New Study Shows How Federal Carbon Tax Would Hurt State Budgets

In a previous post, I summarized the important new study from Capital Alpha Partners, LLC, which showed that the typical “carbon tax swap deals” being bandied about would run out of money. Specifically, the study shows that using conventional budget-scoring methods for legislative analysis, a new carbon tax would only net the government some 32 cents on the dollar. This wouldn’t leave enough money left over to accomplish the other myriad goals that supporters of a carbon tax have promised to achieve.

Yet the fiscal hole isn’t just at the federal level. The Capital Alpha study also featured something I haven’t seen before in this debate: A carbon tax at the national level would severely impact state budgets. The public and policymakers alike should consider this extra wrinkle when weighing their support for a carbon tax.

Why a Federal Carbon Tax Hurts State Budgets

The Capital Alpha study identifies several mechanisms through which a federal carbon tax would impose fiscal problems on state (and local) governments. First, state and local governments themselves use energy, and so would pay higher prices just like regular citizens because of a carbon tax.

Beyond that, a carbon tax makes everyone poorer, and hence reduces the base for income taxes and the receipts flowing from sales and property taxes. Thus, not only would state governments be paying higher energy prices, but they would collect less revenue than they otherwise would, because of a new federal carbon tax.

One of the most obvious hits to states would be in their collection of gas taxes. As the Capital Alpha study explains:

To take gasoline as an example, the current national average of combined state excise and sales taxes applied to a gallon of gasoline expressed in 2015 dollars is 32 cents. When fully phased in, the carbon taxes studied in this paper would impose additional federal levies in amounts ranging from 32 cents to $1.28 per gallon, or anywhere from one time to four times the existing state taxes on gasoline. [Capital Alpha study, p. 39, bold added.]

After all, one of the primary purposes of a federal carbon tax would be to induce Americans to drive less and/or switch away from gasoline-powered vehicles into electric vehicles. Either way, they would be reducing their purchase of gasoline. Regardless of the potential benefits for the environment, such a shift will obviously hurt state governments that rely on gas tax receipts to fix roads and bridges. (Of course, they could make it up by diverting funds from education, medical, and social welfare programs, or look for new tax opportunities to replenish diminished funding.)

Estimates of the Size of the Hit to State Budgets

In this section I’ll reproduce some of the key charts to indicate the potential size of the impacts a federal carbon tax could have on state budgets.

Figure 3.3.2-1 (taken from page 32 of the study) shows the average annual burden over the ten-year period from 2019-2028 on the states, arising from their higher energy costs and the loss of other revenues, from a federal carbon tax.

For example, the Climate Leadership Council (CLC) proposes a tax starting at $40 per ton and rising 2 percent thereafter. This is shown in the figure above as the second last bar. As the chart indicates, this magnitude of a tax would impose an average annual burden of $25.51 billion on the states.

However, these estimates are only for the static burden of a new federal carbon tax. Beyond its direct impact, however, a carbon tax would reduce conventional economic growth, and would thereby make state budgets worse over time for that reason as well. The study refers to these impacts as dynamic ones.

The following table summarizes both the static and dynamic impacts on a selection of states that have median GDPs:

The table above (taken from page 35 of the study) shows the combined static and dynamic burden on “typical” states, through all of the mechanisms described earlier. For example, in the more pessimistic case where a $40/ton carbon tax has a 1 percent impact on economic growth, the total annual impact on the Missouri state budget is $535.63 million.

To be clear, this figure of some $536 million doesn’t refer to all the people in Missouri, but narrowly refers to the Missouri state government’s budget. If state officials in Missouri hear proposals for the CLC carbon tax plan, for example, they should realize that it might put a half-billion-dollar-a-year hole in their budget.

Conclusion

The new carbon tax study from Capital Alpha Partners extends the policy debate in several dimensions. Most important, it applies conventional tax scoring methods to various levels of a carbon tax, showing that most of the new revenue would already be gone before the fun begins. In the present essay, I’ve focused on one particular element of the study’s scope: Namely, state and local governments would see a large burden imposed on their finances from a federal carbon tax. This important fact is rarely discussed in the national policy discussion, but it is obviously important to keep in mind.

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