News - Harvard Project on Climate Agreements, Belfer Center

The "Great Swap"

| December 5, 2016

Joseph Aldy proposes a carbon tax and regulatory streamlining as a part of tax reform.

A "Great Swap" — a carbon tax and regulatory streamlining as a part of tax reform — can navigate the political challenges facing more effective climate-change policy, while promoting investment and providing other economic benefits associated with a shift from taxes on capital and labor to taxes on pollution.

The U.S. government taxes both business profits and the labor income of workers. But it doesn't tax the carbon pollution that is a byproduct of business operations. In short, society taxes the fruits of labor and the returns to capital — and hence discourages labor supply and investment — but not pollution. Labor and capital are overtaxed while carbon pollution is undertaxed. Smart tax reform would lower the taxes on the socially beneficial factors of production and raise taxes on the adverse byproducts of production.

A tax swap — for example, through a revenue-neutral carbon tax and suite of income tax cuts — can address economic efficiency and distributional objectives. Some recent research shows that a carbon tax coupled with a well-targeted reform of the tax code could result in net economic growth relative to no tax swap — and this is even before the pro-growth benefits of streamlining the regulatory framework are taken into account.

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For Academic Citation: Stowe, Robert C.. “The "Great Swap".” News, Harvard Project on Climate Agreements, Belfer Center, December 5, 2016.