Background

Carbon-Taxing and Tax-Shifting at the State Level

A carbon tax, as the name implies, taxes fuels on the basis of their carbon content. The effect is to make cleaner energy sources less expensive than dirtier ones or, at a minimum, narrow the substantial price gap that currently exists between fossil fuels and renewable energy sources. This tax change involves reorienting the tax code by eliminating existing taxes on those things, which society wishes to encourage, such as income and labor, and imposing taxes onto behaviors, which society wishes to discourage, such as pollution and other environmentally destructive practices. The legislative measure found here proposes a tax on carbon-based emissions, which would produce revenues that would then be used to reduce or eliminate existing, inefficient tax burdens such as income and payroll taxes.

Carbon taxes are desirable for a number of reasons. First and foremost, the economic impact of the tax (depending on size and structure) forces a shift in energy production, increasing the competitiveness and, hopefully, the availability of alternative energy sources. Second, by favoring cleaner fuels, carbon taxes have the potential to reduce harmful emissions of carbon dioxide – a major contributor to current climate changes – as well as bring about an overall reduction in the use of fossil fuels. Third, because carbon taxes can be imposed on an input basis, the need for extensive emissions monitoring networks – which are often cost prohibitive – is eliminated. Fourth, by creating slightly higher energy prices a carbon tax can serve to stimulate the development of energy-efficient technologies. Fifth, environmental taxes help make prices more reflective of true costs, helping to ensure that those causing environmental harm pay for it. Finally, carbon taxes generate revenue that can be directed toward any number of useful ends.

This concept has broad-based appeal because it combines the implementation of pollution taxes with offsets of traditional taxes, such as income, payroll, sales, and other consumption taxes. When you tax something, you get less of it. So, what do we currently tax? Mostly, we tax things we want more of, such as income and labor, not things we want less of, such as pollution and resource depletion. As a result, we get less money, fewer jobs, and more messes. Shifting the existing tax burden from those things we want to encourage – income and labor – to those things we want to discourage – pollution and other environmental harms – has the potential to improve environmental quality and, at the same time, enhance economic vitality – two goals which are often considered to be mutually exclusive.

State Level Opportunities

The Clean Air Act requires that states meet federal air quality standards but gives them broad discretion in the choice of policy instruments they use to meet these standards. This freedom allows states to experiment with cutting-edge, market-based alternatives to traditional regulatory devices.

Currently, many states are faced with a fiscal crisis. This crisis is precipitated by a number of factors tied to the changing nature of the American economy. As the economy has changed, shortcomings in our current tax systems have become apparent – such as the increase in the service sector’s share of the economy. Since service sector products fall outside most state sales tax laws, revenues are failing to keep up with the growing economy and the growing demands placed on government as a result of such growth. While this is only one example, it illustrates the problem of inefficient and inelastic taxes in the context of the states’ fiscal crises. By replacing the most inefficient taxes with taxes that grow in direct proportion to the energy consumed (and, therefore, in greater proportion to the growth of the economy; i.e., are more elastic), states can address both the growing concerns about environmental quality while improving their existing tax structure.

Any time one discusses leveling taxes at a state level, there is bound to be concern that the state will, through its taxation policies, hurt its competitive position in relation to other states. However, recycling the revenues from a carbon tax on a budget-neutral basis ensures that the state sees no net increase in tax liability. Rather, the taxes are simply shifted from one sector to another. As all taxes create some level of inefficiency, using carbon tax revenues to eliminate or scale back highly inefficient taxes, such as payroll taxes, can actually have a positive net effect on the economy. Undeniably, some sectors and consumers will be hit particularly hard by carbon taxes. However, if revenues from such a tax are appropriately designated to broad-based tax rollbacks, then only those who consume the most energy (and are, therefore, the biggest polluters) will be adversely affected. Many others will, in fact, see positive economic gains.

In the absence of federal leadership on carbon dioxide regulation, vehicle emissions standards, and global climate change, states are uniquely poised to play an innovative and crucial role in the national and international debate over air quality, environmental health, and global warming.