State Governments Should Consider Adopting State-Level Carbon Taxes with Border Tax Adjustments

The hottest topic in tax policy discussions of late has been analyzing the proposed border tax adjustments contained within the House Republicans’ Destination-Based Cash-Flow Tax (DBCFT) reform proposal. (For some of my prior posts on this topic, see here and here).

Regardless of what happens with the House Republican’s DBCFT proposal, the recent discussion on border tax adjustments is helping to advance our understanding of how border tax adjustments can and do work in practice. This improved understanding should be used to guide future tax reform efforts beyond just the DBCFT debate.

In a recent pair of essays, Darien Shanske and I explain how a U.S. state government could implement a state-level carbon tax with border tax adjustments without violating the Commerce Clause of the U.S. Constitution. The first of these essays, titled “Why a State-Level Carbon Tax Can Include Border Adjustments”, can be downloaded from here. The second of these essays — full title “Strengthening the Case for a State-Level Carbon Tax with Border Adjustments” and abridged title of “A State-Level Carbon Tax with Border Adjustments” — can be downloaded from here.

Many state governments continue to have dire revenue needs. Carbon taxes offer the possibility for state governments to raise substantial revenues while simultaneously helping to mitigate a pressing environmental concern — global warming. Yet, absent border tax adjustments, a state-level carbon tax will do little beyond harming industry and jobs within the state, without raising much revenue or doing much to combat global warming. As we elaborate in our first of these paired essays (on page 583):

“Border tax adjustments are crucial because a carbon tax in one state would make products in that state more expensive, particularly energy-intensive products such as concrete. Thus, if consumers or businesses could just import those products from other states, a carbon tax in one state would accomplish little except to harm that state’s domestic industries. That problem could be solved if a state could impose a surcharge on out-of-state imports to make up for the tax on domestic producers.”

Border tax adjustments are thus a critical element for any state-level carbon tax to be successful. Indeed, border tax adjustments may have more promise as tools for state-level tax reform than for federal-level tax reform, because the smaller size of state governments as compared to the federal government makes problems related to cross-border transactions a larger cause for concern. Of course, there are also obstacles to implementing border tax adjustments at the state level beyond just the Commerce Clause, but I believe these obstacles are surmountable. As research and debate on the border tax adjustment proposal contained within the DBCFT continues, I thus urge my fellow tax policy analysts to also consider the potential lessons for state-level tax reform. Although I am skeptical of the current DBCFT proposal, I have high hopes for border tax adjustments as a tool for future tax reforms — especially at the U.S. state level.