Charles Wheelan, Ph.D. The Naked Economist

I had lunch not long ago with a fund-raiser for a prospective presidential candidate. He admitted that his candidate is still looking for a "big idea."

I won't say who the candidate is, or even what party he or she belongs to, but I will offer a "big idea" for whoever wants to take it. Since this proposal isn't inherently liberal or conservative (arguably it's both), it would work for a Republican or a Democrat, provided he or she has the backbone for it.

So here's the idea: Create a carbon tax -- basically a tax on energy calculated based on its carbon content -- and use the new revenue to provide offsetting cuts in the income tax, the payroll tax (the tax on wages used to fund Social Security), or both.

The whole package should be revenue neutral, meaning that it will not increase or decrease the total amount of revenue the government collects. The money will simply come from different sources.

High Price, Low Demand

Yes, I'm arguing that we should increase your taxes and cut your taxes at the same time. To understand why that makes sense, you must appreciate an often-overlooked feature of taxation: Taxing something does not merely raise revenue; it also changes behavior.

If we tax red sports cars more than blue sports cars, some car buyers are going to switch from red to blue. In real life, even taxes on addictive products like cigarettes have been shown to cut smoking.

A tax raises the price of something, and the most basic idea in economics is that when price goes up, demand goes down. And that is exactly the point of my "big idea."

A carbon tax raises the price of using carbon-based energy, everything from coal to gasoline. As a society, we're better off if we curtail our use of fossil fuels. We can start to make progress on global warming; we will improve air quality; we will be less dependent on places like Saudi Arabia and Venezuela; and we could even improve traffic congestion, the bane of just about every metropolitan area in the U.S., by making it more expensive to commute long distances alone by car.

More Than Just Talk

We can talk about our "addiction to oil," as President Bush did in his last State of the Union address, or we can actually do something that will change behavior in a major way. Think about the incentives created by a broad-based carbon tax:

1. We'll use less carbon-based energy. Have you seen the sales figures for SUVs lately? People kvetched about SUVs for a decade, but they only stopped buying the really big ones when gas got to be $3 a gallon.
   
   
2. We'll invest more in conservation and alternative sources of energy. Ours is the most entrepreneurial nation in the history of human civilization. How about using that talent to find some new, cleaner sources of energy? When the old kinds of energy become more expensive, the new kinds of energy look a lot more profitable. That helps to focus the great minds of corporate America.

Meanwhile, cutting the income tax and/or the payroll tax increases the returns from working. A tax cut on income is the same as a pay increase, which makes work more attractive - meaning more hours, a second job, a spouse going back to work, agreeing to write a column for Yahoo! Finance, and so on.

The Payoff

Obviously, gas prices are already painfully high and nobody wants to pay more. But before you hit "Send" on a vitriolic email response to this column, remember that you're also getting the tax cut on the income side. On average, one cancels out the other.

Will that be true for everyone? No, but that's the point. The tax burden will go up for those who use more than the average amount of carbon-based energy and down for those who use less.

In the grand scheme of global injustice (e.g., being born in a malarial village in rural Africa), that just does not strike me as terribly unfair. If you contribute more than your fair share to global warming, traffic congestion, air pollution, and propping up a repressive regime in Saudi Arabia, then you should pay more.

And if you bicycle to work from your modest, solar-powered home, then society should cut you some slack. (As a matter of disclosure, I do bicycle to work, though I have never owned a solar- or wind-powered home.)

Caveats to Consider

Before the presidential candidates rush to embrace my plan, I would offer a couple of caveats.

First, the plan should take into account the fact that higher energy prices hit low-income households hardest. The poor are likely to spend a higher proportion of their income on gas and utilities and may have fewer options for minimizing those expenses. A family living from paycheck to paycheck cannot run out and buy a Prius or a house closer to work. Thus, the offsetting tax cuts on income should be designed explicitly to address the regressive impact of higher energy prices.

Second, things become a little tricky when government depends on revenue from activities that we're trying to discourage. The good news about a carbon tax is that people will use less energy. The bad news -- or at least the complication -- is that when people use less energy, the government gets less money. That's not an intractable problem, but it is something that has to be considered when designing the plan.

Those are details. To my mind, the big idea is compelling: If we've got to raise revenue somehow, we might as well do it in a way that creates socially desirable incentives. How does someone legally avoid the income tax? By working less. How does the same person legally avoid a carbon tax? By using less energy. Which do you think is better for society?

I'm eager to see which presidential candidate jumps on the idea first.