More on Revenue Neutrality

     Since my last post I've been trying to make sense out of the idea of revenue neutrality and why anyone would think it a desirable quality in any tax, let alone one like a carbon tax which is intended to provide an active incentive to shift away from fossil fuels. I have found two ideas plausible.

     The first is that someone has co-opted the concept of revenue neutrality from its original context. There are, after all, situations in which you want a particular set of options to be revenue neutral. 

     For example, suppose you run a small business as a corporation of which you are the owner and sole employee. You have a couple of options as to how you might take your compensation. You can have the company pay you a salary, which is deducted from the company's revenues as an expense so the company doesn't pay corporate income tax on it, but it means you have to pay personal income tax on your salary. Or, you can have the company pay you no salary as an employee, but issue you as a shareholder dividends on its profits. (Or you can use some mix of the two methods.) There may be all sorts of considerations you take into account in deciding which way to go. Maybe you want the company to buy some equipment, or maybe you expect to be able to sell the business to someone else in a couple of years, or maybe you need to establish a particular salary to qualify for a credit card or something. But your choice of method shouldn't make a big difference to your tax bill: we want the choice between paying a salary and paying a dividend to be revenue neutral in that respect. 

     There are a whole lot of similar scenarios in which we don't want tax consequences to  unduly influence a person's decisions, and so we need to design our tax regime to be revenue neutral with respect to those sorts of decisions.

     Notice, though, the context in which revenue neutrality of this sort applies. It doesn't apply to overall revenue, just the revenue consequences of a particular set of options for a given taxpayer or group of related taxpaying entities. Presumably, the government would be happy if the business prospered, made more money and ended up paying more taxes as a result. Indeed, that's part of why these particular choices should be revenue neutral; for the business to prosper, it should be making its administrative decisions on solid business reasons, rather than trying to figure out the best way to keep more of the money it's already earned. Encouraging it to favor dividends over salary or vice versa doesn't really help it to be more productive in the future. If you want to encourage them to invest more in new equipment or hiring more staff, it makes sense to give them those incentives regardless of whether they're paying dividends or salaries. There shouldn't be rewards or penalties for doing things that make no difference to the state's interest in promoting prosperity. So making these sorts of choices revenue neutral in the immediate instance is arguably part of a policy to increase revenue overall in the future.

     So I suspect that the term "revenue neutral" derives some of its appeal from the fact that it's often used in discussion of this sort of tax policy problem. And, as a term perhaps vaguely remembered as something tax policy experts treat as a desirable feature, it makes the objection that a carbon tax is not revenue neutral more informed and credible than just complaining "it makes you pay more taxes!" 

     The other way in which revenue neutrality might make some sense in the context of a carbon tax is when it's structured simply as a complete internalization of the externalities. As I argued in the previous post, the harmful impact of carbon fuels on climate is a cost that is paid by everyone, while only the consumer of the carbon fuels enjoys the benefit; that cost is external to the balance sheet of the consumer, and doesn't really factor into their buying decision. The carbon tax is intended to make the consumer pay a price that more accurately reflects that externalizer cost, thus encouraging them to use less carbon. 

     But that's only half of the externality equation. Ideally, the revenue from the carbon tax would be going to compensate those who are affected by climate change, in proportion to their losses. Failing that, it could go to funding efforts to reduce or avoid the damage. In an ideal world, the carbon tax would raise exactly enough money to make it all work out, either fully compensating the victims or fully preventing the damage. And, of course, if the costs of remediation or compensation are exactly equal to the revenue raised by the carbon tax, then in principle it's revenue neutral.

     If you see the entire purpose of a carbon tax, then, as redistribution of the costs of carbon emissions back to the people doing the emitting, then ideally, yeah, it should be revenue neutral as a broad first approximation. Person A inflicts an externality of $50 on person B, so government taxes person A $50 and gives it all to person B. Obviously there will be some administrative costs along the way, so it might not be perfectly revenue neutral, but close enough.

     The reason I reject this argument, though, is because it ignores the value of the shared resource itself: the carbon sink, our planet's capacity to absorb our carbon emissions without harm by growing plants or forming the calcium carbonate shells of sea creatures or whatever. A person who releases carbon into the atmosphere has a responsibility to ensure they don't thereby cook the planet, and ideally can use a little bit of the carbon sink to do that. But the sink can only absorb so much carbon in a given year, and so it's a scarce resource, one that can be rationed the same way we ration most other scarce resources: by pricing it appropriately. 
     A private owner of the carbon sink would be justified in charging a fee for its use, and earning income on that asset. A prudent manager would reinvest some of their revenue in efforts to preserve the asset's usefulness in the future, but there is no reason why that private owner should be expected to structure their fees to be revenue neutral. Of course, the carbon sink does not belong to any one person, but it is a valuable and scarce resource nonetheless, and one that the Crown therefore ought to manage on behalf of its collective owners (i.e. everyone). And our collective interest in it is no less than that of any single private owner would be: we should want to earn as much profit as we sustainably can from it. So we should want the government to charge a carbon tax on it that generates lots of revenue from it.
     Importantly, this principle applies independently of the whole externality concern; if the price of carbon is kept high enough that carbon emissions are kept low, there is no need to compensate those who don't suffer the consequences of a climate change that never happens. If we had started charging an appropriate fee for the use of this scarce resource many years ago, we could have avoided our current peril.