Taxing Carbon Dividends

Taxing Carbon Dividends Laser Talk

Question:  Why are carbon dividends counted as taxable income?

Answer:  The 2010 Pay-As-You-Go (PAYGO) Act, [1,2] as well as procedural rules in both Houses of Congress, [3] dictate that any bill that affects the budget must be scored by the Congressional Budget Office (CBO) to be deficit-neutral over 10 years, and if it’s not, the deficit must be offset in some way.

According to that same CBO, any new tax on business will suppress other taxes they pay by 21 to 25 percent of the new revenue. [4,5] If that loss is not offset, it would trigger automatic cuts to federal programs that include farm support, student loans, and even Medicare. [6]

With respect to a carbon fee, CBO has already ruled that carbon pricing, even if the cost is passed on to consumers, would be subject to the offset requirement. [7]

There are four ways for a carbon pricing bill to satisfy this requirement:

  • Take 21 to 25 percent of the carbon fee revenue off the top and pay it to the Treasury to compensate for presumably lost future tax revenues.
  • Designate the carbon dividend as taxable income, in which case the government recovers the lost revenue in the income taxes paid by households.
  • Allow the automatic spending cuts, known as ‘sequestration,’ to take place.
  • Find enough support in Congress to waive the PAYGO rules.

Energy Innovation and Carbon Dividend Act sponsors have agreed that the simplest, most politically viable solution is to designate the carbon cash back payments (carbon dividends) as taxable income. Because personal income tax rates start at 10 percent and go up to 37 percent at the highest income, this is actually the most progressive option. It helps the most vulnerable households because they get to keep more of their dividend cash compared to wealthy Americans who are typically responsible for much higher emissions.

In a Nutshell: The Energy Innovation Act was carefully designed to satisfy the PAYGO law which prohibits non-budgetary legislation from increasing the deficit. Making carbon dividends taxable satisfies that requirement and inherently protects the finances of poor and middle-income families.

  1. “What is PAYGO?” The Tax Policy Center’s Briefing Book (accessed 5 Jul 2018).
  2. “H.J.Res. 45 (111th): Increasing the statutory limit on the public debt.” Govtrack (accessed 5 Jul 2018).
  3. “FAQs on PAYGO.” House Committee on the Budget (13 Jul 2020).
  4. “The Role of the 25 Percent Revenue Offset in Estimating the Budgetary Effects of Legislation.” CBO Economic and Budget Issue Brief (13 Jan 2009).
  5. “New Income and Payroll Tax Offsets to Changes in Excise Tax Revenues for 2019-2029.” Joint Committee on Taxation (28 Feb 2019).
  6. “How PAYGO Rules Could Affect Tax Reform.” Committee for a Responsible Federal Budget (18 Oct 2017).
  7. Stone, C., J. Horney, and R. Greenstein. “How CBO estimates the cost of climate-change legislation.” Center of Budget and Policy Priorities (13 May 2008).

This page was last updated on 05/05/21 at 18:00 CDT.