Different Takes on Taxing Greenhouse Gas Emissions Allowances

The US Senate Committee on Finance entertained divergent views on the Federal income tax implications of proposed cap-and-trade legislation to reduce carbon and other greenhouse gas emissions during a June 15 hearing.  Among the issue aired was whether emission allowances under the program should be treated as ordinary for tax purposes and, if so, then how should they be valued.  In addition, when should valuation occur - when the allowances are first awarded or when they are used (i.e. when they can be surrendered to account for emissions produced)?  The cap-and-trade bill currently making its way through the US House of Representatives would cause the government to allocate at no cost to the recipient 85% of allowances and auction the remaining 15%.

At the hearing, Gary Hufbauer, a Senior Fellow at the Peterson Institute for International Economics, indicated his preference for a carbon tax over the cap-and-trade approach.  But since politics favored cap-and-trade, he proceeded to advocate treating allocated carbon allowances as ordinary income to be valued upon issuance.  The purchase price of an allowance bought at auction or in the secondary market, Hufbauer testified, should qualify as a business deduction in the year used.   Trading in allowances should be accounted for on a first-in-first-out basis (on the assumption that values will increase over time) and trading gains and losses, he continued, should be taxed at the relatively higher rate of ordinary income and not lower rate applying to capital.

Taking a contrary view, Mark Price, an officer of the tax firm KPMG, testified that tax treatment of carbon allowances under a cap-and-trade program would likely follow Internal Revenue Service precedent involving the taxation of sulfur dioxide (SO₂) emission allowances under Title IV of the Clear Air Act Amendments of 1990.  Under that program, SO₂ allowances allocated at no cost create no tax basis and are not taxed as ordinary income.   Also by analogy to the tax treatment of SO₂ allowances, Mr. Price testified that trading gains and losses would likely be taxed as capital and not ordinary income, but that may vary depending on the purpose for which allowances are held.  Mr. Price also addressed carbon offsets, such as forestry programs.  Revenues from sales of offsets, he testified, would be taxed as ordinary income.