Enacting a Carbon Tax Would Help Offset TCJA Extension Costs

Most taxpayers will face income tax increases in 2026, as most of the individual income tax provisions in the 2017 Tax Cuts and Jobs Act are set to expire. Congress will likely prevent that, but extending the tax cuts would substantially increase the federal budget deficit. Lawmakers should consider a carbon tax as an alternate source of revenue to help pay for the extension.

Extending the TCJA would greatly reduce federal revenue. According to the Congressional Budget Office, extending the law’s individual income and estate tax provisions would cost roughly $3.9 trillion between 2025 and 2034.

If lawmakers were to also extend business tax provisions, such as bonus depreciation and the current tax rates on foreign profits of multinational corporations, it would raise the cost an additional $666 billion for a total of $4.6 trillion in lost revenue and increased interest costs over the next decade.

Also, the official TCJA extension score likely understates the cost. It doesn’t account for reversing amortization of research and development costs or the stricter limit on interest deductions, which would cost roughly $262 billion.

Further, lawmakers might not extend all the TCJA’s base-broadening provisions. For example, lawmakers from New York and California may want to scale back the $10,000 cap on the state and local tax deduction, increasing the cost even more.

The size of this potential tax cut is concerning given the current level of federal borrowing. The CBO estimates that federal debt held by the public will total 118% of GDP by 2035, even before extending any of the TCJA.

Meanwhile, net interest costs on the debt will climb to 4% of GDP by 2035—the highest it’s been in US history. The additional borrowing and interest costs will crowd out spending on other federal priorities and reduce future national income.

Although the TCJA made important improvements to the US tax code, it would be a mistake and a missed opportunity to simply extend the law. Legislators should approach the TCJA extension exercise aiming to enact fiscally responsible, pro-growth tax reform.

A carbon tax—an excise tax based on the carbon content of goods and services—is one option lawmakers should consider to offset the cost of extending the TCJA. Its goal would be to price carbon emissions to reflect their negative externalities and reduce emissions.

In isolation, a carbon tax could raise a significant amount of revenue. We’ve estimated that $35 per ton carbon tax could raise $95.2 billion in net revenue in 2024, which would translate to roughly $1.26 trillion over a decade.

Besides raising significant revenue and incentivizing emission reductions, enacting a carbon tax would have other benefits. First, it would shift the tax base from income taxation more toward consumption taxation.

Consumption taxes, such as the carbon tax, raise revenue without distorting saving and investment decisions. An analysis by EY estimated that using a carbon tax to fund the permanent extension of the individual income tax provisions and 100% bonus depreciation would lead to a 2.1% increase in long-run GDP.

Enacting a carbon tax also would bolster the case for repealing the Inflation Reduction Act’s clean energy tax credits. Republicans have targeted the credits for repeal as part of a tax package.

Repealing these credits could raise $795 billion over 10 years to help offset TCJA extension. A carbon tax is more efficient and effective in discouraging emissions, and it would make the clean energy credits redundant.

Third, a carbon tax is a better idea than other tax increases being considered. According to Rep. Jason Smith (R-Mo.), chairman of the Ways and Means Committee, some Republican House representatives have indicated they are comfortable with raising the corporate tax rate. Doing so would reverse progress made by the TCJA by increasing incentives to shift profits and mobile assets overseas while discouraging investment in the US.

Congress would need to address some challenges with a carbon tax—it would be somewhat regressive and raise taxes on low-income households even when paired with the TCJA’s income tax cuts. Some of the carbon tax revenue could be used to provide transfers to these households.

Lawmakers are unlikely to allow taxes to rise for Americans at the end of 2025. Extending the tax cuts, however, would significantly increase federal borrowing.

This borrowing would have negative consequences for the economy and federal budget. Lawmakers should consider a carbon tax as an efficient way to offset part of the cost of extending the TCJA.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Kyle Pomerleau is senior fellow at the American Enterprise Institute, where he studies federal tax policy.

Shuting Pomerleau is deputy director of climate policy at the Niskanen Center. Her areas of research include carbon taxation, carbon border adjustments, and climate and trade policies.

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