Like it or not, states and local governments must fill that void. They will bear the initial cost burden of worker retraining and income-support programs. State legislators and local policymakers will soon need to identify and frame out targeted revenue-raising structures — let’s call them “robo-taxes” — that go to the heart of bridging the fiscal gaps from these economic displacements.
This is not just an American problem. A Nobel Prize awaits any political economist who figures this out.
Welcome to the Fourth Industrial Revolution: the advent and dizzying ascent of new technologies such as AI and robotics that are already changing the way we live and work. Presently the AI impact on labor markets is moving faster than robotics, and likely to be more disruptive to the U.S. economy in the remaining 2020s. The magnitude and pace of this shrinkage of the workforce and labor markets are impossible to predict with much accuracy, but one AI industrialist has estimated that the number of jobs likely to be replaced by AI technology, including the eventual introduction of humanoid robots, will likely be akin to the almost 20 percent of the workforce that operated remotely during the COVID-19 pandemic — clearly enough of a dent in future payroll income and consumer spending to painfully shrink state income and sales tax receipts.
Even before Joseph Schumpeter coined the term in 1942, “creative destruction” has been a hallmark of capitalist economies. Two centuries ago, David Ricardo famously worried about machines replacing labor. My best guess is that the number of incumbent employees whose jobs are destroyed by 2030-ish will more likely be half or a third of the aforementioned 20 percent estimate, because the first round of job destruction will be entry-level positions. (An unhired worker is not a layoff.) That range comes closer to another, somewhat lower forecast of about 6 percent of the workforce getting pink slips, which is still a staggering 10 million jobs. Even a 6 percent workforce reduction would be one and a half times worse than the loss of payroll income in the Great Recession of 2007-09, which crushed state and municipal budgets and pension funds.
College graduates without still-marketable skills will be hardest hit initially, as the traditional entry-level white-collar work they often perform will be the easiest for AI agents to replace. Where those youngsters will now land their first job will remain to be seen, but it’s a safe bet that the “boomerang generation” already flocking back to middle-aged parental nests will be expanding soon. Yet some of those parents will be facing stresses of their own: Older workers in affected industries will face involuntary early retirement.
Robots and AI assistants don’t pay income, payroll or sales taxes. The jobless won’t pay into Social Security and Medicare. Governmental budgets at all levels will be the inevitable losers in this shift from labor to capital, at least until such time as new industries and new jobs arise from the ashes. But a “green shoots” economy is not an inevitable outcome of high-tech cost-cutting, at least in the foreseeable future. In the context of investment capital’s disparate and unnecessary tax preferences, the approaching governmental revenue dilemma was illustrated by last month’s double-digit surge in the stock price of a company whose CEO announced plans to replace half its workforce with AI.
The best hope for federal and state treasuries will be new and stiffer taxes on high-tech “users” and, most importantly, on the future returns on capital increasingly invested in AI and robotics. That’s where the money must be found to bridge the safety net’s transition and pay for its aftermath, not from the workforce that they supplant and not even from the workers who become more productive. The states will need to scramble to find replacement revenues for their existing operations, not to mention increased costs of accelerated community college retraining programs, social services and income assistance for displaced workers.
The First-Mover Advantage
In the forthcoming scramble for new revenues to offset shrunken payrolls, states and local governments actually have a strategic advantage over Uncle Sam, at least in theory. After going out of its way to deliver lower taxes to businesses and billionaire tech titans in the One Big Beautiful Bill Act (OBBBA), the current political leadership in Washington is highly unlikely to reverse course in the near future. That gives state legislatures and municipalities a 33-month window to grab a first-mover advantage in the inevitable race to capture revenues from these next-generation high-tech businesses and user applications.
For starters, states and municipalities need to quickly eliminate the loopholes and exemptions in their existing sales, income, property and business franchise taxes that enable the AI and robotics industries to dodge taxation of their products and services. For example, the business-to-business exemption of sales and use taxes in some states will need revisions to stop sheltering such transactions involving these disruptive technologies. Property assessments for plants and equipment should be based on their beneficial economic value, not just the acquisition or construction cost, so that facilities that reduce labor costs are assessed at higher levels to reflect their enhanced profitability. That may require both state-specific legislation and changes in local assessment practices.
Similarly, local governments will need to rethink taxation on robotaxis. This industry is already replacing human drivers, while sending the profits upstream to vehicle fleet owners and licensees, most of whom reside in other jurisdictions. State-mandated uniform local taxation of taxi fares, along with robo-operating license fees, are warranted. Without uniform state-level tax policies, a free-for-all by hundreds of municipalities will become an unmanageable burden on the industry. When trucks become self-driving, similar tax policies will be needed, while giving deference to the Constitution’s interstate commerce clause.
Consumers typically prefer to enjoy the benefits of digital services sponsored by advertisers, rather than paying cash. The AI industry’s business model already relies heavily on advertising for its revenues, so states will need to quickly find ways to levy some kind of advertising excise tax on providers of AI services to the users located in their jurisdictions. Think of it as a tax on consumer “clicks” which could extend beyond AI users to all kinds of promoters and “influencers.” As litigation targeting the ad-taxing pathbreaker Maryland has shown, this won’t be easy to legislate and enforce, but as the notorious Willie Sutton famously said about robbing banks, “That’s where the money is.”
None of these single-digit revenue-raisers, however, will be sufficient to finance the likely surge of governmental expenses wrought by this unique socioeconomic-industrial transition. Eventually, a combined total of double-digit-tax-rate revenues newly derived from the benefiting industries will be required, some of them from overlapping taxes exacted by the IRS, the states and local governments. Altogether the public sector could well need to raise something closer to 20 to 25 percent of the incremental revenues generated in these disruptive industries. It will take years to reach that level — and that seems unlikely to be quick enough.
Big Business Responsibilities
The federal government will eventually need to step in to standardize the treatment of certain taxes so that state venue-shopping by industrialists is discouraged and the revenues are devoted nationwide to the inevitably higher costs of sustaining Social Security and Medicare when workers are replaced by machines and AI. Although some future Congress will hopefully wake up and smell the coffee, that delayed reaction creates a vacuum for the states to step in more quickly.
Their role goes beyond taxation. States must also quickly enact workplace laws to require employers who displace workers with these new technologies to provide advance notice, extended severance benefits and financial assistance for retraining. Some pundits expect a workforce backlash that will eventually prod legislators to impose such mandates. Those measures can at least reduce the pain suffered by those who lose jobs as they seek alternative ways to support themselves in this rapidly evolving economy. Such rules will also help on the revenue side.
Although business spending to expand the AI industry by building new data centers and robot-powered manufacturing facilities will unarguably generate some new tax revenues in the next few years, simple business math tells us that the cost savings from replacing today’s workers must ultimately produce profits. Presently those profits are taxed at lower rates, if at all. With federal taxes on income from capital now capped at 20 percent or less, it takes no genius to see that such preferential rates won’t replace employee-and-employer Federal Insurance Contributions Act payroll taxes plus the higher marginal rates on earned income paid by many white-collar employees and skilled factory workers. Accelerated depreciation under the OBBBA tax code will strip away first-year income tax revenues from companies that exploit these new technologies. For government at some level, it will be a time to practice “the art of plucking the goose so as to get the most feathers with the least hissing,” in the memorable words of Jean-Baptiste Colbert, the French finance minister of the late 1600s.
Any significant fat-goose-plucking will need to start at the federal level. States will find it insufficient and arguably futile to formulate wealth taxes on the investment elites who benefit most from these new technologies. Ultimately, Congress will likely be forced to implement such new tax strategies, if only to make a dent in its own budget deficits. It’s premature to guess how that plays out, but some form of higher federal investment income tax or alternative minimum taxes seems inevitable in the 2030s, and the corporate-profits tax rate will need to revert to pre-Trumpian levels. Of course, any targeted taxes on the tech industry are sure to face heavy lobbyist resistance on Capitol Hill, unless unemployment becomes a widespread, dominating issue. The states are ill-equipped to enact such levies because many of the rich and their businesses will simply relocate to lower-tax locations.
For their part, states will have little choice but to tax the sales and use of robotic devices by resident businesses and households. Some states will need to secure legislative supermajorities, and various municipalities may even require voter approval to impose their own robo-taxes on business and personal property. But until Congress gets its act together, state-level excise taxes on AI applications and robotic devices should not be ruled out, preferably with a sunset provision so they must be revisited in perhaps five years or supplanted by comprehensive uniform federal taxes that are shared with the states and their citizenry.
Public Finance Policy Leadership
For now at least, the pace of technological change is moving far faster than political awareness and processes — especially the cumbersome, convoluted and reactive legislative methods of taxing new revenue sources. This presents an immediate and potentially dangerous challenge to the public finance community.
Leaders from the national professional and policy associations need to awaken now to the challenge of developing viable strategies and drafting model legislative provisions to address the imminent funding challenges — and possibly crises — that lie ahead of us before 2030 arrives. For starters, they need to quickly establish a taxonomy of viable revenue options; identify pros and cons, implementation and risk-mitigation measures; and recommend those most suited to state legislation.
And because nobody else is doing it now, the public finance community and especially its academic wing needs to develop a road map for their universities and community colleges to quickly build symposia and curricula on the shifting labor markets that their graduates will face, forecast where the job openings will be and design skills-based classes to fill that gap. A wake-up call from financial professionals can help shake academia out of its inertia — and alert state legislators to the urgency of swift action by their states’ public institutions.
It’s too early to put hard numbers on the new taxation framework that the Fourth Industrial Revolution will require, but tax policy wonks and fiscal professionals need to start mapping out their strategies, sensible policy frameworks and action agendas now — before it’s too late.
Governing's opinion columns reflect the views of their authors and not necessarily those of Governing's editors or management.
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