Federal and State
The Case for Shared Leadership
Federalism has a long tradition in the political norms and fiscal architecture of the United States. Indeed, it is an essential part of the U.S. Constitution and how our country works best. A system of rights and responsibilities shared between the federal government and state governments makes sense. In some contexts, the federal government is in a better position to collect revenue (such as with border tariffs or customs fees) or provide services efficiently (such as national defense or airline safety regulation). In others cases, state governments’ superior knowledge of the preferences, opportunities and needs of their citizens allows them to raise or spend revenue better than the federal government. Education is the classic example where citizens prefer local control.
Still in other areas, revenue is best raised by the federal government but spent by state or local governments, sometimes with a few strings attached. Under this approach the federal government tends to distribute revenue to states in large blocks, known as “block grants.” States are then free to distribute revenue further to their cities, towns and rural communities, as well as spend the resources at the state level. The United States now has a system of over 200 block grant programs that collectively account for about 17 percent of all federal outlays. Some of these intergovernmental transfers, particularly for social safety net programs like unemployment benefits, Medicaid and food stamps, primarily serve to redistribute resources to areas where they are needed most. Others, like grants for infrastructure, help compensate for states’ inadequate incentives to make investments whose benefits extend beyond their borders.
A block grant approach is the best way to implement an economy-wide U.S. carbon price. The federal government is in the best position to ensure that incentives to abate GHG emissions are harmonized broadly across the U.S. economy—covering all sources, sectors, and states. This minimizes the cost of achieving any given environmental goal, while easing compliance by companies that operate in multiple states and reducing the economic distortions that could arise from different carbon prices in different jurisdictions. A federally imposed carbon price also allows for an upstream approach to pricing carbon, meaning the price can be imposed at the chokepoint of the fossil fuel distribution channels. This minimizes the number of regulated companies, broadens the scope of coverage, and lowers the administrative burden of the policy. A federal carbon price can also piggyback on existing federal levies on fossil fuels, such as the tax on coal that funds the Black Lung Disability Trust Fund, or existing federal GHG reporting requirements. This creates economic efficiencies that would not be achieved at the state level alone. Finally, the United States can best leverage a federal carbon pricing policy diplomatically to ensure other nations do their fair share to tackle climate change too. A federal policy best demonstrates political will and provides a predictable indicator of overall U.S. action for other nations to follow. Importantly, a federal carbon pricing policy can give individual states the option to pursue more ambitious abatement measures, but that would be their choice and not an artifact of a piecemeal state-by-state approach.
A much different question arises in how best to use the revenue from a carbon-pricing policy. A wide range of proposals has suggested giving households rebates, lowering existing federal taxes like payroll taxes and corporate income taxes, reducing the federal budget deficit, spending on energy or climate-related priorities and more. This paper argues that states may be in the best position to decide how much of revenue should be used and which activities this revenue should fund. Specifically, this proposal envisions the federal government retaining about one quarter of the projected revenue from the program, as estimated by the Congressional Budget Office and Congress’ Joint Committee on Taxation.1 The remainder of the projected revenues would be transferred to states. The benefits of this approach are discussed below.
- To avoid worsening the federal budget deficit, some of the gross receipts collected by the federal government would be used to compensate for any revenue-reducing effects the carbon pricing policy might have on other federal taxes.