Designing Carbon Dividends

Carbon dividends are the hottest idea in climate policy. A diverse mix of progressive and conservative voices are backing the idea of returning carbon tax revenues to households in the form of regular “dividend” payments. So are a range of businesses and environmental groups. Two weeks ago, six House members—three Democrats and three Republicans—introduced carbon dividend legislation.

Here is the idea: A robust carbon tax would cut emissions of carbon dioxide and other gases that are threatening our climate. It also would indirectly increase taxes on consumers and raise significant revenue. Carbon dividends would distribute that revenue back to households through regular payments, thus softening the financial blow of the tax while still reducing emissions. (Of course, the revenue also could be directed to other purposes.)

While the premise is simple, the details of implementing carbon dividends are complex. Policymakers face a range of philosophical, political, and practical issues. In a new report, How to Design Carbon Dividends, my Tax Policy Center colleague Elaine Maag and I explore those issues. Our work was funded by the Climate Leadership Council, an advocate for carbon dividends (full disclosure: I am a senior research fellow with the organization).

Two distinct philosophic views animate carbon dividend proposals. One sees dividends as shared income from a communal property right. Just as Alaskans share in income from the state’s oil resources, so could Americans share in income from use of atmospheric resources.

The second sees dividends as a way to rebate carbon tax revenues back to the consumers who ultimately pay them.

Though these ideas can be complementary, they have different implications for designing carbon dividends. The communal property view, for example, implies people should receive identical dividends that would be taxed as a new source of income. But those who see dividends as a tax rebate would link the payment to a person’s carbon tax burden and make the payment tax-free. Similar differences arise for dividend eligibility, the treatment of children, and other issues.

Elaine and I show how dividends should be designed under each of these views. But we do not recommend either pure approach. Political and practical concerns also matter.

Instead, we suggest a hybrid model that combines the best of both ideas. As a starting point, we suggest US residents with Social Security numbers (a group that could be expanded) would be eligible for dividends that would be paid out quarterly.  Adults would receive equal dividends. Children would receive half as much as adults. Dividends would not be taxed as income, nor would they be treated as income in means-tested benefit programs such as SNAP (food stamps).

Our proposal strikes a balance among the philosophical, political, and practical issues. Paying identical dividends to adults, for example, reflects the communal property view – but halving the benefit for children nods in the direction of a rebate. Paying dividends quarterly reflects both practical and political concerns. They’d be less complicated, less costly to administer, and more visible than smaller, monthly payments.

Unfortunately, the dividend would be somewhat less than the amount of revenue collected by the tax. If life were simple, outgoing dividends would equal incoming carbon tax receipts. But rebating all the revenue would significantly increase budget deficits.

Why? Because it would cost the government money to manage the tax and dividend program. And the government itself would bear some of the cost of the carbon tax. To keep from adding to the deficit, the government must keep enough revenue to cover those costs.

To illustrate, suppose a carbon tax of $43 per metric ton goes into effect in 2021, as the Climate Leadership Council has proposed. Gross revenues would be about $200 billion. It would cost the government about $6 billion to operate the dividend program and cuts in other revenues and higher spending would total more than $40 billion. Thus, to avoid deficit increases, the dividend pool would be about $150 billion.

Even with these offsets, we estimate that eligible adults would receive an annual dividend of $570 in 2021 while a family of two adults and two children would get $1,710.

Different design choices could raise or lower these amounts. Collecting income tax on dividends, for example, would allow larger dividends. But the after-tax dividend would be the same, on average, with more going to people in lower income tax brackets and less to those in higher ones. Different treatment of children also would change dividends. Giving children full dividends, for example, would reduce dividends for adults, but increase them for families with children. Dividend amounts could also vary depending on eligibility, participation rates, the size of the carbon tax, and other factors.

In short, details matter in designing carbon dividends. We hope our paper provides a useful guide to those details and the choices and tradeoffs that carbon dividends pose.