A concept that is often overlooked when it comes to encouraging sustainable behavior is the economics of sustainability. Money runs this world, and it is often the biggest barrier to encouraging people to take environmental action. The purpose of this post is to discuss the overarching concept of “Green Taxes,” specifically, a carbon tax. I will discuss what they are, how they work, and why such a tax has not been implemented in the United States. In addition, this post will address the present-day incentives in the current tax system that support and encourage environmentally friendly behaviors, as well as a potential future option.
Green Taxes
Environmental, or “Green Taxes,” are taxes placed on activities that are harmful to the environment. They include taxes on energy, carbon emissions, fuel consumption, waste production and disposal, use of natural resources, motor vehicles and more. The primary purpose of these taxes is to promote environmentally friendly activities, by ensuring polluters are fined appropriately for their harmful emissions. The idea is that people will stop the environmentally harmful activity in order to avoid paying a tax.
One of the most commonly known “Green Tax” is a carbon tax. This tax makes the costs of a particular activity (in this case, emitting carbon dioxide) the responsibility of the producers and consumers. This tax forces the producers and consumers to internalize the costs of the harmful activity. In other words, “the polluter pays.” At a basic economic level, producers are incentivized to reduce the harms of the emissions, and consumers are motivated to consume less. While several other European countries have had success in implementing such a tax, the U.S. has not.1Alex Muresianu and Huaqun Li, Carbon Taxes and the Future of Green Tax Reform, Tax Foundation (June 21, 2022), https://taxfoundation.org/research/all/federal/carbon-taxes-green-tax-reforms/ (noting Ukraine’s carbon tax covers 71 percent of the country’s carbon emissions, while British Columbia’s carbon tax covers 78 percent of the province’s emissions).
Barriers of Implementing Green Taxes
The main barriers to implementing such a tax are both social and political. One social barrier is the concern about how carbon taxes would affect people with different incomes. Carbon tax works like a consumption tax, so it is more likely to fall on people with lower incomes. Typically, lower-income households consume a larger share of their annual income, meaning they are unable to save as much as higher-income households. In addition, subsidies for green technology tend to benefit the wealthy.2Green Taxation – In Support of a More Sustainable Future, Eur. Comm’n (July 14, 2021), https://taxation-customs.ec.europa.eu/green-taxation-0_en.
The political barrier is that the carbon tax would have to be high to achieve sufficient emission reductions. Many of the biggest polluters in the U.S. hold significant sway over the political process. Thus, a high tax will no doubt meet strong opposition politically. Further, because this tax also affects every day Americans, as consumers, any increased taxation will almost certainly not go over well for most citizens of this country. Many people would rather wait on the new development of new technology that wouldn’t lead to a tax and, in the best-case scenario, would actually lead to spending less money.
Double Dividend Hypothesis
Despite these barriers, like any other tax, carbon taxes collect revenue. In fact, due to the need for a high carbon tax, they actually collect a significant amount of revenue. The question then becomes: what should be the ultimate disposition of this revenue? Based on where the revenue ends up, the economic impact of this tax could be substantially lessened.
A popular potential use of the carbon tax revenue is known as the “double dividend hypothesis.” This is the idea that carbon tax revenues can be used to reduce pre-existing taxes. This kind of “green tax reform” could potentially lower the economic distortions from pre-existing revenue-motivated taxes. The “double” dividend is the benefit of improving the environment (reducing pollution) and reducing distortions in the tax system.
This does not mean such an idea is without its difficulties. To have a positive impact on the tax system, the tax reduced by the carbon tax revenue must be more economically harmful than the carbon tax. Examples of possible reductions yielding the necessary benefit are: lower corporate tax rates, reduction in capital taxation, and better cost recovery for capital investment.3Jaume Freire-González, Environmental Taxation and the Double Dividend Hypothesis in CGE Modeling Literature: A Critical Review, 40:1 J. Pol’y Modeling, Apr. 2018, https://www.sciencedirect.com/science/article/pii/S0161893817301205?via%3Dihub. Tax reductions that do not produce the desired economic effect are reductions in labor tax and payroll tax.
As discussed, many European countries have successfully implemented carbon taxes. Observing how these countries have done so provides the valuable insight that the double dividend effect is possible, however, it is not a guarantee.4Muresianu & Li, supra note 1. It is clear from the success in other countries that a carbon tax does work, but implementation raises several practical concerns. The U.S. will be unable to solve these concerns without cooperation from people in environmental agencies, economists, and the present-day tax system.
Alternatives to Green Taxes
It is unlikely the U.S. would implement a “Green Tax” in the near future due to the drastic changes it would bring to the present tax system, and the needed cooperation of politicians. However, there are several alternatives to a “Green Tax,” some of which the U.S. has already implemented. Unfortunately, while these alternatives do encourage environmentally friendly practices, the key difference between the carbon tax and these alternatives is that they are voluntary as opposed to required.
Deductions for Green Businesses
Businesses are entitled to several deductions for business expenses. The general rule is: there shall be allowed as a deduction all the ordinary necessary expenses paid or incurred during the taxable year in carrying on any trade or business.526 U.S.C. § 162. It would be interesting to discover whether the IRS would see sustainable upgrades to businesses as satisfying this rule. Unfortunately, I was unable to find any cases or rulings answering this question. This is not that surprising, due to the fact that sustainable energy practices are still not very common, especially among businesses. In addition, several U.S. states explicitly offer deductions for businesses who engage in several different “green practices.”65 Types of Tax Breaks for Eco-Friendly Businesses, First Citizens Bank (Nov. 11, 2021), https://www.firstcitizens.com/small-business/insights/taxes/types-of-tax-breaks-for-eco-friendly-businesses. Due to the existence of specific deductions, it is likely sustainable deductions do not need to follow the general rule.
The available deductions for “green practices” vary on which state the business resides. However, a popular deduction is a tax deduction for energy-efficient commercial buildings. This is called the 179D deduction. Under this provision, a building owner may deduct up to $1.80 per square foot of the cost of energy efficient improvements made to a building. The amount of the deduction depends on the technology used, and how much it reduces energy usage. The building must be independently certified to receive the deduction.
Some states also offer tax credits. Two examples are a biodiesel income tax credit and alternative energy tax credits. The biodiesel tax credit applies to businesses that operate as wholesalers or a large fleet that uses specific types of biodiesels. These businesses could qualify for a $1.00 per gallon incentive. Also, businesses who want to become more sustainable by installing solar panels, and even small wind turbines, can take advantage of corporate tax credits that may offset some of the cost. The maximum incentive is $1,500 per 0.5 kilowatts for solar and $200 per kilowatts for wind.
Indirect Taxes
Indirect taxes are also a potential option. Indirect taxes are levied on goods and services, as opposed to individual taxpayers. A common example is increasing gasoline prices to reduce automobile emissions due to the idea that people will forego their vehicles and use public transportation, thus indirectly reducing pollution.
Indirect taxes encounter several obstacles. The most obvious being the end-goal relies on people making an alternative choice on their own. Indirect taxes can encourage a particular response, but it does not guarantee it.7Environmental Management: Green Taxes, IvyPanda (June 15, 2018), https://ivypanda.com/essays/life-circle-engineering/.
Another obstacle is imposing the tax in the first place. Typically, there is an uproar when gas prices increase to nearly $5.00 a gallon. That increase may not be entirely purposeful either, meaning it was more or less simply a natural fluctuation in gas prices. One can only imagine what would happen if gas prices were raised on purpose and closer to $8.00 a gallon. The interesting thing is that many European countries have actually imposed this indirect tax, and it has been quite successful in encouraging less driving and reducing automobile emissions. Granted, many European countries already have the public transportation infrastructure in place, while many U.S. cities do not. However, like the carbon tax, it is unlikely an indirect tax will be imposed any time soon.
Contrary to a carbon tax, I think there is an argument that portions of an indirect tax could be deductible under the current tax system (even more so after 2025). Unlike a carbon tax, indirect taxes are not meant to punish a party, instead they are more like an increase in a normal everyday tax. So, the various deductions, like for transportation expenses, could easily still apply even with an indirect tax. For example, the cost of commuting between one business location and another business location are generally deductible.
Obviously, because there has not been an indirect tax imposed, this theory for deductions remains untested. Also, it is likely the current tax system may still need to change some, because the increased tax would likely need to be offset by an increase in the amount allowed to be deducted. Overall, indirect taxes are an option that has worked for other countries, and while it changes the U.S. economy, it is more easily accommodated into the current tax system, as opposed to a carbon tax that effectively encourages the system to be rewritten.
Conclusion
Climate change is an increasingly pressing issue around the world, and it does not limit its damage to just the environment. In fact, the economic impact of climate change could be severe. This post explored several tax-based options to encourage sustainable behavior. However, I propose that when the U.S. is exploring different ways to incentivize sustainable behavior, they also consider making the necessary changes to the present-day tax system. Fighting climate change requires substantial changes, but change is not impossible. Each of the options discussed here have been successfully implemented in many countries around the world, the world is just waiting for the U.S. to catch up.
