How will the Carbon Fee and Dividend be scored by the Congressional Budget Office regarding the deficit?

According to the 2010 Pay-As-You-Go Law (“PayGo”) [1], a carbon fee will constitute a new excise tax on businesses that will reduce other taxes paid by those businesses by 25%, even if those businesses pass the entire cost on to consumers. Returning 100% of the carbon fee back to households less administrative costs is not expected to change that. Congressional Budget Office scoring will determine that a 25% offset is required.

This presents a challenge that could technically be met in one of four ways:

(1) counting the household dividend as taxable income;

(2) stipulating offsetting spending cuts elsewhere in the Federal budget;

(3) stipulating offsetting revenue increases elsewhere in the Federal budget; or

(4) convincing Congress to exempt the CF&D bill from PayGo.

All of these present significant pros and cons, and a final decision requires the judgment of the bill’s sponsors to maximize support and ensure passage. CCL believes that the best starting position, due to its simplicity, is option #1.

How will the Carbon Fee and Dividend be scored by the Congressional Budget Office regarding the deficit?

In 2010, Congress passed the Pay-as-you-Go law [1], which stipulates that no new legislation can contribute to the deficit. This is why some congressional offices have raised the question of whether the carbon fee and dividend as we originally envisioned it will be in compliance.

By longstanding convention, when the Congressional Budget Office (CBO) [2] estimates how a bill would affect the budget, they assume that policy changes do not change the total amount of income in the economy. Under this assumption, for every $100 collected by a new excise tax on business, the government will lose $25 in revenues from other taxes because the new tax “squeezes out” profits and wages. That $25 must be offset in some way, either through compensating revenue or spending reductions. This “PayGo” rule applies even if the cost of the carbon fee is entirely passed on to consumers in the cost of gasoline and utility bills.

Returning 100% of the carbon fee back to households less administrative costs is a bedrock principle of the Carbon Fee and Dividend, but if the CBO would score our bill as increasing the deficit, as we have been assured they will [3], that presents a challenge that must be met.

Pay as you go workarounds

There are four possible workarounds, each of which has pros and cons:

1. The carbon dividend can be counted as regular taxable income, and that amount of tax – 25% of the dividend for most middle-income families – would be due at tax time.
   • Pro: this is the simplest approach, has been endorsed by some key Congressional offices, and PayGo compliance would automatically be assured.
   • Con: reduces the amount of carbon dividend that households keep.
2. The bill can stipulate spending cuts in some other areas of the Federal budget to provide the required offset.
   • Pro: households would be able to keep 100% of the dividend tax-free.
   • Con: as the carbon fee goes up, spending cuts would have to go up proportionately, with potential political battles for each cut.
3. The bill can stipulate an offsetting revenue increase, such as rolling back fossil fuel depletion allowances or other tax benefits.
   • Pro: households would keep all of the dividend tax-free, and the roll-back of tax breaks for fossil energy would enhance the climate benefit of the bill.
   • Con: besides strong opposition from fossil energy interests and associated lawmakers, those revenues would fall far short of the required offsets, even in the first year.
4. The bill can simply stipulate that Pay-as-you-Go does not apply, as has been done for numerous other instances of legislation that affect the deficit.
   • Pro: households would keep all of the dividend tax-free, no battles over spending cuts, and no battles over fossil fuel tax breaks. Also, there would be no concern about increasing the offset as the carbon fee increases.
   • Con: would be strongly opposed by deficit hawks, which could make passage extremely difficult.

Crafting a workable approach to the PayGo challenge must involve judgment of the bill’s sponsors to maximize support and ensure passage. CCL believes that the best starting position is Option 1 due to its simplicity.