October 25, 2016

Among the issues Washington will vote on in the November election is whether the state should enact the Carbon Emission Tax Act via Initiative 732. The Initiative proposes a tax on the sale or use of carbon. If it passes, Washington will be the first state in the nation to impose a carbon tax.

Overview of the Proposed Carbon Tax

Initiative 732 is modeled after British Columbia’s 2008 Carbon Tax Act. The objective of the carbon tax is to change behaviors by taxing activities that contribute to global climate change. Specifically, the goals of Initiative 732 are to encourage businesses to develop and use alternative energy solutions, decrease non-renewable electricity consumption and, ultimately, reduce greenhouse gas emissions.

Proponents of Initiative 732 hope to accomplish these goals by imposing a tax on businesses and consumers, measured by the carbon content in fossil fuels and electricity consumed in the state. Carbon emissions would only be taxed once by the state. Businesses will pay the tax when buying or bringing fossil fuel into the state, and consumers will see the tax passed on to them in their electricity and fuel bills. The act’s effective date would be July 1, 2017.

Measuring the tax is straightforward, at least initially. The tax on each metric ton of carbon dioxide (CO2) emitted would be $15 during the first year, and rise to $25 during the second year.  For reference, unleaded gasoline emits approximately 20 pounds of CO2 per gallon, so the carbon tax would equate to about 15 cents per gallon in year one and 25 cents per gallon in year two. Each year thereafter, the measure of the tax would escalate by 3.5% plus inflation, and be capped at $100 (in 2016 dollars). The tax would reach its $100 cap in 2059 and would only increase with inflation, thereafter.

According to Carbon Washington, the group behind Initiative 732, the carbon tax is not intended to be an overall tax increase, but rather a shift of the tax burden. In addition to imposing the carbon tax, Initiative 732 would incrementally reduce the state-level sales tax from 6.5% to 5.5% by July 1, 2018. It would also lower the manufacturing B&O tax rate from 0.484% to 0.0001%.

The proceeds of the carbon tax would be allocated to the state’s general fund, which may be spent for any governmental purpose. However, under Initiative 732, the tax would fund the state’s currently unfunded Working Family Tax Rebate (WFTR). The WFTR was set up in 2008 to provide an annual sales tax refunds to individuals who qualify equal-to-a-percentage of the federal Earned Income Credit.

There is ongoing debate regarding Carbon Washington’s claim that Initiative 732 is revenue neutral. The Department of Revenue’s latest fiscal projection predicts an almost $800 million revenue loss during the first five years of the Initiative. Carbon Washington has publicly disputed the Department’s projection and continues to assert that the carbon tax is designed to be a revenue neutral swap – and it may even be revenue positive.

Thoughts about Initiative 732

The initiative raises a number of issues, such as whether a tax on carbon is the most effective mechanism for combating climate change (as opposed to a “cap & trade” system, for example). It also raises the question of whether tax policy is an appropriate tool for trying to implement large-scale behavioral change. A few more observations on the proposed tax:

  • The carbon tax would operate essentially as a ‘sin’ tax, such as the high taxes currently imposed on cigarettes, alcohol, marijuana and other substances that are recognized to have some negative impacts on the user and/or society. Sin taxes are inherently self-defeating; if they influence behavior as intended, the tax base will decrease over time with the decreased consumption of the item being taxed. Ultimately, in order to maintain tax collections, the tax rate must increase commensurate with decreased consumption – as is the intent of Initiative 732. However, decreased demand is unlikely to be linear over time. This means that the revenue from a sin tax is inherently less predictable than that from a general consumption tax, like the sales tax.
  • Both the support and opposition to the initiative are diverse – neither the business nor the environmental communities are united in favoring or opposing the measure. Because of the reduction in the general sales tax and manufacturing B&O tax rates, many businesses – particularly those that are relatively less energy intensive – could see a reduction in their overall tax burden if the initiative passes. On the other side, several prominent environmental and social justice organizations have come out in opposition to the measure. This is either because they feel it will be ineffective in preventing catastrophic climate change, or because they fear the measure will have a disproportionate impact on communities of color and low-income people.
  • Federal income tax law allows individuals a deduction for either state income tax or state sales tax paid. Because Washington does not impose an individual income tax, most state residents who itemize deductions claim the sales tax deduction. Because Initiative 732 would reduce the sales tax rate by 1% statewide, it would also reduce the amount of the sales tax deduction for Washington residents in 2017 and future years. The impact on most taxpayers would be relatively insignificant, however. For example, the increase in federal income tax for a household earning $100,000 per year would likely be less than $50 per year. There would be no impact on taxpayers that take the standard deduction rather than itemizing deductions on their federal tax return.

Although it may be somewhat overshadowed by the results at the top of the ballot, it will be fascinating to see whether Washington will become the first state to tax carbon consumption. Only time will tell whether Initiative 732 is on the leading edge of future tax policy, or just a creative idea that gets relegated to the dustbin of history.

© Clark Nuber PS and Developing News, 2016. Unauthorized use and/or duplication of this material without express and written permission from this blog’s author and/or owner is strictly prohibited. Excerpts and links may be used, provided that full and clear credit is given to Clark Nuber PS and Developing News with appropriate and specific direction to the original content.

This article contains general information only and should not be construed as accounting, business, financial, investment, legal, tax, or other professional advice or services. Before making any decision or taking any action, you should engage a qualified professional advisor.