How to compensate consumers under carbon pricing

By Felix Salmon
September 28, 2009
Greg Mankiw, when it comes to cap-and-trade, is more or less on the side of the angels: he's quite right that permits should be auctioned rather than given away to polluters. But is the tax code really the best way to compensate consumers for the higher energy prices they're going to end up paying? Mankiw writes:

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Greg Mankiw, when it comes to cap-and-trade, is more or less on the side of the angels: he’s quite right that permits should be auctioned rather than given away to polluters. But is the tax code really the best way to compensate consumers for the higher energy prices they’re going to end up paying? Mankiw writes:

From the standpoint of economic efficiency, the price of carbon emissions should be passed on to consumers in the form of higher energy prices, so that consumers can make optimal decisions regarding energy consumption. Consumers should be compensated for paying these higher prices via cuts in income or payroll taxes. Those tax cuts would be financed by the revenues received from the auctioning of carbon rights (or, better yet, a carbon tax).

The first sentence is right, it’s the second I take issue with. If you cut income or payroll taxes, you end up giving more benefit to high earners than to low earners, and people who pay little or no taxes at all (eg the unemployed) get precious little benefit at all.

Better would be a flat refundable tax credit: the government essentially gives every taxpayer a flat amount each year, passing on the revenues it gets from the carbon auction.

Even that, however, would create inequities: three college roommates sharing a small city apartment would get three times the amount going to a single mother trying to raise three kids in the countryside — someone whose energy consumption would naturally be much higher.

There isn’t a simple and fair way of doing things — even channeling fixed payments through the energy companies themselves would unfairly advantage people who use say electricity and natural gas and heating oil. Instead, I fear that the fair method is going to be complicated, based on ZIP codes and size of household at the very least.

But the compensation should certainly be capped at no more than the average energy bill for the area. If people use less energy than the average, then it’s fine for them to profit from that. But there’s no reason to use a carbon-pricing mechanism to give high earners yet another tax break.


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I’m confused by your examples, because the point of a carbon tax is ultimately to change behaviour, including behaviour of consumers; we should be encouraging people to have roommates and live in cities, to the extent it helps carbon reduction. Your example is needlessly complicated by referring to single mothers of three, who naturally already get tax benefits relative to your college roommates.

Posted by Dylan Thurston | Report as abusive

Let’s say there’s a $3/gallon tax on gasoline, which makes it very expensive, especially for those in the lower income bracket. Increase the personal exemption to $15,000, that should make up for the taxes they will pay. Or make mass transit free. Or both. That will piss off people living in rural areas, but they already get enough subsidies anyway (electricity, phone, cable TV, water – basically everything that has to be brought to them on a wire or a pipe).

Increase the tax on heating oil and natural gas, and subsidize heating that uses renewable energy.

We could do a lot to really drive change in our fossil fuel consumption, but we don’t, because it will cause pain for the incumbent energy providers. But so what? What are they doing for the rest of us that they deserve such protection? Let them adapt like everybody else has to.

Posted by KenG | Report as abusive

Given the amount of revenue the U.S. will have to raise in the coming years, maybe we should put aside the idea that, in order to attenuate the retrogressive effects of a carbon tax, the U.S. should give some money back. If you want progressiveness, put in a carbon tax *and* higher income tax rates.

Posted by a | Report as abusive

We still seem to obsess with an atmospheric accounting system. What about water and land pollution ?

Posted by Casper Lab | Report as abusive

I think it’s really simple in countries that have a national sales tax. You just impose a carbon tax (or equivalent) then use the money to refund the sales tax. In essence you replace a tax on value with a tax on negative externalities. I’m not so sure what to do in the US.

giving credits would completely defeat the purpose of the tax. It takes away any incentive for an individual to become more efficient.


You will be happy to know that Waxman Markey has exactly this provision, where the consumer is actually paid back a per household sum irrespective of their consumption. Your point on multiple power sources is a good one, though the setup costs are sufficiently high (typically in the thousands of dollars to add gas if all you have is electricity) that it may not be financially prudent. Additionally, people with multiple sources of energy tend to be typically affluent, and therefore, they consume more energy than the average household. So, it is unlikely to be a significant effect. The question I have is regarding the mechanics of sending the money back to consumers. If it is part of the electricity bill itself, then the price signal is lost. It has to be a separate check that gets sent to the consumer. If you are interested in the actual estimates of your electricity bill increase, please see

I see no good reason (outside realpolitik) to conflate a carbon tax with a proposed “offsetting” tax break. They are two different policy issues. If you the sell the carbon tax on the premise that it is paying for some other tax break, people will mentally merge the two as a single issue. When you do that, people will naturally think of the fairness of a carbon tax in terms of the net impact of tax and offset. In a farcical world where fairness is the status quo, this would walk you down a path to where each individual’s carbon taxes would be exactly offset by a “carbon tax tax credit,” completely defeating the purpose of the tax.

I second Dylan’s comment. A fair carbon tax is one borne in proportion to how much carbon you consume on an absolute basis, not on a relative-to-your-neighbor basis. Whatever we would do with the incremental tax revenue should be justifiable independent of the source of the funds. Returning that revenue to individual taxpayers in proportion to how it was raised is pretty much the dumbest way to spend it to my eyes.

Felix: Given your thinking, would you also be a proponent for educational vouchers and healthcare vouchers?

I agree with drewbie. The compensation for consumers is not having to tread water (with apologies to Bill Cosby).

Posted by Ken | Report as abusive

Felix — Why not go the “dividend” route, with every American getting a quarterly check equal to 1/305,000,000 of the prior quarter’s carbon tax or permit revenue? Clean, simple, and arguably at least as fair as any other distribution?

The dividend check is the way to go. And the tax on gasoline wouldn’t be $3 per gallon, closer to $0.10 per gallon. Carbon neutral just isn’t that expensive. See this study in New Scientist on affordability. 427373.400-lowcarbon-future-we-can-affor d-to-go-green.html

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