How to Love the One You're With: Changing Tax Policy to Fit Cap-and-Trade

This paper will begin with an introduction of climate change issues, including a brief history of international mitigation efforts. The next section will give an overview of cap-and-trade systems and describe how a typical cap-and-trade system would interact with the current federal income tax system. The discussion of the interaction of cap-and-trade with the income tax will include both direct and indirect effects. This section will then compare those effects with the potential impact of a carbon tax.

The direct impacts of cap-and-trade on the income tax system occur because the “trade” part of cap-and-trade creates a new financial instrument that needs to be accounted for within the tax system. A carbon tax would not create a new financial instrument. Both a carbon tax and a cap-and-trade system could cause international trade issues that could affect the income tax system. Both a carbon tax and a cap-and-trade system, by placing an additional cost on energy-intensive products, could alter the effectiveness of existing energy tax incentives and place a disproportionate burden on low-income populations.