The dramatic deterioration in the labor market since March has brought increased attention to the economics of the payroll tax and the possibility of a permanent reduction in the tax rate. The recently enacted Coronavirus Aid, Relief, and Economic Security (CARES) Act included an often-overlooked retention tax credit that reduces payroll taxes for certain workers. The credit, both temporary and limited, was intended to encourage employers not to lay off workers as the pandemic forced widespread shutdowns across the economy. The credit also addresses a concern that the current payroll tax discourages labor market participation and more hiring. Lawmakers, including Senator Josh Hawley (R-MO) and a handful of progressive lawmakers in the House, have proposed significantly expanding this credit. Such reforms are intriguing but costly, and some fiscal conservatives are raising valid concerns about the rising federal debt burden. One constructive way to finance a permanent payroll tax cut is with the revenue from a federal carbon tax. This policy is not only pro-growth and pro-work, but also pro-environment.
Before the pandemic hit, the demand for climate change action had been growing, prompting many conservatives to look for policy options while holding true to the conservative values of free markets, limited government, and fiscal responsibility. The business community was also taking note of the need to address climate change, with the U.S. Chamber of Commerce warning that “inaction is simply not an option.” A revenue-neutral carbon tax is a market-oriented strategy to reduce carbon emissions. And now, while the reduction of carbon emissions to combat climate change is as important as ever, another important reason to implement a carbon tax is that it could help spur economic growth when we desperately need it.
The point of a carbon tax is not to increase overall taxes on the economy, but rather to have a tax code operate in a more efficient and pro-growth manner. Smart tax policy would tax more heavily the things society wants less of (carbon emissions) and tax less, or even not at all, the things society wants more of (labor, savings, and investment). For example, a $40-per-metric-ton carbon tax would raise approximately $167 billion in the first year, or enough to provide a two-percentage-point reduction in the payroll tax rate (from the current 12.4 percent to 10.4 percent).
A big cost of operating a business is labor. Labor costs include not just the wage paid to an employee, but also the additional costs of employing someone, such as health insurance and payroll taxes. As the cost of labor increases, either through legislated increases in the minimum wage or higher payroll taxes, employers look to automation to reduce costs. Not only would a reduction in the payroll tax rate lower the cost of labor, thereby making workers more attractive to employers, but paychecks would increase as well.
Reducing the burden of the payroll tax would boost employment in fields that are labor-intensive. For example, a reduction in the payroll tax rate would lower the cost of employing daycare and senior care employees. A lower payroll tax would also increase the returns to self-employed workers and those working in the gig economy. With approximately 20 million workers now receiving unemployment benefits, removing barriers to work is more critical than ever.
On top of this, while climate change remains incredibly important for Democrats and independent voters, conservative constituents are increasingly concerned about the issue. Republican lawmakers must anticipate shifting conservative public opinion and strategically prepare policies that address climate change while promoting economic growth. Democrats have historically turned to regulatory policies, but a large body of research shows that command-and-control regulations are less efficient and less effective than market-based alternatives, including a revenue-neutral carbon tax.
Some legislation proposing a carbon tax has suggested using the revenue to provide an annual rebate check as a form of lump-sum payment to every American. But a rebate would not lower the cost of labor to employers or raise the after-tax return from working. A reduction in the payroll tax rate would be a better pro-growth and pro-work use of any revenue from a carbon tax.
Jason J. Fichtner, Ph.D., is a senior lecturer in international economics at the Johns Hopkins University School of Advanced International Studies (SAIS) in Washington, D.C. Views expressed are the author’s and are not intended to represent official views of any affiliated organization. This article is based on a July 2019 paper he wrote for the Alliance for Market Solutions, “Why Conservatives Should Support a Pro-Growth, Revenue-Neutral Carbon Tax to Lower the Social Security Payroll Tax Rate.”