Dividends or tax shift: which is better?

By Steve Stoft and Dan Kirshner

OK, we’re agreed: the revenues from carbon pricing—whether from cap and trade or from a carbon tax—should be returned, not kept by the government. It’s good politics—t-a-x is a four-letter word—and it’s good government—we don’t need to entice special interests with more revenue. Once that’s settled, however, a new issue arises: how should the revenues be returned? Renowned climate scientist James Hansen advocates a 100 percent dividend—a check to your mailbox. Al Gore favors reducing the payroll tax. Economists will tell you it’s more efficient to reduce an existing tax; that’s their preference. We’re here to tell you that they’re wrong. In fact, they’ll prefer a 100 percent dividend once they think about it for a moment.

It is good news to find that a dividend is good economics in addition to what we already knew: that a dividend is good politics. It’s a lot easier to explain a check in the mailbox than a “revenue neutral tax shift.” On top of that, once you explain it, it’s a lot easier for people to trust a check in the mailbox. If the tax shift reduces your payroll tax by $100, you might see your paycheck go up by $100 on day one. But five years from now when your payroll tax has gone up, you just can’t be sure if your paycheck is still $100 higher than “it would have been,” or if the government is playing games.

So, how do we convince economists that a dividend is good economics? Most economists believe that using carbon pricing revenues in place of regular tax revenues is better because it’s more efficient. Most taxes are inefficient because they tax “goods”—as in “good things,” like income and consumption items such as books, iPods, you name it. But taxing such “goods” also discourages their use and production. Much better to tax “bads”—such as carbon emissions—and reduce taxes on “goods.” And better to use the revenues to reduce taxes on “goods” than to provide dividends. Or so economists seem to think.

Economists are probably right that shifting taxes from “goods” to “bads” increases efficiency. But that’s not the whole story. For example a “capitation tax” taxes everyone (every head if you know Latin) equally. Since you can’t avoid this tax, it doesn’t discourage any “goods.” So replacing any other tax on “goods” with a capitation tax would increase economic efficiency. But wait. A capitation tax would tax the poorest person and the richest person the same, say $1000. That’s grossly unfair and that’s why economists reject a shift to capitation taxes—even though it would increase economic efficiency.

We can use the universal rejection of a capitation tax as unfair to prove to economists that they prefer dividends. In fact, pricing carbon plus dividend refunds meets the economists’ gold standard of fairness: it’s equivalent to giving everyone their own “atmospheric climate right,” which they are free to sell. Economists: read the following carefully. The rest of you: hang loose for a moment. Let’s add the policy we reject—replacing an existing tax with a capitation tax—to pricing carbon plus dividend refunds. Since a capitation tax is just the negative of dividend refunds (assuming the same magnitude), we see that pricing carbon plus dividend refunds plus a bad policy is the same as pricing carbon and replacing an existing tax. Since pricing carbon plus dividend refunds is fair, pricing carbon and replacing an existing tax is worse, since the only difference is “plus a bad policy.”

Bottom line: a dividend is good politics and good economics. However carbon pricing is implemented—cap and trade or carbon tax—let’s go for the gold: 100 percent dividend refunds.

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Steve Stoft is an economist and Dan Kirshner an analyst, both in Berkeley CA. Stoft’s new book (with which Kirshner assisted) is Carbonomics: How to Fix the Climate and Charge It to OPEC. It’s available on Amazon, and can be downloaded free from http://www.stoft.com. In it you’ll find a more complete explanation of tax shifting and dividends.