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California’s Proposed Carbon-Based Fuel Tax

4 min readBy: David Splinter

One of the main proposals from a California commission on taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. reform looks promising, but one commissioner has also suggested a vaguely defined fuel tax in the Blue Proposal.

The proposed “pollution tax on carbon-based fuels” seeks to: discourage carbon-based fuel use, stabilize gas and diesel prices at a higher level with a price floor, and use refundable tax creditA refundable tax credit can be used to generate a federal tax refund larger than the amount of tax paid throughout the year. In other words, a refundable tax credit creates the possibility of a negative federal tax liability. An example of a refundable tax credit is the Earned Income Tax Credit (EITC). s to offset the tax or even make the plan revenue neutral.

The proposal says:

Adopt a Pollution Tax on Carbon-based Fuels. The proposed pollution tax on fuels will be structured so that it moves inversely with the price of crude oil, effectively putting a rough floor under the price of gasoline…The intention also is that the tax is borne by California residents so as to promote more efficient use of energy (i.e. driving, home heating, etc.). Exemption certificates will be considered in the event that it is determined that the proposed tax will impact manufacturers and possibly lead to job loss (although this raises issues with respect to the scope of the exemption)….

Add to the Income Tax a Universal Tax CreditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly. of $100 to $300 as a “universal rebate” of the carbon taxA carbon tax is levied on the carbon content of fossil fuels. The term can also refer to taxing other types of greenhouse gas emissions, such as methane. A carbon tax puts a price on those emissions to encourage consumers, businesses, and governments to produce less of them. revenues, the exact amount depending on the amount of revenues expected to be generated by the carbon tax and the degree of offset of the carbon tax desired. Every state resident would receive the exact same refundable credit or “prebate” (to use the language of “Fair Tax” advocates)…[which] shows that such a tax is not about raising revenue for government, but changing the collective habits of the state’s citizens.

Some concerns include:

Doubling to Quadrupling of Fuel Taxes Implied
The California state government would need to pay out $3.6 billion if the minimum credit of $100 were to reach every one of the state’s 36 million residents. If we compare this to California’s 2008 fuel tax revenue of $3.4 billion, this implies a doubling of fuel taxes at the minimum suggested credit, and a quadrupling at the maximum ($300 per resident rebate). However, these estimates may change significantly with the scope of the tax, as the proposal is unclear as to which fuels would be affected.

Transparency for Taxpayers and Administrative Questions
Will consumers see the tax on receipts or will it be embedded in the price of gas, as with current excise fuel taxes? The tax will use the spot price of which kind of oil (heavy, light, a weighted average)? How often is the oil price evaluated and the tax level adjusted? How will the inverse oil price tax relate to taxes on other carbon-based fuels like coal and natural gas? How will the tax integrate with the state-level cap-and-trade system required to start by 2012?

Name Misleads
The “pollution tax” name suggests that it is a sort of Pigouvian taxA Pigouvian tax, named after 1920 British economist Arthur C. Pigou, is a tax on a market transaction that creates a negative externality, or an additional cost, borne by individuals not directly involved in the transaction. Examples include tobacco taxes, sugar taxes, and carbon taxes. , but such a tax should be proportional to the harm done by the fuels used. The marginal harm done per gallon of gas consumed is unlikely to increase much as the price of oil falls (granted, road congestion may increase some).

To emphasize the price stability effect of the tax, it could be called a “fuel price floor tax.” To emphasize the revenue neutrality aspect, it could be called a “net zero floating fuel tax” (as the revenue neutrality is similar to the “net zero gas tax” plan).

Exemptions Open the Door for Government Choosing Winners
The stated goal of the tax is to discourage energy use, which may lead to job losses as companies seek lower energy states. Government officials will have difficulty in determining who qualifies for tax exemptionA tax exemption excludes certain income, revenue, or even taxpayers from tax altogether. For example, nonprofits that fulfill certain requirements are granted tax-exempt status by the Internal Revenue Service (IRS), preventing them from having to pay income tax. s to prevent job losses, and they may ultimately tilt the playing field.

Refundable Tax Credits Could Become a New Entitlement
The tax credit would require distributing billions of taxpayer dollars, in effect creating a new entitlement. Some Californians may not receive the credit because they do not file tax returns but still pay the new tax at the pump. Another Commissioner has already questioned the tax credit-based “reinvestment” of fuel tax revenues.

Tax Competition
Californians living near borders with other states and Native American reservations may evade the tax by buying fuels where there are lower fuel taxes and no price floor. Californians already pay the highest gas taxA gas tax is commonly used to describe the variety of taxes levied on gasoline at both the federal and state levels, to provide funds for highway repair and maintenance, as well as for other government infrastructure projects. These taxes are levied in a few ways, including per-gallon excise taxes, excise taxes imposed on wholesalers, and general sales taxes that apply to the purchase of gasoline. and second-highest diesel tax, according to a 2007 Tax Foundation study.

An Alternative: The Commission’s “Tax Proposal 2” suggests a simple 18 cents per gallon (cpg) tax increase on transportation fuels. To achieve revenue neutrality, the sales taxA sales tax is levied on retail sales of goods and services and, ideally, should apply to all final consumption with few exemptions. Many governments exempt goods like groceries; base broadening, such as including groceries, could keep rates lower. A sales tax should exempt business-to-business transactions which, when taxed, cause tax pyramiding. rate could be reduced concurrently.