Analysis: Could Fracking Close the Budget Deficit?

You can measure the success of a disruptive new market by how freaked out existing market participants are. And oil producers around the globe are plenty freaked by the U.S. oil boom.

The surprising shift in fortunes has major implications. The boom could help to boost the economic recovery and wean the U.S. off of its reliance on foreign sources of energy, potentially disentangling it from conflicts and support roles abroad. But there's another potential upside: if harnessed well, the oil boom could be used to help solve the nation's fiscal problems.

Increasing the oil-consumption tax could help tame the nation's growing deficits. So could implementing a new carbon tax. There are downsides, of course: The taxes would hit the nation's poorest citizens hardest and be, um, tough to pass politically. But the burden on the poor can be offset and, given the current options, once off-limits proposals could find their way into negotiations. In the end, a new carbon tax and hiking oil taxes could help to reduce emissions, oil consumption, the price of oil and, of course, deficits.

On its own, an increase in oil-consumption taxes is politically unpalatable, but it could be a viable option if its an alternative to deep income tax hikes or cuts to beloved programs, two researchers with the Council on Foreign Relations argued in a February study. The duo used the 2011 Simpson-Bowles deficit-reduction package as a starting point, adding oil taxes and analyzing changes to that plan's corporate tax, income tax, and government spending levels. In many configurations, an oil-tax hike made the deficit-reduction packages that much more effective, they found.

"[O]il taxes can bring, through the end of this decade, stronger economic growth, lower unemployment and reduced oil consumption -- even while raising more money," Michael Levi and Daniel Ahn wrote in an accompanying op-ed at the time.

The impact on the economy could be broad, they found. After accounting for effects on the tax base and on world oil prices, one such package boosted economic output by more than 0.8 percent through 2020 with unemployment dropping more than 0.2 percent. (That package adds an oil tax hike and maintains the levels of income and corporate tax hikes in the Simpson-Bowles plan, all while halving the level of spending cuts in the plan.)

There are other consequences of raising oil taxes, some good, some bad. A tax hike would lower oil consumption, which would also reduce world prices, they suggest. It would also disproportionately affect the poor. But that impact could be partially offset by a tax rebate, they argue.

Levi and Ahn are the first to caution that any economic-forecasting model could turn out to be way off. But, they conclude in the op-ed, "if lawmakers decide to go ahead with further deficit reduction, they would be remiss not to take a hard look at higher oil taxes as part of the deal."

Some have suggested a carbon tax could serve a similar purpose. At first glance, the consequences are stark: costs for businesses would rise, pushing up prices for carbon-intensive goods and services. High prices, in turn, would devalue purchasing power, discouraging workers and decreasing the labor supply. Investment would fall and output would follow. And the impact would be uneven and disproportionately hit the poor, the nonpartisan Congressional Budget Office reported last week.

But that's only one half of the picture. There are ways to offset the downsides, depending on how the new revenue is used. Applying that new cash to deficit reduction, for example, or offsetting cuts to marginal tax rates could offset the impact, CBO found. And the new revenues could even be used to ease the burden the tax would ultimately create for the poorest Americans. It would take less than 30 percent of the carbon-tax revenue to offset the cost to the lowest two-fifths of income earners, according to one study. And then there are the costs, though difficult to estimate, of doing nothing.

Given conflicting study results and its limited scope, the CBO report didn't come to a definitive conclusion on the ultimate impact a carbon tax would have on the economy, but other studies have suggested it could be a universal positive. Regardless of how the new revenue is used, the economy would be better off with a carbon tax than by simply maintaining the high tax rates needed to maintain the federal revenue stream, two MIT researchers found in an August report.

"We find that any of several different options for using the carbon tax revenue would generate a win-win-win solution," they found. "Given that all other options for dealing with the Federal deficit require difficult tradeoffs, it would seem hard to pass up one that offers so many advantages."

The findings of the recent studies on energy taxes may not be conclusive, but they offer potentially viable alternatives to painful cuts or tax hikes elsewhere.