Tax Reform And Its Environmental Implications Investigated

January 10, 1997

WASHINGTON, DC -- National tax reform may have a substantial impact on the environment as well as on economic growth, researchers at Resources for the Future (RFF) and Stanford University suggest. They have recently launched a study of the environmental implications of three alternative tax plans -- the flat tax, the national sales tax, and the unlimited savings account (USA) tax -- now under discussion in Congress.

"Although each of the three proposals will, to one extent or another, spur economic growth, relatively little analysis has been conducted to date that assesses which proposal would generate the greatest growth, how that growth would be distributed across the economy, and what the potential is for each plan to impact the environment," says Raymond Kopp, principal investigator and director of RFF's Quality of the Environment division. "We're trying to determine the potential of each tax reform proposal to grow the economy and to also maintain or improve environmental quality."

Lawmakers from both the Republican and Democratic parties have long advocated sweeping changes to the nation's complicated income tax system. The prospect for substantial change is high as Congress begins its 105th session.

House Majority Leader Dick Armey's (R-TX) flat tax bill is a sweeping overhaul of the tax code introduced in the House as part of the Freedom and Fairness Restoration Act in June 1994 (and later introduced in the Senate by Senator Richard Shelby (R-AL) in July 1995). It would replace the current income tax system with a single 17 percent flat tax rate on all wages, salaries, and pensions of U.S. households.

Representative Bill Archer (R-TX), chairman of the House Ways and Means Committee, has strongly supported a national consumption tax. In separate legislative activity, Representatives Billy Tauzin (R. LA) and Dan Schaeffer (R-CO) introduced a bill that would establish a 15% national sales tax. It would eliminate both the corporate income tax and the personal income tax and raise the same amount of tax revenues -- collected simply at cash registers.

The unlimited savings account (USA) tax plan was sponsored by Senator Pete Domenici (R-NM) now-former Senator Sam Nunn (D-GA). Retaining much of the current tax code's structure, it would create an Individual Retirement Account (IRA)-type account for every person into which unlimited, tax-deductible contributions could be made. All assets would then accumulate on a tax-free basis, and corporate tax would be changed to a value-added tax that would permit capital investment as a tax deduction.

To determine whether each proposed tax code would support or run counter to environmental policies that reduce emissions of greenhouse gases and other important air pollutants, researchers are modeling the U.S. economy to analyze three potential impacts for each proposal: the impact on capital investment, employment, and output, and on U.S. investments, economic growth, and gross national product; ; the impact on emissions of eight air pollutants; and, the impact on capital turnover in each of the nation's industrial sectors.

It is possible, says Kopp, that if tax reform leads to increased economic growth, then pollution levels from production and consumption activities can be expected to trend upwards as well. For example, every time the nation's electric utilities generate an additional kilowatt hour of electric power they emit an incremental amount of pollution. As additional power is generated to meet increased industrial demand, pollution from power plants will rise. Similarly, every mile traveled by a tractor-trailer rig is associated with a particular amount of exhaust pollution. As the economy grows from tax reform and more goods are transported, the greater the amount of pollution generated.

However, adds Kopp, tax reform could also yield a double dividend of economic growth and environmental improvement. It depends largely on how the plans would affect the savings and investment decisions of households and firms. If tax reform succeeds in stimulating increased savings, the pool of money available for investment by U.S. firms then increases, which means more money will flow into the nation's equity markets where firms turn for investment funds. At the same time, the increased pool lowers the interest rates paid by firms for money borrowed. Increases in the flow of money entering the equity markets and lower interest rates on borrowed capital then combine to encourage firms to retire old factories and aged equipment and invest in newer, more productive and -efficient capital. If this newer equipment pollutes less than the old equipment it replaces, pollution might decrease while industrial activity increases.

Results from the project are expected by mid-1997. The project is part of RFF's Climate Economics and Policy Program, which aims to increase understanding and knowledge of the complex issues that must be addressed to design appropriate domestic and international climate change policies that are reliable and efficient.

Resources for the Future is an independent, nonprofit organization that conducts original policy analysis and environmental economics research. RFF aims to provide accurate, objective information to policy makers, legislators, public opinion leaders, environmentalists, and the public to help them make better decisions about the conservation and use of their natural resources and the environment.

Resources for the Future (RFF)

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