Monday, May 26, 2008

High Prices, Yes - Taxes, NO!!!

The following line comes from one of Richard Posner's posts on the excellent Becker-Posner Blog:

I would like to see the price of oil rise to $200, despite the worldwide recession that would probably result, provided that it rises as a result of heavy taxes on oil or (better) carbon emissions.

This strikes me as something that I should respond to, since I have also often celebrated rising gas prices on this blog. One could easily get the impression that I'm in favor of higher taxes on oil for all the reasons Posner gives in his post: reducing economic dependence on hostile and unstable foreign powers, stimulating investment in environmentally-friendly energy alternatives - you know, all the usual perks. But in point of fact my opinion is the opposite of Posner's here: I would also like to see the price of oil rise to above $200, despite the worldwide recession that would probably result, provided that it rises NOT as a result of heavy taxes on oil or carbon emissions, but rather as the result of natural market processes.

In fact, I have trouble understanding what the reasoning would be behind Posner's assertion that $200/barrel oil is somehow only a good thing if it's an artificial price brought on by taxes. Thinking independently, the only thing I came up with is that it gives us a "safety word" in case the recession becomes too painful. If $200/barrel prices result from taxation rather than supply problems, then the government can always "turn off the problem" (by lowering the taxes) if consumers cry "uncle!" But this reasoning is nowhere to be found in Posner's post. What he gives instead seems specious:

The taxes would jump start the development of clean fuels, and the financial impact on consumers could be buffered by returning a portion of the tax revenues in the form of income tax credits.

This seems downright irrational. If we "buffer" the financial impact on consumers, then we blunt their drive to search for alternatives. Granted, oil companies themselves might want to invest in alternative fuels to avoid the price barrier imposed by the hefty taxes Posner is proposing, but with what capital, one wonders? If their profits are suddenly slashed by an added tax burden, where is this investment money going to come from? Presumably Posner is proposing that the tax revenues be spent by the government to stimulate research into alternative energy sources, but believing that this would be done efficiently or in good faith requires me to imagine a fantasy government quite different from the one we actually have. The government we actually have, if you'll recall, sends the president to Saudi Arabia twice in the last four months to beg for cuts in the price of oil that they well know the Saudis either cannot or will not supply. Meanwhile no one mentions that we have plenty of oil right here at home that we're not allowed to touch for silly environmental reasons. Instead of talk about that, Congress votes to allow lawsuits against OPEC for price gouging, something that can only ever increase prices further. And let's not even talk about ethanol subsidies, where Congress gives handouts to the least energy-efficient form of ethanol while simultaneously slapping import tarrifs on the kinds of foreign-produced ethanol (sugar cane ethanol) that actually work. This is NOT a government we can trust to micromanage our energy spending choices!

And this:

Heavy taxes on oil would reduce not only the amount of oil we import but also the revenue per barrel of the oil exporting nations, so there would be a double negative effect on those countries' oil revenues: they would sell less oil and earn less per unit sold. The reason for the latter effect is the upward-sloping supply curve for oil. Suppose the first million barrels of oil can be produced at a cost of $1 per barrel and the second million at $2 per barrel. If total demand is one million barrels, the suppliers break even: they have revenues of $1 million and costs of $1 million. If total demand is two million barrels, the suppliers have revenues of $4 million (because the price of all barrels is determined by the price that the marginal purchaser is willing to pay) but costs of only $3 million ($1 million for the first million barrels, $2 million of the second). The lower the price of oil received by the oil producers (that is, the price net of tax), the lower their net income.

Neat trick, but is there any reason to believe that it actually works this way? Oil is well known to be an inelastic-demand product, meaning that there's really only a certain point to which we can reduce our use of it in the shortterm without completely killing our economy. I have no doubt that on the free market things work as Posner says (it costs more to produce extra oil to meet demand, and since it's a demand-driven production, prices can rise to keep pace with production cost, true), but what of a situation where demand is artificially depressed? Surely in this case the oil company can afford to sell at a higher profit margin to compensate for the tax cuts, and also save itself the trouble of extracting as much oil as it had in the past. The dampening effect on the company's profits would seem to be less than Posner anticipates. We know from the previous scenario that there is $4million worth of demand for the oil. If this demand is inelastic, there will be somewhat - but not much - less than that after the taxes, so let's call it $3million. Oil companies charge $2million on top of $1million production costs, and the other $1million goes to pay the taxes. They still make $1million ($2million in profit on $1million in production), and for doing less work. Over the long term, of course, I suppose I can't really argue against Posner's scenario. Demand would drop with time as people found alternatives. The point is simply that the punishing effect on oil-producing countries is not going to materialize for a time, and relative to what they suffer, we suffer a lot more in terms of economic slowdown. It really is cutting off the nose to spite the face.

If, however, it's a real drop in demand, then the scenario is obviously quite different. As there are real alternatives in this case, oil-producing countries then don't have the luxury of pumping up their prices safe in the knowledge that someone will buy. Once demand is more elastic, then oil profits for these countries will fall on their own. But this is pointedly not the situation caused by the taxation scenario.

Of course, I'm not a trained economist (though neither is Posner), so perhaps there are things I'm overlooking. The REAL argument against "going the tax route," in any case, is that it's an ill-advised transfer of wealth to the government.

I hear lots of arguments to the effect that the government should artificially raise prices on oil to "wean us off our addicition," and these arguments almost always focus on the supposed benefits that higher prices would have on consumption. What most people fail to consider is that all that money that gets collected in the taxes that account for the price increase is money that gets collected in taxes. It's money that people used to spend on themselves that the government is now spending for them, money lifted from the economy and given over to government programs. And like every tax, it's economically inefficient. What people would have spent on food, on entertainment, on education, etc. is now given to the government to spend on ... what, exactly? Posner suggests it could be spent on energy programs, but the government doesn't have a very encouraging history there. As noted, it's currently spending a lot of its "energy money" subsidizing hugely inefficent "alternatives" like ethanol. So let's imagine that the gas tax goes to fund some such subsidy. And let's further imagine that it works and people start buying other things instead of oil. So what happens to the subsidy? Politicians go to the subsidy receivers and say "fair is fair, people stopped buying oil, so we have less income in taxes from oil, we're going to reduce your subsidies accordingly?" In some distant utopia, maybe - but here in the real world what happens is that the subsidy-receivers threaten to vote for the opponent, and so they get their subsidies anyway. And the government pays for that by ... raising taxes somewhere else and doing more price damage to the economy if it's the Democrats, or more deficit spending doing capital damage to the economy if it's the Republicans. Either way, once you let politicians have a tax, they don't easily let it go. They'll either compensate for it by finding money (real or imaginary) somewhere else, or, more likely, now that the government has a (much larger) stake in oil tax intakes, they will be more reluctant than ever to kill off oil consumption. Making the government hostile to energy alternatives to oil by giving it a stake in oil profits seems like a really bad idea.

No - better that we just let it go. The "transfer" of wealth that currently goes to oil-producing countries happens because they provide us with something useful: an efficient energy source. This is, in itself, hugely profitable for us - comparative advantage and all that. The best way to get ourselves off of oil dependence is simply to evolve out of it, which we are currently doing without help from the government. Call it a "soft landing." Rather than Posner's government-induced shock to the economy which not only causes a recession we might not need (if the goal is energy-independence, I mean) but also gives the government an ever-greater license to meddle, almost certainly making investment in energy alternatives less efficient in the process (because the government invests on the basis of politics rather than economic and scientific reality) - what we could have instead is a slow, comfortable transition where the private market sends investment money toward profitable fuel alternatives (rather than the ones that tend to get people elected in the shortterm), leading to a more sustainable base for the future, and without needlessly throwing money to the wind in the meantime.

So yes, I'm all for $200/barrel oil, but only if it's a result of real economic signals and not just a product of the government's imagination.


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