United States of America

Tax Law and Climate Change

Introduction

Taxation can be a powerful tool for meeting policy goals, and the net zero transition is no exception. Government taxation can be utilized to both disincentivize behavior—notably behavior producing greenhouse gas emissions—and encourage behavior that involves adaptation or mitigation measures. Of course, this is all set against the backdrop of economic issues and political attitudes, which are sometimes at odds with environmental objectives in taxation. This is especially true in the U.S., where states have varying attitudes towards and levels of dependency on the fossil fuel industry.

Further, tax revenue is vital to the significant public investment required to address climate change. Reducing emissions, however, will also reduce revenue from taxes paid by highly emissive industries.

Across federal, state, local, and tribal governments, fossil fuels generate about $138 billion in tax revenue annually.[1] While increasing clean energy production will provide additional revenue, tax subsidies designed to incentivize renewables—such as those introduced in the Inflation Reduction Act (IRA)—will limit the industry’s ability to replace fossil fuel tax revenue entirely.[2] This impact is felt more aggressively at the state level in areas economically reliant on the fossil fuel industry. Nine states receive at least 7% of state tax revenue from fossil fuels- and for three states that number is over 20%.[3] Presidents Obama and Biden have both proposed eliminating fossil fuel subsidies from the tax code, but attempts have been politically unsuccessful.[4] President Biden’s most recent budget proposal includes eliminating these subsidies, which would raise an additional $31 billion over the next decade.[5]

General Impact

Despite the significance of the tax revenue received from the fossil fuel industry, many economists predict state economies will survive through other industries. Texas, for example, a state traditionally dependent on oil and gas, maintained economic strength through growth in the tech and renewable sectors.[6] While not all fossil fuel reliant states are ripe for renewable energy production, one analysis found that a quarter of counties with the greatest wind and solar potential are located in current fossil fuel hubs.[7] Surges in clean energy investment following the IRA and growth in other industries illustrate the U.S. can continue raising sufficient tax revenue despite transition away from a carbon-based economy.[8]

Existing Framework

Taxation Incentivizing Emissions

The Federal Tax Code contains a number of subsidies targeting the fossil fuel industry. Subsidies for oil, gas, and coal development, for example, reduce federal tax revenue by about $11.5 billion from 2019-2023.[9] The largest of these subsidies treat expenses in tax favorable ways- one by setting a fixed amount companies can count as expenses to deduct from gross revenue annually regardless of how much actually spent, and the other by allowing depreciation deductions for exploration and development costs, rather than treating these costs as capital investments.[10]

These, among other tax provisions, incentivize continued exploration, development, and production of fossil fuels. These subsidies not only encourage continued reliance on the fossil fuel industry, but also reduce tax revenue that could otherwise fund clean energy investment of other projects aligned with a net zero world. In fact, the Biden Administration’s budget proposal eliminated many of these exact provisions.[11] While the political feasibility of eliminating oil and gas subsidies is low, taking such steps is key to mitigating climate disaster and building a net zero world.

Taxation Disincentivizing Emissions

While significant incentives to participate in the fossil fuel industry exist in the tax code, U.S. tax law also has a number of provisions designed to discourage emissions-producing ventures and encourage renewables. One major emissions disincentive is the taxation of fuel, which exists both at the federal level and in each of the 50 states.[12] Another is the taxation of plastics- an industry associated with 4-8% of oil consumption and therefore significant greenhouse gas emissions.[13] A number of local governments have either proposed or passed legislation taxing the use of plastic bags in the last several years.[14] While a national-level plastic tax has been proposed, it has not passed.[15] Even prior to the IRA, the U.S. tax code offered credits for the investment and production of wind and solar energy.[16]

Further, while major initiatives like a carbon tax and cap and trade have not taken hold nationally, a number of states have adopted cap and trade programs. Cap and trade programs essentially institute a limit on the amount of allowed emissions, then creates a market for companies to buy and sell allowances to emit certain amounts of greenhouse gasses, thus both capping the overall emissions and increasing the cost associated with emitting greenhouse gasses.[17] Many states’ programs seek to reduce greenhouse gas emissions specifically in the power sector, but others—notably the program in California—covers larger swaths of the state’s economy.[18] Another significant cap and trade program includes twelve states in the Regional Greenhouse Gas Initiative.[19] As cap and trade expands across the U.S., particularly regional programs with fewer opportunities for companies to relocate and emit elsewhere—emissions will decline and put states closer in line with net zero emissions targets.

One noteworthy criticism of such programs is that without global consistency, companies will simply outsource their work to other countries with less stringent emissions standards.[20] Given concern about “carbon leakage,” it is important to consider the international system’s role in climate mitigation taxation. The UNFCCC has created a voluntary global carbon market, but no mandatory agreement exists.[21] Even were proposals to spark international agreements, such as the creation of an international carbon price floor as supported by the IMF,[22] the U.S. does not have a strong history of ratifying international treaties imposing significant obligations on the country. The Paris Agreement, for example, despite imposing legal obligations only on processes and not on concrete goals still faced enormous challenges to U.S. participation.[23] Even with current opposition, practitioners should note global debates regarding carbon taxation or pricing, as such mechanisms may continue to gain traction. Another possible solution to carbon leakage is carbon border adjustments, which is discussed further in our trade law section.

How Tax Law May Help Drive the Net Zero Transition

Recent Government Action: The IRA and Other Budgetary Proposals

The newly introduced IRA, implemented following the election of the Biden Administration which ran on a campaign of building a clean energy economy,[24] is the most prominent tax legislation within the U.S. designed with net zero and climate mitigation objectives. The IRA was a landmark investment which sought to combat and mitigate the impacts of climate change by implementing a multipart framework: tax increases for wealthy corporations, expanded healthcare subsidies, and tax incentives designed to discourage fossil fuel emissions while encouraging growth in the renewable and clean energy sectors.[25] In the context of taxation, the IRA establishes tax credits for a variety of clean energy or net zero tools and contains provisions designed to incentivize individual investment in climate mitigation technology. For example, the legislation offers rebates for individuals who invest in energy-efficient appliances and home improvements, as well as for purchasing electric cars.[26] There are some concerns, however, that these provisions offer little actual value. The electric vehicle tax credit, for example, comes with a price cap that most vehicles on the market do not meet.[27]

Other IRA provisions target corporations and investment activities, offering a host of tax credits for investment in renewable energy technologies. Tax credits for carbon capture technology have been expanded under the IRA, and billions will go towards tax credits for clean energy technologies like solar panels and wind turbine development.[28] Other tax credits will benefit the production of tools needed for climate crisis mitigation efforts, including batteries, solar panels, and electric vehicles.[29] The IRA’s strategy to spark investment in clean energy appears to be working, with investments soaring in areas from battery production to clean power plants.[30] We must build on these successes to reach net zero targets.

In addition to the IRA, the Biden administration continues to pressure the fossil fuel industry in its budget proposals. In 2021, the administration proposed repealing and adjusting a variety of provisions that benefit the fossil fuel industry, such as tax credits for enhanced oil recovery and marginal oil and gas wells.[31] The Biden administration followed this up in 2022, continuing to advocate for clean energy tax credits through the repeal of fossil fuel tax preferences and increased taxation of fossil fuel income.[32] Most recently, in 2023 the administration’s budget proposal included funding for a number of adaptation and resilience programs across the country as well as funding for investment in clean energy jobs.[33]

Despite the Biden Administration’s continued push for investment in climate mitigation efforts, the country will face significant roadblocks in meeting President Biden’s campaign promise to achieve a 100% clean powered electric grid by 2035.[34] Such a goal requires huge investment in solar, wind, and battery power.[35] However, budget proposals involving these investments face opposition in Congress, particularly by representatives from big oil states or whose campaigns are funded by fossil fuel money.[36] Practitioners working in the energy space should note this divide, as tax legislation often involves sunset provisions, meaning provisions impacting energy transactions may undergo regular changes as legislators are forced to decide whether to renew incentives. Practitioners should pay continued attention to the taxation of fossil fuels and renewables to monitor any changes. Further, efforts to implement tax incentives for clean energy sources will help meet the Administration’s goal, a goal which will advance net zero targets.

Using Tax Law to Address Climate Change

Many fossil fuel taxes, renewable energy credits, and clean energy subsidies such as those discussed above should continue to be used to disincentivize fossil fuel production and decrease greenhouse gas emissions. Fuel taxes, plastic taxes, credits for clean energy and energy-efficient consumption, and the repeal of credits and subsidies for fossil fuel production and consumption will all aid efforts to reach net zero emissions. Proposals for more widespread and direct taxation of fossil fuels—namely the carbon tax and cap and trade programs—should also continue to be discussed and implemented.

The Case for a U.S. Carbon Tax

As explored above, the IRA has introduced a number of provisions designed to reduce overall greenhouse gas emissions. However, climate taxation in the U.S. is contradictory; provisions promoting clean energy and discouraging fossil fuel production send one message, while provisions subsidizing fossil fuel extraction suggest the opposite. Similarly, variation among state taxation policies prevent the U.S. from addressing national emissions holistically. One potential solution to this challenge is a carbon tax.

By taxing all carbon usage, a carbon tax incentivizes producers to use more efficient technologies with the fewest emissions, advantaging it over policies such as cap and trade that encourage emissions reduction only up to a predetermined amount.[37] One key issue with the carbon tax, however, is the disproportionate impact it would have on low-income taxpayers, who would face a far greater reduction in after-tax income than higher income taxpayers.[38] Additionally, many economists argue a carbon tax would reduce overall economic output, with studies corroborating these concerns.[39] While economists draw attention to the output and production impacts of a carbon tax, climate activists note concerns that such a tax’s market-based mitigation approach will not reduce emissions as quickly as necessary given the magnitude of the climate crisis.[40]

Many of the benefits of a carbon tax could also be manipulated to address these concerns. For example, a carbon tax would generate significant revenue, some of which could be used to replace income lost to higher prices in low-income communities.[41] Regardless of the benefits and drawbacks, a carbon tax would need to surmount immense political challenges in the U.S. to pass.[42] Other jurisdictions can serve as an example – 38 jurisdictions worldwide have implemented a carbon tax in some form.[43]

Cap and Trade Programs

Another debated tool in zero emissions efforts is cap and trade programs, also referred to as carbon pricing or emissions trading. Cap and trade programs have already been adopted in a number of U.S. states and twelve jurisdictions globally,[44] including in the EU and the UK.[45] Carbon pricing can be a cost-effective mechanism in climate change mitigation efforts, allowing economies to gradually transition away from carbon-intensive energy sources.[46] Briefly described in the “Taxation Disincentivizing Emissions” section, emissions trading involves instituting a cap on total carbon “allowances,” which companies must expend in order to emit a corresponding amount of greenhouse gasses. These allowances develop prices based on their market value. Through trading, companies can redistribute their emissions allowances to those generating the most greenhouse gas emissions while keeping total emissions below the government-instituted cap. Further, the government can regularly decrease the number of allowances available, gradually reducing the overall emissions produced within the carbon pricing regime’s realm.

The nature of carbon pricing programs, however, has led to concerns about the overproduction of greenhouse gas emissions up to the specified cap.[47] Rather than disincentivizing emissions entirely, as a carbon tax would do, carbon pricing incentivizes reducing emissions to a specified level, or even purchasing emissions allowances from other companies which is often cheaper than converting to clean energy technology.[48] Further, for carbon pricing to be an effective tool, it must operate across industries and borders, which would require significant global cooperation.[49] Even so, both carbon taxation and pricing are tools that, if implemented effectively, could help align the U.S. and the world more closely with net zero goals.

[1] ‘US Revenues from Fossil Fuels, Responsible for $138 Billion Annually, Expected to Fall Regardless of Climate Action‘ (Resources for the Future, 13 January 2022) <https://www.rff.org/news/press-releases/us-revenues-from-fossil-fuels-responsible-for-138-billion-annually-expected-to-fall-regardless-of-climate-action/> accessed 24 April 2024.

[2] Brad Plumer, ‘Quitting Oil Income is Hard, Even for States That Want Climate Action (New York Times, 07 July 2022) <https://www.nytimes.com/2022/07/07/climate/california-fossil-fuel-tax-revenue.html> accessed 24 April 2024.

[3] Ibid.

[4] Reuters, ‘Biden budget targets U.S. fossil fuel subsidies‘ (Reuters, 09 March 2023) <https://www.reuters.com/business/energy/biden-budget-targets-us-fossil-fuel-subsidies-2023-03-09/> accessed 24 April 2024.

[5] Ibid.

[6] See Christopher Slijk & Keith R. Phillips, ‘Once- oil-dependent Texas economy to keep growing as renewable energy expands‘ (Federal Reserve Bank of Dallas, Southwest Economy, Third Quarter 2021) <https://www.dallasfed.org/research/swe/2021/swe2103/swe2103b> accessed 24 April 2024;  see also Ayelet Sheffey, ‘3 reasons Texas’ economy will be just fine without oil and gas — and so will the rest of the country‘ (Business Insider, 19 October 2021) <https://www.businessinsider.com/texas-economy-green-energy-oil-gas-dallas-fed-climate-crisis-2021-10> accessed 24 April 2024.

[7] Plumer (2022).

[8] Brian Deese, ‘The New Climate Law Is Working. Clean Energy Investments Are Soaring‘ (New York Times, 30 May 2023) <https://www.nytimes.com/2023/05/30/opinion/climate-clean-energy-investment.html> accessed 24 April 2024.

[9] ‘What tax incentives encourage energy production from fossil fuels?‘ (Tax Policy Center Briefing Book) <https://www.taxpolicycenter.org/briefing-book/what-tax-incentives-encourage-energy-production-fossil-fuels> accessed 24 April 2024.

[10] Ibid

[11] Alex Muresianu & William McBride, ‘A Guide to the Fossil Fuel Provisions of the Biden Budget‘ (Tax Foundation, 02 September 2021) <https://taxfoundation.org/biden-fossil-fuel-tax/> accessed 24 April 2024.

[12] See ‘How Do We Tax Energy In The United States? How Does It Compare To Other Countries?‘ (Peter G. Peterson Foundation, 13 September 2021) <https://www.pgpf.org/blog/2021/09/how-do-we-tax-energy-in-the-united-states-how-does-it-compare-to-other-countries> accessed 24 April 2024; see also Janelle Fritts, ‘State Gasoline Tax Rates as of July 2020′ (Tax Foundation, 29 July 2020) <https://taxfoundation.org/state-gas-tax-rates-2020/> accessed 24 April 2024.

[13] Brooke Bauman, ‘How plastics contribute to climate change‘ (Yale Climate Connections, 20 August 2019) <https://yaleclimateconnections.org/2019/08/how-plastics-contribute-to-climate-change/> accessed 24 April 2024.

[14] Renu Zaretsky, ‘The Case of the Plastic Bag Tax: Why don’t we all carry that weight?‘ (Tax Policy Center, 04 April 2018) <https://www.taxpolicycenter.org/taxvox/case-plastic-bag-tax-why-dont-we-all-carry-weight> accessed 24 April 2024.

[15] Patrick Gleason, ‘National Plastic Tax Proposal Follows The Enactment Of New State Level Plastics Fees‘ (Forbes, 24 September 2021) <https://www.forbes.com/sites/patrickgleason/2021/09/24/national-plastic-tax-proposal-follows-the-enactment-of-new-state-level-plastics-fees/> accessed 24 April 2024.

[16] In relation to wind tax credits, see Jonathan Katz et al, ‘Overview of Wind Tax Credits: Internal Revenue Code Sections 45 and 48‘ (National Law Review, 06 May 2021) <https://www.natlawreview.com/article/overview-wind-tax-credits-internal-revenue-code-sections-45-and-48> accessed 24 April 2024; in relation to solar tax credits, see ‘Solar Investment Tax Credit (ITC)‘ (Solar Energy Industries Association) <https://www.seia.org/initiatives/solar-investment-tax-credit-itc> accessed 24 April 2024.

[17] ‘How cap and trade works‘ (Environmental Defense Fund, 22 January 2020) <https://www.edf.org/climate/how-cap-and-trade-works> accessed 24 April 2024.

[18] ‘State Climate Policy Maps‘ (Center for Climate and Energy Solutions) <https://www.c2es.org/content/state-climate-policy/> accessed 24 April 2024.

[19] The RGGI includes Maine, Vermont, New Hampshire, New York, Rhode Island, Massachusetts, Connecticut, New Jersey, Maryland, Delaware, Virginia, and Pennsylvania as the most recent addition. See ibid; see also  Marc Levy, ‘Big greenhouse gas state taking biggest climate step yet‘ (Associated Press, 22 April 2022) <https://apnews.com/article/climate-business-environment-pennsylvania-lawsuits-ca1da47e732e3fb318fd9d7047978172> accessed 24 April 2024.

[20] Louise Gaille, ‘20 Cap and Trade System Pros and Cons‘ (Vittana, 16 April 2019) <https://vittana.org/20-cap-and-trade-system-pros-and-cons> accessed 24 April 2024.

[21] See United Nations, ‘The Paris Agreement‘ <https://www.un.org/en/climatechange/paris-agreement> accessed 24 April 2024, art. 6.4

[22] Ian W.H. Parry et al, ‘Proposal for an International Carbon Price Floor Among Large Emitters‘ (International Monetary Fund, 18 June 2021) <https://www.imf.org/en/Publications/staff-climate-notes/Issues/2021/06/15/Proposal-for-an-International-Carbon-Price-Floor-Among-Large-Emitters-460468> accessed 24 April 2024.

[23] Lila MacLellan, ‘Is the Paris Climate Agreement legally binding? Experts explain‘ (World Economic Forum, 22 November 2021) <https://www.weforum.org/agenda/2021/11/paris-climate-agreement-legally-binding/> accessed 24 April 2024.

[24] The IRA was enacted into law in August 2022. See ‘IRA passage is the capstone achievement for Americans who chose competence over chaos‘ (Third Way, 12 August 2022) <https://www.thirdway.org/press/ira-passage-is-the-capstone-achievement-for-americans-who-chose-competence-over-chaos> accessed 24 April 2024.

[25] Emily Cochrane & Lisa Friedman, ‘What’s in the Climate, Tax and Health Care Package‘ (New York Times, 08 August 2022) <https://www.nytimes.com/2022/08/07/us/politics/climate-tax-health-care-bill.html> accessed 24 April 2024.

[26] See Sam Cabral & Natalie Sherman, ‘Biden signs climate, tax and health bill into law‘ (BBC, 17 August 2022) <https://www.bbc.com/news/world-us-canada-62568772> accessed 24 April 2024; see also Kemberley Washington & Doug Whiteman, ‘Here Are 3 Tax Breaks Included In Biden’s Climate Law‘ (Forbes Advisor, 19 August 2022) <https://www.forbes.com/advisor/taxes/climate-law-tax-breaks/ > accessed 24 April 2024.

[27] Cabral & Sherman (2022).

[28] Cochrane & Friedman (2022).

[29] Ibid.

[30] Deese (2023).

[31] Muresianu & McBride (2021).

[32] Huaqun Li et al, ‘Details and Analysis of President Biden’s FY 2022 Budget Proposals‘ (Tax Foundation, 16 June 2021) <https://taxfoundation.org/biden-budget-proposals/> accessed 24 April 2024.

[33] ‘President Biden’s FY 22023 Budget Advances Equity‘ (The White House, 30 March 2022) <https://www.whitehouse.gov/omb/briefing-room/2022/03/30/president-bidens-fy-2023-budget-advances-equity/> accessed 24 April 2024.

[34] Ella Nilsen, ‘Can Biden achieve his cornerstone climate goal? Why 100% clean power is still out of reach‘ (CNN Politics, 14 July 2023) <https://www.cnn.com/2023/07/14/politics/biden-clean-electricity-goal-report-card-climate/index.html> accessed 24 April 2024.

[35] Ibid.

[36] Dharna Noor, ‘US Republicans oppose climate funding as millions suffer in extreme weather‘ (The Guardian, 13 July 2023) <https://www.theguardian.com/us-news/2023/jul/13/us-republicans-climate-funds-extreme-heat> accessed 24 April 2024.

[37] Kyle Pomerleau, ‘Addressing Climate Change and Reforming the Tax Code with a Carbon Tax‘ (American Enterprise Institute, 07 January 2022) < https://www.aei.org/articles/addressing-climate-change-and-reforming-the-tax-code-with-a-carbon-tax/> accessed 24 April 2024.

[38] Ibid.

[39] Kyle Pomerleau & Elke Asen, ‘Carbon Tax and Revenue Recycling: Revenue, Economic, and Distributional Implications‘ (Tax Foundation, 06 November 2019) <https://taxfoundation.org/carbon-tax/> accessed 24 April 2024.

[40] Pomerleau (2022).

[41] Ibid.

[42] Ibid.

[43] See: https://carbonpricingdashboard.worldbank.org/

[44] ‘Regional Greenhouse Gas Initiative (RGGI)‘ (Center for Climate and Energy Solutions) <https://www.c2es.org/content/regional-greenhouse-gas-initiative-rggi/> accessed 24 April 2024; https://carbonpricingdashboard.worldbank.org/

[45] ‘Our ambition for 2030‘ (European Union) <https://climate.ec.europa.eu/eu-action/eu-emissions-trading-system-eu-ets/revision-phase-4-2021-2030_en> accessed 24 April 2024.

[46] IMF/OECD, ‘Tax Policy and Climate Change: IMF/OECD Report for the G20 Finance Ministers and Central Bank Governors, September 2021, Italy‘ (Organisation for Economic Co-operation and Development, 2021) <https://www.oecd.org/tax/tax-policy/tax-policy-and-climate-change-imf-oecd-g20-report-september-2021.pdf> accessed 24 April 2024, p.4.

[47] Will Kenton, ‘Cap and Trade Basics: What It Is, How It Works, Pros & Cons‘ (Investopedia, 05 December 2020) <https://www.investopedia.com/terms/c/cap-and-trade.asp> accessed 24 April 2024.

[48] Ibid.

[49] IMF/OECD (2021), pp. 5-6.