the IRS the payroll taxes that were due when the workers were employed with them.

Hence most expect that firms will continue to withhold for the payroll taxes due, as they always have.  The firms would likely hold off on forwarding these payments to the IRS until December 31 and instead place the funds in an escrow account to earn a bit of interest, but they would still withhold the taxes due in each paycheck just as they always have (and as their payroll systems are set up to do).  This also then defeats the whole purpose of Trump’s re-election gambit.  Workers would not see a pre-election bump up in their take-home pay.

b)  But even in this limited impact scenario, there will still be a loss to the Social Security Trust Fund:

Thus there is good reason to believe that Trump’s executive order will likely be basically just ignored.  There would, however, still be a loss to the Social Security Trust Fund, although that loss would be relatively small.

Payroll taxes paid for Social Security go directly into the Social Security Trust Fund, where they immediately begin to earn interest (at the long-term US Treasury rate).  Based on what was paid in payroll taxes in FY2019 ($1,243 billion according to the Congressional Budget Office), and adjusting for the fewer jobs now due to the sharp downturn this year, the 6.2% component of payroll taxes due would generate approximately $40 billion in revenue each month.  Assuming the $160 billion total (over four months) were then all paid in one big balloon payment on December 31 rather than monthly, the Social Security Trust Fund would lose what it would have earned in interest on the amounts deferred.  At current (low) interest rates, the total loss to Social Security would come to approximately $250 million.  Not huge, but still a loss.

c)  If collection of the 6.2% payroll tax is deferred further, beyond December 31, the losses to the Social Security Trust Fund would then grow further, and exponentially, and become disastrous if terminated:

Trump promised that “if re-elected” he would defer collection by the IRS of the taxes due further, beyond December 31.  How much further was not said, but Trump did say he would want the tax to be “terminated” altogether.  This would of course be disastrous for Social Security.  Even if the employer share of the payroll tax for Social Security (an additional 6.2%) continued to be paid in (where what would happen to it is not clear), the loss to Social Security of the employee share would lead the Trust Fund to run out in less than six years.  At that point, under current law the amounts paid to Social Security beneficiaries (retirees and dependents) would be sharply scaled back, by 50% or more (assuming the employer share of 6.2% continued to be paid).

d)  Even if the Social Security Trust Fund were kept alive by Congress acting to replenish it from other sources of tax revenues, under current law individual benefits would be reduced on those who saw their payroll tax contributions diminished:

There is also an issue at the level of individual benefits, which I have not seen mentioned but which would be significant.  The extent of this impact would depend on the particular scenario assumed, but suppose that the payroll taxes that would have come due and collected from September 1 to December 31 were permanently suspended.  For each individual, this would affect how much they had paid in to the Social Security system, where benefits are calculated by a formula based on an individual’s top 35 years of earnings (with earnings from prior years adjusted to current prices as of the year of retirement eligibility based on an average wage inflation index).

The impact on the benefits any individual will receive will then depend on the individual’s wage profile over their lifetime.  Workers may typically have 20 or 25 or maybe even 30 years of solid earnings, but then also a number of years within the 35 where they may have been not working, e.g. to raise a baby, or were unemployed, or employed only part-time, or employed in a low wage job (perhaps when a student, or when just starting out), and so on.

There would thus be a good deal of variation.  In an extreme case, the loss of four months of contributions to the Social Security Trust Fund from their employment history might have almost no impact.  This would be the case where a worker’s income in their 36th year of employment history was very similar to what it was in their 35th, and the loss in 2020 of four months of employment history would lead to 2020 dropping out of their employment top 35 altogether.  But this situation is likely to be rare.

More likely is that 2020 would remain in the top 35 years for the individual, but now with four months less of payroll contributions being recorded.  One can then calculate how much their Social Security retirement benefits would be reduced as a result.

The formulae used can be found at the Social Security website (see here, here, and here).  Using the parameters for 2020, and assuming a person had earned each year the median wages for the year (see table 4.B.3 of the 2019 Annual Statistical Supplement of Social Security), one can calculate what the benefits would be with a full year of earnings recorded for 2020 and what they would be with four months excluded, and hence the difference.

In this scenario of median earnings throughout 35 years, annual benefits to the retiree would be reduced by $105 (from $17,411 without the four months of non-payment, to $17,306 with the four months of the payroll tax not being paid).  Not huge, but not trivial either when benefits are tied to a full 35 years of earnings.  That $105 annual reduction in benefits would have been in return for the one-time reduction of $669 in payroll taxes being paid (6.2% for four months where median annual earnings of $32,378 in 2019 were assumed to apply also in 2020 despite the economic downturn).  That is, the $669 not paid in now would lead to a $105 reduction in benefits (15.8%) each and every year of retirement (assuming retirement at the Social Security normal retirement age).

The loss in retirement benefits would be greater in dollar amount if the period of non-payment of the payroll tax were extended.  Assuming, for example, a scenario where it was extended for a full year (and one then had just 34 years of contributions being paid in, with the rest at zero), with wages at the median level throughout those now 34 years, the reduction in retirement benefits would be $316 each year (three times as much as for the four-month reduction).  Payroll taxes paid would have been reduced by $2,007 in this scenario, and the $316 annual reduction is again (given how the arithmetic works) 15.8% of the $2,007 one-time reduction in payroll taxes paid.

All this assumes Social Security would continue to pay out retiree benefits in accordance with current law and assumes the Trust Fund remained adequate.  The suspension of these payroll taxes would make this difficult, as noted above, unless there was then some general bailout enacted by Congress.  But any such bailout would raise further issues.

e)  If Congress were to appropriate funds to ensure the Social Security Trust Fund remained adequately funded, the resulting gains would be far greater for those who are well off than for those who are poor:

Suppose Congress allowed these payroll taxes to be “terminated”, as Trump has called for, but then appropriated funds to ensure benefits continued to be paid as per the current formulae.  Who would gain?

For at least this part of the transaction (the origin of the funds is not clear), it would be the rich.  The savings in the payroll taxes that would be paid in order to keep one’s benefits would be five times as high for someone earning $100,000 a year as for someone earning $20,000.  The tax is a fixed 6.2% for all earnings up to the ceiling (of $137,700 in 2020, after which the tax is zero).  The difference in terms of the benefits paid would be less, since the formulae for benefits have a degree of progressivity built-in, but one can calculate with the formulae that the change in benefits from such a Congressional bailout would still be 2.3 times higher for those earning $100,000 than for those earning $20,000.

One might question whether this is the best use of such funds.  Normally one would want that the benefits accrue more to the poor than to those who are relatively well off.  The opposite would be the case here.

f)  Importantly, none of this helps those who are unemployed:

Unemployment has shot up this year due to the mismanagement of the Covid-19 crisis, with the unemployment rate rising to a level not seen in the US since the Great Depression.  Unemployment insurance, expanded in this crisis, has proven to be a critical lifeline not only to the unemployed but also to the economy as a whole, which would have collapsed by even more without the expanded programs.

Yet cutting payroll taxes for those who have a job and are on a payroll will not help with this.  If you are on a payroll you are still earning a wage, and that wage is, except in rare conditions, the same as what you had been earning before.  You have not suffered, as the newly unemployed have, due to this crisis.  Why, then, should you then be granted, in the middle of this crisis where government deficits have rocketed to unprecedented levels, a tax cut?

It makes no sense.  Some other motive must be in play.

g)  This does make sense, however, if your intention is to undermine Social Security:

Trump pushed for a cut in the payroll taxes supporting Social Security when discussions began in July in the Senate on the new Covid-19 relief bill (the House had already passed such a bill in May).  But even the Republicans in the Senate said this made no sense (as did business groups who are normally heavily in favor of tax cuts, such as the US Chamber of Commerce), and they kept it out of the bill they were drafting.

The primary advisor pushing this appears to have been Stephen Moore, an informal (unpaid) White House advisor close to Trump.  He co-authored an opinion column in The Wall Street Journal just a week before Trump’s announcement advocating the precise policy of deferring collection of the Social Security payroll tax.  Joining Moore were Arthur Laffer (author of the repeatedly disproven Laffer Curve, whom Trump had awarded the Presidential Medal of Freedom in 2019), and Larry Kudlow (Trump’s primary economic advisor and a strong advocate of tax cuts).

Moore has long been advocating for an end to Social Security, arguing that individual retirement accounts (such as 401(k)s for all) would be preferable.  As discussed above, the indefinite deferral of collection of the payroll taxes that support Social Security would, indeed, lead to a collapse of the system.  Thus this policy makes sense if you want to end Social Security.  It does not otherwise.

Yet Social Security is popular, and critically important.  Fully one-third of Americans aged 65 or older depend on Social Security for 90% or more of their income in retirement.  And 20% depend on Social Security for 100% of their income in retirement.  Cuts have serious implications, and Social Security is a highly popular program.

Thus advocates for ending Social Security cannot expect that their proposals would go far, particularly just before an election.  But suspending the payroll taxes that support the program, with a promise to terminate those taxes if re-elected, might appear to be more attractive to those who do not see the implications.

The issue then becomes whether enough see what those implications are, and vote accordingly in the election.

A Carbon Tax with Redistribution Would Be a Significant Help to the Poor

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A.  Introduction

Economists have long recommended taxing pollution as an effective as well as efficient way to achieve societal aims to counter that pollution.  What is commonly called a “carbon tax”, but which in fact would apply to all emissions of greenhouse gases (where carbon dioxide, CO2, is the largest contributor), would do this.  “Cap and trade” schemes, where polluters are required to acquire and pay for a limited number of permits, act similarly.  The prime example in the US of such a cap and trade scheme was the program to sharply reduce the sulfur dioxide (SO2) pollution from the burning of coal in power plants.  That program was launched in 1995 and was a major success.  Not only did the benefits exceed the costs by a factor of 14 to 1 (with some estimates even higher – as much as 100 to 1), but the cost of achieving that SO2 reduction was only one-half to one-quarter of what officials expected it would have cost had they followed the traditional regulatory approach.

Cost savings of half or three-quarters are not something to sneer at.  Reducing greenhouse gas emissions, which is quite possibly the greatest challenge of our times, will be expensive.  The benefits will be far greater, so it is certainly worthwhile to incur those expenses (and it is just silly to argue that “we cannot afford it” – the benefits far exceed the costs).  One should, however, still want to minimize those costs.

But while such cost savings are hugely important, one should also not ignore the distributional consequences of any such plan.  These are a concern of many, and rightly so.  The poor should not be harmed, both because they are poor and because their modest consumption is not the primary cause of the pollution problem we are facing.  But this is where there has been a good deal of confusion and misunderstanding.  A tax on all greenhouse gas emissions, with the revenue thus generated then distributed back to all on an equal per capita basis, would be significantly beneficial to the poor in purely financial terms.  Indeed it would be beneficial to most of the population since it is a minority of the population (mostly those who are far better off financially than most) who account for a disproportionate share of emissions.

A specific carbon tax plan that would work in this way was discussed in an earlier post on this blog.  I would refer the reader to that earlier post for the details on that plan.  But briefly, under this proposal all emissions of greenhouse gases (not simply from power plants, but from all sources) would pay a tax of $49 per metric ton of CO2 (or per ton of CO2 equivalent for other greenhouse gases, such as methane).  A fee of $49 per metric ton would be equivalent to about $44.50 per common ton (2,000 pounds, as commonly used in the US but nowhere else in the world).  The revenues thus generated would then be distributed back, in full, to the entire population in equal per capita terms, on a monthly or quarterly basis.  There would also be a border-tax adjustment on goods imported, which would create the incentive for other countries to join in such a scheme (as the US would charge the same carbon tax on such goods when the source country hadn’t, but with those revenues then distributed to Americans).

The US Treasury published a study of this scheme in January 2017, and estimated that such a tax would generate $194 billion of revenues in its initial year (which was assumed to be 2019).  This would allow for a distribution of $583 to every American (man, woman, and child – not just adults).  Furthermore, the authors estimated what the impact would be by family income decile, and concluded that the bottom 7 deciles of families (the bottom 70%, as ranked by income) would enjoy a net benefit, while only the richest 30% would pay a net cost.

That distributional impact will be the focus of this blog post.  It has not received sufficient attention in the discussion on how to address climate change.  While the Treasury study did provide estimates on what the impacts by income decile would be (although not always in an easy to understand form), views on a carbon tax often appear to assume, incorrectly, that the poor will pay the most as a share of their income, while the rich will be able to get away with avoiding the tax.  The impact would in fact be the opposite.  Indeed, while the primary aim of the program is, and should be, the reduction of greenhouse gas emissions, its redistributive benefits are such that on that basis alone the program would have much to commend it.  It would also be just.  As noted above, the poor do not account for a disproportionate share of greenhouse gas emissions – the rich do – yet the poor suffer similarly, if not greater, from the consequences.

This blog post will first review those estimated net cash benefits by family income decile, both in dollar amounts and as a share of income.  To give a sense of how important this is in magnitude, it will then examine how these net benefits compare to the most important current cash transfer program in the US – food stamp benefits.  Finally, it will briefly review the politics of such a program.  Perceptions have, unfortunately, been adverse, and many pundits believe a carbon tax program would never be approved.  Perhaps this might change if news sources paid greater attention to the distribution and economic justice benefits.

B.  Net Benefits or Costs by Family Income Decile from a Carbon Tax with Redistribution

The chart at the top of this post shows what the average net impact would be in dollars per person, by family cash income decile, if a carbon tax of $49 per metric ton were charged with the revenues then distributed on an equal per capita basis.  While prices of energy and other goods whose production or use leads to greenhouse gas emissions would rise, the revenues from the tax thus generated would go back in full to the population.  Those groups who account for a less than proportionate share of greenhouse gas emissions (the poor and much of the middle class) would come out ahead, while those with the income and lifestyle that lead to a greater than average share of greenhouse gas emissions (the rich) will end up paying in more.

The figures are derived from estimates made by the staff of the US Treasury – staff that regularly undertake assessments of the incidence across income groups of various tax proposals.  The study was published in January 2017, and the estimates are of what the impacts would have been had the tax been in place for 2019.  The results were presented in tables following a standard format for such tax incidence studies, with the dollars per person impact of the chart above derived from those tables.

To arrive at these estimates, the Treasury staff first calculated what the impact of such a $49 per metric ton carbon tax would be on the prices of goods.  Such a tax would, for example, raise the price of gasoline by $0.44 per gallon based on the CO2 emitted in its production and when it is burned.  Using standard input-output tables they could then estimate what the price changes would be on a comprehensive set of goods, and based on historic consumption patterns work out what the impacts would be on households by income decile.  The net impact would then follow from distributing back on an equal per capita basis the revenues collected by the tax.  For 2019, the Treasury staff estimated $194 billion would be collected (a bit less than 1% of GDP), which would allow for a transfer back of $583 per person.

Those in the poorest 10% of households would receive an estimated $535 net benefit per person from such a scheme.  The cost of the goods they consume would go up by $48 per person over the course of a year, but they would receive back $583.  They do not account for a major share of greenhouse gas emissions because they cannot afford to consume much.  They are poor, and a family earning, say, $20,000 a year consumes far less of everything than a family earning $200,000 a year.  In terms of greenhouse gas emissions implicit in the Treasury numbers, the poorest 10% of Americans account only for a bit less than 1.0 metric tons of CO2 emissions per person per year (including the CO2 equivalent in other greenhouse gases).  The richest 10% account for close to 36 tons CO2 equivalent per person per year.

As one goes from the lower income deciles to the higher, consumption rises and CO2 emissions from the goods consumed rises.  But it is not a linear trend by decile.  Rather, higher-income households account for a more than proportionate share of greenhouse gas emissions.  As a consequence, the break-even point is not at the 50th percentile of households (as it would be if the trend were linear), but rather something higher.  In the Treasury estimates, households up through the 70th percentile (the 7th decile) would on average still come out ahead.  Only the top three deciles (the richest 30%) would end up paying more for the carbon tax than what they would receive back.  But this is simply because they account for a disproportionately high share of greenhouse gas emissions.  It is fully warranted and just that they should pay more for the pollution they cause.

But it is also worth noting that while the richer household would pay more in dollar terms than they receive back, those higher dollar amounts are modest when taken as a share of their high incomes:

In dollar terms the richest 10% would pay in a net $1,166 per person in this scheme, as per the chart at the top of this post.  But this would be just 1.0% of their per-person incomes.  The 9th decile (families in the 80 to 90th percentile) would pay in a net of 0.7% of their incomes, and the 8th decile would pay in a net of 0.3%. At the other end of the distribution, the poorest 10% (the 1st decile) would receive a net benefit equal to 8.9% of their incomes.  This is not minor.  The relatively modest (as a share of incomes) net transfers from the higher-income households permit a quite substantial rise (in percentage terms) in the incomes of poorer households.

C.  A Comparison to Transfers in the Food Stamps Program

The food stamps program (formally now called SNAP, for Supplemental Nutrition Assistance Program) is the largest cash income transfer program in the US designed specifically to assist the poor.  (While the cost of Medicaid is higher, those payments are made directly to health care providers for their medical services to the poor.)  How would the net transfers under a carbon tax with redistribution compare to SNAP?  Are they in the same ballpark?

I had expected they would not be close.  However, it turns out that they are not that far apart.  While food stamps would still provide a greater transfer for the very poorest households, the supplement to income that those households would receive by such a carbon tax scheme would be significant.  Furthermore, the carbon tax scheme would be of greater benefit than food stamps are, on average, for lower middle-class households (those in the 3rd decile and above).

The Congressional Budget Office (CBO) has estimated how food stamp (SNAP) benefits are distributed by household income decile.  While the forecast year is different (2016 for SNAP vs. 2019 for the carbon tax), for the purposes here the comparison is close enough.  From the CBO figures one can work out the annual net benefits per person under SNAP for households in the 1st to 4th deciles (with the 5th through the 10th deciles then aggregated by the CBO, as they were all small):

The average annual benefits from SNAP were estimated to be about $1,500 per person for households in the poorest decile and $690 per person in the 2nd decile.  These are larger than the estimated net benefits of these two groups under a carbon tax program (of $535 and $464 per person, respectively), but it was surprising, at least to me, that they are as close as they are.  The food stamp program is specifically targeted to assist the poor to purchase the food that they need.  A carbon tax with redistribution program is aimed at cutting back greenhouse gas emissions, with the funds generated then distributed back to households on an equal per capita basis.  They have very different aims, but the redistribution under each is significant.

D.  But the Current Politics of Such a Program Are Not Favorable

A carbon tax with redistribution program would therefore not only reduce greenhouse gas emissions at a lower cost than traditional approaches, but would also provide for an equitable redistribution from those who account for a disproportionate share of greenhouse gas emissions (the rich) to those who do not (the poor).  But news reporters and political pundits, including those who are personally in favor of such a program, consider it politically impossible.  And in what was supposed to be a personal email, but which was part of those obtained by Russian government hackers and then released via WikiLeaks in order to assist the Trump presidential campaign, John Podesta, the senior campaign manager for Hillary Clinton, wrote:  “We have done extensive polling on a carbon tax.  It all sucks.”

Published polls indicate that the degree of support or not for a carbon tax program depends critically on how the question is worded.  If the question is stated as something such as “Would you be in favor of taxing corporations based on their carbon emissions”, polls have found two-thirds or more of Americans in support.  But if the question is worded as something such as “Would you be in favor of paying a carbon tax on the goods you purchase”, the support is less (often still more than a majority, depending on the specific poll, but less than two-thirds).  But they really amount to the same thing.

There are various reasons for this, starting with that the issue is a complex one, is not well understood, and hence opinions can be easily influenced based on how the issue is framed.  This opens the field to well-funded vested interests (such as the fossil fuel companies) being able to influence votes by sophisticated advertising.  Opponents were able to outspend proponents by 2 to 1 in Washington State in 2018, when a referendum on a proposed carbon tax was defeated (as it had been also in 2016).  Political scientists who have studied the two Washington State referenda believe they would be similarly defeated elsewhere.

There appear to be two main concerns:  The first is that “a carbon tax will hurt the poor”.  But as examined above, the opposite would be the case.  The poor would very much benefit, as their low consumption only accounts for a small share of carbon emissions (they are poor, and do not consume much of anything), but they would receive an equal per capita share of the revenues raised.

In distinct contrast, but often not recognized, a program to reduce greenhouse gas emissions based on traditional regulation would still see an increase in costs (and indeed likely by much more, as noted above), but with no compensation for the poor.  The poor would then definitely lose.  There may then be calls to add on a layer of special subsidies to compensate the poor, but these rarely work well.

The second concern often heard is that “a carbon tax is just a nudge” and in the end will not get greenhouse gas emissions down.  There may also be the view (internally inconsistent, but still held) that the rich are so rich that they will not cut back on their consumption of high carbon-emission goods despite the tax, while at the same time the rich can switch their consumption (by buying an electric car, for example, to replace their gasoline one) while the poor cannot.

But the prices do matter.  As noted at the start of this post, the experience with the cap and trade program for SO2 from the burning of coal (where a price is put on the SO2 emissions) found it to be highly effective in bringing SO2 emissions down quickly.  Or as was discussed in an earlier post on this blog, charging polluters for their emissions would be key to getting utilities to switch use to clean energy sources.  The cost of both solar and wind new generation power capacity has come down sharply over the past decade, to the point where, for new capacity, they are the cheapest sources available.  But this is for new generation.  When there is no charge for the greenhouse gases emitted, it is still cheaper to keep burning gas and often coal in existing plants, as the up-front capital costs have already been incurred and do not affect the decision of what to use for current generation.  But as estimated in that earlier post, if those plants were charged $40 per ton for their CO2 emissions, it would be cheaper for the power utilities to build new solar or wind plants and use these to replace existing fossil fuel plants.

There are many other substitution possibilities as well, but many may not be well known when the focus is on a particular sector.  For example, livestock account for about 30% of methane emissions resulting from human activity.  This is roughly the same share as methane emissions from the production and distribution of fossil fuels.  And methane is a particularly potent greenhouse gas, with 86 times the global warming potential over a 20-year horizon of an equal weight of CO2.  Yet a simple modification of the diets of cows will reduce their methane emissions (due to their digestive system – methane comes out as burps and farts) by 33%.  One simply needs to add to their feed just 100 grams of lemongrass per day and the digestive chemistry changes to produce far less methane.  Burger King will now start to purchase its beef from such sources.

This is a simple and inexpensive change, yet one that is being done only by Burger King and a few others in order to gain favorable publicity.  But a tax on such greenhouse gas emissions would induce such an adjustment to the diets of livestock more broadly (as well as research on other dietary changes, that might lead to an even greater reduction in methane emissions).  A regulatory focus on emissions from power plants alone would not see this.  One might argue that a broader regulatory system would cover emissions from such agricultural practices, and in principle it should.  But there has been little discussion of extending the regulation of greenhouse gas emissions to the agricultural sector.

More fundamentally, regulations are set and then kept fixed over time in order to permit those who are regulated to work out and then implement plans to comply.  Such systems are not good, by their nature, at handling innovations, as by definition innovations are not foreseen.  Yet innovations are precisely what one should want to encourage, and indeed the ex-post assessment of the SO2 emissions trading program found that it was innovations that led to costs being far lower than had been anticipated.  A carbon tax program would similarly encourage innovations, while regulatory schemes can not handle them well.

There may well be other concerns, including ones left unstated.  Individuals may feel, for example, that while climate change is indeed a major issue and needs to be addressed, and that redistribution under a carbon tax program might well be equitable overall, that they will nonetheless lose.  And some will.  Those who account for a disproportionately high share of greenhouse gas emissions through the goods they purchase will end up paying more.  But costs will also rise under the alternative of a regulatory approach (and indeed rise by a good deal more), which will affect them as well.  If they do indeed account for a disproportionately high share of greenhouse gas emissions, they should be especially in favor of an approach that would bring these emissions down at the lowest possible cost.  A scheme that puts a price on carbon emissions, such as in a carbon tax scheme, would do this at a lower cost than traditional approaches.

So while many have concerns with a carbon tax with redistribution scheme, much of this is due to a misunderstanding of what the impacts would be, as well as of what the impacts would be of alternatives.  One sees this in the range of responses to polling questions on such schemes, where the degree of support depends very much on how the questions are worded or framed.  There is a need to explain better how a carbon tax with redistribution program would work, and we have collectively (analysts, media, and politicians) failed to do this.

There are also some simple steps one can take which would likely increase the attractiveness of such a program.  For example, perceptions would likely be far better if the initial rebate checks were sent up-front, before the carbon taxes were first to go into effect, rather than later, at the end of whatever period is chosen.  Instead of households being asked to finance the higher costs over the period until they received their first rebate checks, one would have the government do this.  This would not only make sense financially (government can fund itself more cheaply than households can), but more important, politically.  Households would see up-front that they are, indeed, receiving a rebate check before the prices go up to reflect the carbon tax.

And one should not be too pessimistic.  While polling responses depend on the precise wording used, as noted above, the polling results still usually show a majority in support.  But the issue needs to be explained better.  There are problems, clearly, when issues such as the impact on the poor from such a scheme are so fundamentally misunderstood.

E.  Conclusion 

Charging for greenhouse gases emitted (a carbon tax), with the revenues collected then distributed back to the population on an equal per capita basis, would be both efficient (lower cost) and equitable.  Indeed, the transfers from those who account for an especially high share of greenhouse gas emissions (the rich) to those who account for very little of them (the poor), would provide a significant supplement to the incomes of the poor.  While the redistributive effect is not the primary aim of the program (reducing greenhouse gases is), that redistributive effect would be both beneficial and significant.  It should not be ignored.

The conventional wisdom, however, is that such a scheme could not command a majority in a referendum.  The issue is complex, and well-funded vested interests (the fossil fuel companies) have been able to use that complexity to propagate a sufficient level of concern to defeat such referenda.  The impact on the poor has in particular been misportrayed.

But climate change really does need to be addressed.  One should want to do this at the lowest possible cost while also in an equitable manner.  Hopefully, as more learn what carbon tax schemes can achieve, politicians will obtain the support they need to move forward with such a program.