Weighing CarbonWA’s Tax Swap Ballot Initiative

UPDATE Oct 7: We previously said that I-732 could result in a windfall of up to $200 million to Boeing. However, Boeing’s newly-released tax data suggest that it only pays $19 million to $60 million per year in state business taxes, and therefore would benefit from I-732 in the range of tens of millions per year, not hundreds of millions as we previously concluded. We updated the article below to explain the new estimates.

Note from Alan: In Washington state, climate hawks have divided over CarbonWA’s Initiative 732, a proposal for a BC-style revenue-neutral carbon tax shift that will appear on the November ballot. The divisions—over both policy and political strategy—are agonizing and strongly felt. I-732 is therefore a contentious subject to publish about, but with the public vote nearing, Sightline is launching a short series analyzing I-732 and the arguments commonly offered against and for it.

It’s a task we do not relish. At Sightline we believe that climate policy must be effective and fair, not only cutting climate-warming pollution and putting us on track toward clean air and clean energy, but also building a more just and equitable society. We are committed to passing this kind of policy in Cascadia.

We’ve worked toward those goals with most of the parties in this controversy. The leader of CarbonWA is Yoram Bauman, who has been involved with Sightline on and off since 1997, when he began an internship that culminated in co-authoring the book Tax Shift. We have also worked side by side for years with many of the dedicated groups and individuals in the large coalition of organizations assembled as the Alliance for Jobs and Clean Energy, including close collaboration since 2007 on carbon pricing. When CarbonWA gathered the signatures needed to proceed to the ballot, the Alliance urged CarbonWA to stand down and leave the November 2016 ballot uncluttered for an alternative climate policy to be formulated by a broader coalition, including groups dedicated to social justice for historically marginalized communities. Some Alliance coalition members are leading the opposition to I-732.

Sightline’s own board and staff, interns and fellows, volunteers, contributors, and readers include people at just about every point along the spectrum of views about I-732, and I have personal friends both supporting and opposing the initiative. Almost anything we say could cause hard feelings with someone we respect.

Still, Sightline’s duty is clear. We are a research center. We study issues and propose policy solutions. We examine arguments and stress-test them against logic and empirical evidence. We publish what we learn and let everyone judge for themselves. We try hard to get the facts right (as our research staff will tell you), even when it inconveniences our usual allies (as they will tell you).

Throughout the last year, Sightline has sought to remain deeply engaged, supportive of all responsible efforts to make polluters pay for their carbon pollution, but neutral between efforts. Now, we have studied I-732 and tried our best to put aside everything but the policy itself. What does it do or fail to do? How does it stack up? Sightline’s short series aims to allow Washington voters as impartial and informed a review of it as our analysis can provide.

In general, as we explain in this series, we find I-732 a worthy policy to put Washington on a path to cutting pollution and encouraging clean energy while also helping low-income families by making Washington State taxes less regressive. I-732 has weaknesses, which we enumerate, but putting a strong carbon price in place in Washington would be a big step forward.

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This November, Washingtonians will have the chance to vote on a carbon tax: Citizens’ Initiative 732. Enthusiastic grassroots climate activists across the state gathered more than 300,000 signatures to get I-732 on the ballot.

Washington voters who care about the climate may be wondering if the initiative is a well-designed way to cut pollution. When making polluters pay for their climate pollution, these are the three most important policy questions to analyze:

1. How high is the price?
2. What is the revenue used for?
3. Does the policy get the design details right?

Here’s why these three questions are important and how I-732 answers them.

Q. How high is the price?

The price question matters both for pollution-busting and for political feasibility. A higher price results in less pollution but may face greater political hurdles. A lower price will not reduce pollution as much but may be more politically feasible.

To achieve Washington’s state statutory goal of cutting greenhouse gas emissions 50 percent below 1990 levels by 2050, US economic models suggest the pollution price on the transportation and electric sectors probably needs to reach $100 to $150 per ton by 2050. (Throughout this article, we are referring to “real dollars”—dollars adjusted for inflation. That is, $100 in a future year is worth the same as $100 today, though in the future year, the actual price tag, after inflation, would be much more than $100.) Why do we say that? Consider a few modeling results:

• Stanford’s Energy Modeling Forum study on “US Technology and Climate Policy Strategies” analyzed 324 model runs to show that a price rising to around $100 to $150 by 2050 would likely reduce US emissions 50 percent below 2005 levels.
• The World Resource Institute recently summed up the literature, showing that a price on carbon rising to $52 per ton in 2030 could cut transportation and electricity sector emissions by up to 31 percent.
• Synapse Energy estimated that an aggressive national emissions reductions policy might reach a price of $90 per ton by 2040.
• The US Energy Information Administration’s modeling suggests that around $60 per ton by 2040 would slash electricity sector pollution by two-thirds.
• Policy think tank Resources for the Future’s modeling predicts that a pollution price on a path to reach $100 by 2050 would cut electricity sector emissions by more than half by 2035.
• Portland State University estimated that a carbon price rising to $150 per ton would cut Oregon emissions in the transportation, electricity, and industrial sectors by 40 percent below 1990 levels, or more than 50 percent below current levels.

Researchers have also approached the problem of global warming pollution from the other direction, trying to calculate how much each ton of pollution costs us in damaged health, reduced productivity, increased risk of flood and fire, and increased costs for air conditioning. They call this the “social cost of carbon,” and the estimated damages per ton of pollution are remarkably similar to modeling of the price per ton needed to cut pollution: the social cost of carbon rises to about $100 per ton in 2050.

For all these reasons, we think the right price for carbon pollution in Washington is $100 to $150 per ton by 2050.

A. The I-732 price is about right.

I-732 nearly hits the mark. The I-732 tax starts at $15 per ton in 2017, goes up to $25 in 2018, then increases at 3.5 percent plus inflation every year until 2059, when it hits our mid-century target of $100 and flattens out, increasing each year only at the rate of inflation. (Assuming 2 percent annual inflation, the price will be $225 in nominal dollars in 2059.)

A carbon price starting at $15 and steadily rising to $100 in midcentury will put wind in the sails of Washington’s clean energy economy as nothing else possible. It will hasten the decline of coal; level the playing field for clean renewable energy; motivate companies to squeeze pollution out of their processes; encourage more convenient alternatives to driving alone and more efficient vehicles; concentrate urban growth in dense, walkable communities; and spur investment in clean business and technology innovations. The I-732 pollution price would amplify other clean energy policies and speed the Evergreen State toward a thriving clean energy economy.

Moreover, setting the price’s rising trajectory all the way to 2059 would vault Washington to the head of the North American pack on climate leadership. Other North American carbon prices are not yet high enough nor sustained enough to achieve climate-stabilizing pollution reductions: northeastern states’ RGGI price maxes out just above $7 per ton. California and Quebec’s joint price hovers around $13 per ton, and California’s cap-and-trade plan is currently only authorized through 2020 (though the state’s leaders are working to extend it). British Columbia’s price is stalled at Can$30, and although a committee recommended the province resume increasing its carbon tax in 2018, BC’s leaders have said they will not change the carbon price until the Canadian federal government makes a decision about carbon pricing.

I-732 would give Washington the continent’s, if not the world’s, most potent, persistent, and comprehensive incentive to move swiftly beyond dirty fossil fuels and to a carbon-free future.

Q. What is the revenue used for?

Holding polluters accountable for the pollution they heave into our shared atmosphere will encourage private investors—including electricity utilities, auto manufacturers, and entrepreneurs—to shift their money and attention to cleaner products and processes. The price itself nudges the economy towards clean energy by making prices tell the truth about how much pollution really costs us, the public.

And the revenue can be put to good use. Whether invested in public interest projects or reducing other taxes or paying dividends to people, polluters-pay revenue can support economically vulnerable and historically marginalized communities that are hit hard by pollution. It can advance racial and economic justice.

Authorities could spend polluters-pay revenue on public investments that encourage a clean, equitable, and prosperous future. California and RGGI use pollution revenue to invest in transit, affordable housing, energy efficiency, and other projects that help families and communities, create jobs, and keep those states on the cutting edge of the clean energy future. California also dedicates one-quarter of its revenue to projects that benefit the Golden State’s most disadvantaged communities. Public investments can also spur private ones, as California has found, leveraging more than $3 in private capital investments for every $1 of polluters-pay revenue it invested.

Authorities could also use polluters-pay revenue to replace regressive or distortionary taxes and help make the tax code more progressive. Tax the bads (what you want less of), not the goods (what you want to encourage), the Pigouvian thinking goes. British Columbia, Washington’s Cascadian neighbor to the north, taxes carbon and uses the revenue to cut individuals’ income taxes and to cut business taxes. In Washington state, with the most regressive tax system in the United States, this option might be especially appealing.

Finally, authorities could give the revenue back to people. They collect the money from polluters and treat it as a common resource, sending dividend checks to all residents. For decades, Alaska has treated oil revenue as a common resource and sent a dividend check of around $1,000 to $2,000 per year to each Alaskan resident. Charging for pollution and sending a check to everyone benefits low-income households the most, because even though lower-income people spend a greater share of their income on energy, they spend less money in gross terms on energy. Therefore, they pocket more of the dividend check than do higher-income households who spend more on energy.

A. I-732 revenue would reduce the state sales tax, aid low-income working families, and protect manufacturing jobs.

Washington State’s Office of Financial Management estimates the carbon tax will raise about $2 billion in revenue in fiscal year 2019, or about 4 percent of the state’s roughly $47 billion annual budget. (Washington plans its budget per biennium. For example, the July 2015 through June 2017 budget is about $94 billion, and the budget will grow as Washington’s economy and population expand in future years.)

The I-732 proposal aims to be revenue-neutral, meaning the new polluters-pay revenue is intended to replace cuts to other taxes. The state treasury is supposed to receive the same amount of revenue, but now some of it will come from large polluters paying a carbon tax instead of from people and businesses paying sales and other taxes. (How close I-732 will get to revenue neutrality in practice has been the subject of considerable controversy, and we’ll delve into the question in another article.)

1. Cut the state sales tax

The bulk of the carbon revenue from I-732—around $1.5 billion per year in 2019—would finance a one percentage point reduction in the state sales tax, decreasing it from 6.5 percent to 5.5 percent. People and businesses would save about $1.5 billion per year at the cash register, and instead, polluters would contribute about $1.5 billion to the state budget.

The 1 percent decrease in the state sales tax would save low-income households around $70 to $150 per year and higher-income households would save around $400 per year (because they buy more stuff). (If you’re curious about what this means for your wallet, the University of Washington offers a calculator where you can input some information about how much energy you use and see the likely net effect for you.)

2. Fund the Working Families Tax Credit

About $250 million per year in carbon revenue would fund Washington’s Working Families Tax Credit, created in 2008 but never funded. Because Washington relies heavily on the regressive sales tax, Washington has the most regressive state tax system in the United States: the lowest-income families pay nearly 17 percent of their income for state and local taxes, while the richest families pay only 2.4 percent.

By refunding a portion of the state sales tax to 460,000 families in Washington (about 17 percent of Washington’s 2.6 million households) through the Working Families Tax Credit, I-732 would tilt the scales toward a more progressive state tax system. It could also bring additional money into the state by spurring more eligible families to sign up for the federal Earned Income Tax Credit.

For example, a family with two children can currently access up to $5,548 in federal Earned Income Tax Credit (EITC). With I-732 in place, that family would be eligible for an additional $1,387 from Washington in 2018. So while low-income families’ energy costs would rise around $150 to $300 per year due to the carbon tax, I-732’s sales tax break plus Working Families Tax Credit would still put an eligible low-income family with two children ahead by around $1,300 a year.

Notably, the Working Families Tax Credit would reduce the tax burden on this working family with two children from 17 percent to 6.8 percent of income, constituting the biggest improvement in Washington tax progressivity in almost 40 years, at least for working families in the lowest two quartiles of households. About 800,000, or 31%, of Washington’s 2.65 million households are low-income ($39,060 or less for a single parent with two children), and the Credit would reach 460,000 of them.

Some 340,000 households, though, would not qualify for the Credit, including retirees and working people who make too much to qualify, such as a single person making more than $14,820. However, low-income people who don’t qualify for the Working Families Tax Credit would still benefit from I-732’s sales tax reduction, so most of them would come out roughly even, some paying tens of dollars more and some paying tens of dollars less in taxes annually due to I-732, though some of them might end up paying hundreds more.

Unfortunately, the tax benefit or loss for those households depends, to a large extent, on which utility delivers their electricity. Washington’s investor-owned utilities—Avista, Pacific Power, and Puget Sound Energy—get about half their power from coal and natural gas, while publicly owned utilities—like Benton Rural Electric Association and Seattle City Light—get most of their power from hydro. As a result, a single person who makes $15,000 per year and is average in his spending, driving, and home energy use will save $82 in taxes if he gets his electricity from Seattle City Light, but will pay around $28 per year more in taxes if he gets electricity from Puget Sound Energy. For an average home, in other words, living in one utility district versus another may mean a $100 difference in annual electricity bill, because of the carbon tax—an amount comparable to what a typical low-income family will save from I-732’s sales tax reduction.

One of the benefits of I-732 is that it lacks messy specifications and exceptions and is simple to understand and administer, but this same quality makes it difficult to address complex situations. California’s carbon pricing scheme is much more complex—it took six years and thousands of pages of regulations to implement—but it deals with the differences in utility portfolios by sending each household a climate credit calibrated to each utility’s carbon content. Customers of Pacific Power pay a higher carbon price because of Pacific Power’s coal-heavy portfolio, but they get a bigger climate credit to make up for it. I-732 fails to account for the differences among Washington utilities.

3. Cut the B&O tax for manufacturers

Finally, I-732 would cut Washington State business and occupations (B&O) taxes for manufacturers by about $450 million per year in an attempt to prevent manufacturers from relocating outside Washington as a result of the carbon tax.

Manufacturers worry that a carbon price will increase the cost of running their factories so much that they will have to move out of the state, eliminating Washington jobs and not even cutting pollution (because they will simply run the same operations outside Washington). This concern is legitimate when two things are true: (1) the Washington business is energy-intensive, meaning it burns a lot of fuel or uses a lot of electricity to run its equipment, so that when fossil fuel prices go up, its operational costs go up, and it has to raise its prices to cover the cost of the carbon tax; and (2) the business faces out-of-state competition from factories that don’t have to pay a carbon price. When these two conditions are present, a business is called “energy intensive and trade exposed” (EITE) and requires some aid or tax break to ensure it can remain competitive with out-of-state businesses even while paying a state carbon tax.

I-732 provides this aid by eliminating the B&O tax for all manufacturers. However, cutting the B&O tax for all manufacturers, rather than identifying the EITE business and calculating how much of a tax break they need to remain competitive, may be over-generous to some companies and insufficient for others.  Washington Department of Ecology’s proposed Clean Air Rule identifies 23 EITE industries, including cement manufacturers (which could see costs go up by more than 10 percent of revenue as a result of a carbon price), fertilizer manufacturing (which could see prices increase by 5 to 10 percent of revenue), and pulp and paper mills and glass manufacturing (which could see price impacts of 2.5 to 5 percent). Many other manufacturers would see price impacts of less than 2.5 percent and even less than 1 percent and so are not on Ecology’s list of EITE industries, but will nonetheless receive B&O tax cuts under I-732.

I-732’s approach to protecting EITE industries may be blunt and over-generous, but it is simple—extremely simple to understand and to implement. One way in which the initiative may be too simple, though, is in its treatment of aircraft manufacturers. I-732 will unintentionally grant Boeing and other aircraft manufacturers a tax cut on the sale of commercial aircraft that may save the companies more money than they will pay in carbon taxes. Washington’s Multiple Activities Tax Credit, currently in effect, lets aircraft manufacturers choose whether to pay B&O on manufacturing or on sales, enabling Boeing to sell aircraft from inside Washington but only pay B&O on manufacturing, not sales. This disincentivizes manufacturers from moving its aircraft out-of-state before selling them in order to avoid Washington B&O tax on sales. This quirk of he tax code means that I-732 effectively eliminates the B&O tax on both manufacturing and sales because manufacturers can opt to choose the lower of the two. I-732 backers say this was an “error in drafting” and that the initiative should only have eliminated the B&O tax on the manufacturing of aircraft, not on sales.

The Department of Revenue estimates that I-732 tax breaks would save aircraft manufacturers $175 million per year, and likely around $140 million in cuts would go to Boeing. Boeing might pay roughly $7 million in carbon taxes on its 275,000 tons of reported greenhouse gas pollution, meaning I-732 would give it a windfall of $130 million. However, Boeing’s recently released tax data indicate that, due to special state tax breaks from the state legislature, Boeing only paid $60 million in business taxes in 2014 and just $19 million last year. This new data suggest Boeing would benefit from I-732 by about $10 million to $50 million per year, not $130 million as the Department estimated. The legislature might revisit its generous tax breaks for Boeing and find a way to more accurately tailor I-732’s tax breaks to keep aircraft manufacturers in state without providing a windfall. Then again, the legislature might avoid it for fear of driving aircraft manufacturers out-of-state.

Overall, a good use of revenue

Generally, I-732 makes good use of the revenue. It cuts the regressive Washington State sales tax and sends money to low-income households, making the overall state tax system more progressive and ensuring that most low-income households would be at least a few hundred and as much as $1,300 better off as a result of the tax shift, and few low-income households are more than tens of dollars worse off. It protects against manufacturers moving jobs and pollution out of the state. However, it glosses over a few important details. It fails to protect or boost all low-income Washingtonians, it gives more tax breaks than necessary to some manufacturers while shorting others, and it fails to account for differences in utility power mixes over which customers have no control.

Q. Are the design details right?

Broad coverage

A well-designed program covers as many types of greenhouse gas pollution as practicable. Broad coverage means covering most emitting sectors and most greenhouse gas pollutants. A broad program is like a fishing net that is big enough to catch lots of fish with mesh fine enough to catch the small ones, too. A big net covers the major emitting sectors of the economy: industry, natural gas, transportation, and electricity (including electricity generated by power plants outside the state and delivered to houses and offices in-state). Together, these four sectors account for about 85 percent of Washington’s greenhouse gas pollution.

A fine mesh captures not just the big fish, like carbon dioxide, but also the lesser-known but even more powerful climate pollutants, including methane, nitrous oxide, and high-global-warming-potential gases: chlorofluorocarbons, hydrofluorocarbons, hydrochlorofluorocarbons, perfluorocarbons, and sulfur hexafluoride. These greenhouse gases account for less than 15 percent of Washington’s GHG emissions.

Smooth administration

A well-designed program regulates polluters upstream for ease of administration. It is transparent and loophole-free.

Here for the long haul

Finally, a well-designed program sends a steady, long-term price signal. The program is designed for decades rather than years, and it artfully sidesteps potential legal stumbling blocks that could undermine confidence that the price is going to stick around. A price that is designed for the long haul is predictable, too, encouraging businesses to find ways to power their operations with innovative clean energy and making clear to investors that the better business decision is to divest from fossil fuels.

A.  I-732 covers most of the state’s climate pollution and is designed for the long haul.

Broad coverage—Mostly

The I-732 carbon tax casts a wide net, but without the particularly fine mesh discussed above. It covers pollution from burning fossil fuels, including gasoline, diesel, aircraft fuels, refinery and industrial operations, natural gas, and coal or natural gas burned in power plants in-state, and in plants out-of-state when they deliver electricity to Washington homes and businesses. Combustion emissions are mostly carbon dioxide (CO₂) but also include small amounts of nitrous oxide and methane. Altogether, the price applies to about 85 percent of Washington’s greenhouse gas pollution.

The tax phases in slowly over 40 years for on-farm diesel and for fuels burned for public transit (about 2 percent of state emissions). It does not cover exported fuels, agriculture and waste emissions, industrial emissions from chemical processes rather than combustion of fossil fuels (for example, about half of cement manufacturing emissions are from burning fossil fuels to heat the kiln, and about half are from a chemical process called calcination; I-732 would only tax the burning of fossil fuels), not un-burned methane (such as from pipeline leaks), nor the five high-global-warming-potential gases mentioned above.

Smooth administration—Yes

The tax applies upstream, to utilities and refineries, and it is administratively elegant, simply adding a line to fuel sellers’ existing tax bills so that it doesn’t create any additional administrative burden. For example, British Columbia used existing tax collection infrastructure and staff to implement their revenue-neutral carbon tax.

Here for the long haul—Double yes

Unlike the British Columbia carbon tax, which froze its price in 2012 pending further legislative action, I-732’s tax would continue increasing by 3.5 percent plus inflation every year until 2059 and by the inflation rate thereafter. This price trajectory sends a clear signal that clean energy is the smart choice in the Evergreen State for the rest of the century.

Conclusion

Scientists and economists agree that the most effective way to free ourselves from fossil fuels is to stop the free lunch for polluters. Initiative 732 does exactly what the scientists and economists prescribe: it sets a science-based, steadily rising price on pollution. The citizens’ initiative covers most of the state’s climate pollution, makes the tax code more progressive, and is administratively elegant.

I-732 is not perfect. It is easy to understand and administer, and it will put money in the pockets of hundreds of thousands of low-income families. But it does not benefit all low-income households, and it means that any given household’s utility provider plays an outsized role in the tax’s impact on that household’s budget, leaving benefits and costs for households to geographic luck. Its protections for energy-intensive, trade-exposed companies are blunt and may give money to businesses that don’t necessarily need it, particularly Boeing.

In policy design, there is always a trade-off between simplicity and nuances. Nuanced policies carve out solutions for a range of situations and outcomes. But with nuance comes complexity that can also collapse under its own weight. I-732 leans toward simplicity and omits subtleties.

In future articles, we will dig into the details of the revenue-neutrality issue and explore criticisms of I-732: specifically, that it does not invest in clean energy, dedicate money to projects benefiting neighborhoods that are home to low-income people and people of color, and that it fails to aid workers in fossil-fuel and other high-pollution industries to transition to new employment.