A Proposal for an “Osama Bin Laden Tax”

Filed Under (Environmental Policy, U.S. Fiscal Policy) by Jeffrey Brown on May 10, 2011

I saw an interview on CNN this morning of James Woolsey, former CIA Director, who noted that oil played a key role in bin Laden’s 1998 fatwa, in which he called for violent jihad against the U.S.  Woolsey now drives an electric car, and he has a bumper sticker on the back that says something along the lines of “Osama bin Laden hates this car.”  The idea is that the U.S. addiction to foreign oil – particularly oil from regions of the world that are hostile to our values – is helping to feed and finance our enemies. 

This got me thinking, once again, about the immense economic logic of taxing carbon.  By taxing carbon, and thus reducing domestic demand for carbon-intensive energy such as oil, we can reduce our dependence on imports from volatile regions of the world. 

Politically, Republicans have long been opposed to carbon taxes, just as they have been opposed to raising nearly any tax.  I happen to be a Republican.  I share the conservative view that government is too big, that the growth of entitlements and other spending is a threat to our long-run economic vitality and our economic leadership.  I don’t want to raise taxes either (although neither do I want to run huge deficits – which means, of course, we have to cut spending).  But even so, I remain a supporter of a carbon tax, so long as it replaces other taxes that are far more damaging to our economy.  I also remain completely baffled by the knee-jerk Republican resistance to it.

So let me briefly make my case for what I call the “Osama bin Laden Tax.”

My plan, such as it is, has two simple elements:

  1.  We impose a tax on carbon in order to shift demand to less carbon-intensive energy sources.  This reduces our demand for foreign oil, and indirectly, provides fewer resources in the support of anti-American terrorism.  
  2. However much money is raised by this tax, we use to reduce other taxes.  We could reduce the marginal corporate tax rate, or marginal income tax rates, or – for those concerned about the distributional consequences – we could reduce the payroll taxes for Social Security (which are widely viewed as regressive).  So the plan does NOT raise the net tax burden.  Rather, it simply replaces highly distorting taxes (i.e., those that discourage labor supply) with a beneficial tax (i.e., one that discourages oil use).

What are the benefits?

  1. We would improve national security by reducing our dependence on foreign oil, a policy goal that has been shared, but not achieved, by nearly every Democratic and Republican administration for decades.  
  2. We would also get big environmental benefits, given that carbon emissions are known to contribute to climate change.  This is the usual motivation for the call for a carbon tax, and I also support it for this reason.  But I recognize that some of my fellow Republicans are not as concerned about climate change.  So the key point here is that even if you think the environmental benefits are zero, there is still a compelling case to replace inefficient taxes on income and investment with a more efficient tax that reduces our indirect reliance on a volatile part of the world that often has interests that are counter to ours. 
  3. The usual arguments against a carbon tax, e.g., that it would hurt American competitiveness or cause job losses, are simply not true in this case!  This is because for every dollar we raise, we are reducing taxes by a dollar somewhere else in the economy (e.g., reducing the wage bill).  Thus, the net tax burden would NOT rise. 
  4. Because it is revenue neutral, there is no reason for even the Tea Party to oppose it, as it would NOT grow the government.  Indeed, as I point out in my next bullet below, it could actually reduce government intervention in our lives. 
  5. Best of all for my fellow believers in the power of markets – if we have a carbon tax, then we can get rid of all the command-and-control regulations on energy.  We would no longer need the Department of Energy or the EPA to regulate emissions.  We would no longer need Congress or Presidents to pick winners and losers by subsidizing ethanol or wind power or clean coal.  We just tax carbon, and then we let the market work with minimal government intervention!

In fairness, there would be some individual losers – energy intensive industries would see their costs rise.  But for every loser, there is a winner, such as other industries that are less energy-intensive, but perhaps more labor or capital intensive, which would see their costs go down.  So there would be a transition period during which some U.S. industries would become more competitive while others less so.  But the key is that OVERALL U.S. competitiveness would not be harmed whatsoever.  Our precise areas of comparative advantage might shift, but not the overall level of our ability to compete.

So that is it.  Now, politically, I know this is not easy.  I know that big energy companies, energy-intensive manufacturers, etc. – would oppose this on narrow self-interested grounds.  And I know they are big campaign contributors.  But on philosophical, ideological, and economic policy grounds, it is hard to come up with much of an argument against a revenue neutral carbon tax that is used instead of other taxes, rather than on top of them.

So, let me go on the record as a Republican in favor of an Osama bin Laden tax on carbon.  Anyone care to join me?

The President vs. Big Oil

Filed Under (Environmental Policy, U.S. Fiscal Policy) by Dan Karney on Feb 4, 2011

In last week’s State of the Union (SOTU) Address, President Obama was less than crystal clear about the future of America’s energy policy (see the previous CBPP post “The State of the Union may be strong…”).  However, the President did seem determined to pick a fight with Big Oil by declaring, “We need to get behind [clean energy] innovation.  And to help pay for it, I’m asking Congress to eliminate the billions in taxpayer dollars we currently give to oil companies… So instead of subsidizing yesterday’s energy, let’s invest in tomorrow’s.” (Read the full SOTU Address here.)

Backing up his promise, on Monday the Obama administration asked Congress to eliminate $36.5 billion over 10 years in subsidies for oil and gas companies starting on October 1st, according to Reuters (source).  At issue are industry-specific tax breaks on drilling and extraction costs.  The administration estimates that the $36.5 billion subsidy represents only 1% of expected industry revenues over the coming decade.

In response, the American Petroleum Institute (API), the oil and gas industry’s main lobbying body, declared, “If the president were serious about job creation, he would be working with us to develop American oil and gas by American workers for American consumers.”  And went on to add, “The federal government by no stretch of the imagination subsidizes the oil industry. The oil industry subsidizes the federal government at a rate of $95 million a day.”

I am going to address two issues, one specific and the other general, regarding the Big Oil subsidy debate.

First, the claim the oil and gas industry is not subsidized by the federal government seems factually incorrect.  A 2005 Congressional Budget Office study (here), found the effective tax rate on capital income from petroleum and natural-gas structures to be 9.2%, the lowest rate among all the asset types studied.  The oil industry claims that since it pays $95 million a day in taxes and royalties to the federal government that it is not being subsidized; however, the relative tax rates that determine which industry is being favored by the tax code and thus subsidized.  Here, a relatively low tax rate on capital in oil industry encourages capital investment because the rate of return on capital to be profitable in the oil industry is lower than other sectors due to the lower tax rate.  The over-investment in the oil industry leads to more oil production, and likely total profits, than would be the case if all industries were taxed at the same rate.

Second, a subsidy can come in many forms.  For example, a payment can occur per unit of output, such as the Production Tax Credit (PTC) for renewable energy that provides a 2.1-cent per kilowatt-hour subsidy for electricity generated by generate wind, solar, geothermal, and “closed-loop” bioenergy (source).  Alternatively, paying a lower tax rate relative to other industries is also a type of subsidy as in the case of the oil industry (see above).  However, both types of subsidies affect the federal budget in similar, yet mirrored ways, where the former essentially pays out money, while the later forgoes revenue.  In the end, the fiscal deficit depends on the difference in spending and revenue, so either type of subsidy (payments or forgone taxes) impacts the deficit.

Who Bears the Burden of Energy Policy?

Filed Under (Environmental Policy) by Don Fullerton on Sep 4, 2009

Economists have tools to analyze the distributional effects of income taxes, payroll taxes, property taxes, and corporate income taxes.  Some existing research even looks at distributional effects of environmental or energy taxes used to help control pollution or energy consumption.  Yet most pollution policy does not involve taxation at all!  Instead, we use permits or command and control regulations such as technology standards, quotas, and quantity constraints.  Existing studies of energy policy are mostly about effects on economic efficiency, addressing questions such as: how to measure the costs of reducing pollution or energy use, how to measure benefits of that pollution abatement, what is the optimal amount of protection, and what is the most cost-effective way to achieve it.

Yet environmental mandates do impose costs, and an important question is who bears those costs.  Moreover, those restrictions provide benefits of environmental protection, so who gets those benefits?  Full analysis of environmental policy could address all the same questions as in tax analysis.  Perhaps it could use the same tools to address distributional effects – not of taxes, but of these other policies that are used to protect the environment.

Thinking about the distributional effects of environmental policy is interesting and difficult.  For example, a standard tax analysis would point out some complex implications of an excise tax: not only does it affect the relative price of the taxed commodity, and thus consumers according to how they use income, but it also impacts factors intensively used in the production of that commodity, and thus individuals according to the sources of their income.  Yet an environmental mandate can have those effects and more!  Consider a simple requirement that electric generating companies cut a particular pollutant to less than some maximum quota.  This type of mandate is a common policy choice, and it has at least the following six distributional effects.

First, it raises the cost of production like a tax, so it may raise the equilibrium price of output and affect consumers according to spending on electricity.

Second, it may reduce production like a tax, reduce returns in that industry, and place burdens on workers or investors.

Third, a quota is likely to generate scarcity rents.  For simplicity, suppose pollution has a fixed relation to output, so the only “abatement technology” is to reduce output.  Then a restriction on the quantity of pollution is essentially a restriction on output.  Normally firms want to restrict output but are thwarted by antitrust policy.  Yet in this case, environmental policy requires firms to restrict output.  It allows firms to raise price, and so they make profits, or rents, from the artificial scarcity of production.  Just as tradable permit systems hand out valuable permits, the non-tradable quota also provides scarcity rents – to those given the restricted “rights” to pollute.

Fourth, if it cleans up the air, this policy provides benefits that may accrue to some individuals more than others.  The “incidence” of these costs and benefits usually refers to their distribution across groups ranked from rich to poor, but analysts and policy-makers may also be interested in the distribution of costs or benefits across groups defined by age, ethnicity, region, or between urban, rural, and suburban households.

Fifth, regardless of a neighborhood’s air quality improvement, many individuals could be greatly affected through capitalization effects, especially through land and house prices.  Suppose this pollution restriction improves air quality everywhere, but in some locations more than others.  If the policy is permanent, then anybody who owns land in the most-improved locations experience capital gains that could equal the present value of all future willingness to pay for cleaner air in that neighborhood. Similar capitalization effects provide windfall gains and losses to those who own corporate stock: capital losses on stockholdings in the company that must pay more for environmental technology, and capital gains on stockholdings in companies that sell a substitute product.

Capitalization effects are pernicious.  A large capital gain may be experienced by absentee landlords, because they can charge higher rents in future years.  Certain renters with cleaner air might be worse off, if their rent increases by more than their willingness to pay for that improvement.  Moreover, the gains may not even accrue to those who breathe the cleaner air!  If households move into the cleaner area after the policy change, then they must pay more for the privilege.  The entire capital gain goes to those who happen to own property at the time of the change, even if they sell it at the higher price and move out before the air improves.  Similarly, new stockholders in the burdened company may be “paying” for abatement technology in name only, with the entire present value of the burden felt by those who did own the stock at the time of enactment, even if they sell that stock before the policy is implemented.

Sixth, strong distributional effects are felt during the transition.  If workers are laid off by the impacted firm, their burden is not just the lower wage they might have to accept at another firm.  It includes the very sharp pain of disruption, retraining, and months or years of unemployment between jobs.  These effects are analogous to capitalization effects, if the worker has large investment in particular skills – human capital that is specific to this industry.  If the industry shrinks, those workers suffer a significant loss in the value of that human capital.  They must also move their families, acquire new training, and start back at the bottom of the firm hierarchy, with significant psychological costs.

The challenge here is that many of these effects of environmental policy are likely to be regressive.  Consider the six categories just listed.  First, it likely raises the price of products that intensively use fossil fuels, such as electricity and transportation.  Expenditures on these products make up a high fraction of low income budgets.  Second, if abatement technologies are capital-intensive, then any mandate to abate pollution likely induces firms to use new capital as a substitute for polluting inputs.  If so, then capital is in more demand relative to labor, depressing the relative wage (which may also impact low-income households).  Third, pollution permits handed out to firms bestow scarcity rents on well-off individuals who own those firms.  Fourth, low-income individuals may place more value on food and shelter than on incremental improvements in environmental quality.  If high-income individuals get the most benefit of pollution abatement, then this effect is regressive as well.  Fifth, low-income renters miss out on house price capitalization of air quality benefits.  Well-off landlords may reap those gains.  Sixth, transition effects are hard to analyze, but could well impact the economy in ways that hurt the unemployed, those already at some disadvantage relative to the rest of us.

That is a potentially incredible list of effects that might all hurt the poor more than the rich.  The challenge for those of us who want to claim to do policy-relevant research, then, is to determine whether these fears are valid, and whether anything can be done about them – other than to forego environmental improvements!