Regulation After the Election, Part 1
Strange bedfellows on Election Day +2

9 Nov 2006 in Regulatory Economics, Regulatory Policy, Legislation

Now that the mid-term election is over, what does it mean for federal regulation? A good economist is never wrong as a prognosticator. The answer to every question is, "It depends." Today we start scanning the entrails of the election to map out the new regulatory environment and answer the follow-up question, "Okay, Mr. Smartypants: depends on what?"

Today we venture into the always dangerous terrain (if you will) of carbon dioxide. Take a deep breath, but hold it. It may cost you to exhale.

The saw is told about economists that if they were stretched end to end, they'd never reach a conclusion. If only such reticence were true for pundits.

In today's Wall Street Journal, former Bush administration speech writer David Frum offers snap election analysis and policy recommendations to his erstwhile boss. Among other suggestions, Frum says Bush ought to propose a carbon tax. His proposal is explicitly partisan; he says it would be "bait" to congressional Democrats:

The president should send Congress a tax-reform proposal now, shaping it so that it appeals to enough Democrats to split the opposition. Here's one way to do that: Democrats have made a great theme of "energy independence." The president has likewise denounced America's "addiction to oil" and often presented nuclear power as a crucial element of an ideal energy policy. What if he baited the Democrats with some kind of energy tax (or, better, a carbon tax -- which exempts nuclear-generated energy) in exchange for permanent cuts in taxes on work, savings and investment. "Tax waste, not work" is not a bad slogan.

The Congressional Budget Office has estimated that a carbon tax that began at $12 per ton emitted and rose gradually to $17 would raise $208 billion over 10 years. That's enough to fully compensate for the cost to the Treasury of making permanent the president's cuts to taxes on capital gains and dividends -- and leave over almost $40 billion to balance the budget.

Frum's proposal needs to be deconstructed because it has four explicitly stated policy objectives::

1. Energy independence;
2. Mitigating impacts from climate change;
3. Compensating the Treasury for the lost revenue associated with making permanent cuts on work, savings and investment; and
4. Deficit reduction.

We won't tackle (3) and (4) because they are fiscal policy matters, and we don't do fiscal policy here. We will only note both objectives rest on controversial premises. First, revenue losses from tax cuts typically are estimated using so-called static models. This means they assume no behavioral changes occur in response, an assumption we know to be false. The only debate is how much response occurs. That means actual revenue losses are lower than static models predict.

Second, the budget deficit is an odd economic statistic. Among other things, all expenditures in a given year are treated as if they were expenses; no outlays are treated as financial investments. In 1998 Charles Schultze opposed formal capital budgeting in part because of the political controversies that inevitably would erupt over which programs were classified as investments (which every program would want to be) and which programs were classified as expenditures (which every program advocate would want everyone else's program to be). All we know for sure is that the budget deficit measures the gap between on-budget revenues and on-budget expenditures and investments, with a host of other expenditures left off the budget for largely political reasons. Under these circumstances, the macroeconomic significance of small increases or decreases in the budget deficit are are not settled knowledge within the economics profession

Objectives (1) and (2) are regulatory, so we focus on them.

Energy Independence

This has been a stated objective of US policy since it was first enunciated by President Carter in 1977, but it doesn't have a formal definition. So it has attracted advocates who don't agree with each other. For our purposes, we'll assume that "energy independence" means reducing our reliance on energy from nations that are reasonably considered unreliable political allies such that either (a) there is a non-trivial risk of supply disruption or (b) the financial proceeds from US consumption enrich our enemies. (Note that we've tempered the scope of "independence" to mean only "reducing our reliance" on such sources. Strictly speaking, "independence" requires eliminating it but we don't think very many people really intend that.)

We ignore the most important question ("Is energy independence a good thing?") and focus instead on whether Frum's proposal would achieve it.

Would a carbon tax "that began at $12 per ton emitted and rose gradually to $17" per ton achieve energy independence? We're not sure if Frum intends this to be a tax on carbon or carbon dioxide. Carbon dioxide is 27% carbon. A $12 to $17 per ton tax on carbon dioxide is equivalent to a $3.28 to $4.64 per ton tax on carbon. If he intends the tax to apply to carbon, it is equivalent to a tax of $44 to $62 per ton carbon dioxide. CarbonCounter.org offers CO2 offsets for $10 per ton, so we assume Frum intends his tax to apply to carbon dioxide. We'll also assume that he means metric tons (2,205 lbs), not English tons (2,000 lbs.)

About 85% of the mass of a barrel of oil is carbon. A barrel of oil weighs 0.13637 metric tons. Frum's carbon tax would raise the price of crude oil 38 to 54 cents per barrel. (Taking into account supply and demand elasticities would reduce this figure.)

In 2006, the highest weighted world price of crude consumed in the US was $71.45 per barrel (August, week 2). Since then it has declined to $53.32 per barrel (November, week 1). That's a decline of 25%. Declines equal to or greater than the magnitude of Frum's proposed tax have occurred weekly (and in some cases, daily) during the period. It is difficult to believe that policy changes smaller than noise in the market would have much effect.

In short, Frum's proposal might make a good talking point for the Bush administration on energy independence, but it has no value as a way to actually achieve it simply because it's way too small to do anything of significance except generate tax revenue. It's also a badly targeted instrument for this purpose. A carbon tax hits domestically produced fossil fuels just as hard as imports. (If Frum actually wanted a duty on imported oil, he could have said so. But that's not happening; a duty on oil imports for the purpose of energy independence would be the mother of WTO violations.)

Mitigating Impacts from Climate Change

Frum also implies that his proposed carbon tax would mitigate impacts from climate change, and for that purpose a carbon tax is a plausible policy instrument. Interestingly, a CO2 tax that fully internalizes damages from climate change appears to be rather small compared to the controversy it arouses. We showed above that Frum's $12 to $17 per ton figure works out to about 50 cents per barrel of oil. It seems unlikely that advocates of climate change mitigation think this is sufficient. On the other hand, several nonprofits that sell "carbon offsets" say that $10 per ton is about right.

We don't know whether energy prices will remain near historic peaks, or whether a combination of market-induced conservation and increases in fuel production will bring them back to 1990s levels. What we're pretty sure about, though, is that most of the cost of oil and gas consumption is already borne by consumers. Accordingly, the case for government-induced (as opposed to market-induced) conservation that doesn't focus on coal is, at best, problematic.

If an increase in the federal gas tax of 4 cents per gallon is all that needs to be done to mitigate the impacts of climate change caused by motor vehicle use, it's hard to understand why the issue has drawn so much controversy. (It's also hard to understand why Frum's proposal is such a big deal that the Wall Street Journal placed it prominently on its editorial page.)

Let's suppose Hahn and Passell (and Yale economist William Nordhaus, their source for the $15 per ton figure) are right. There is a an obvious logical fallacy in Frum's proposal. Carbon is carbon: that which is emitted from the combustion of domestically produced crude oil has the same climate change impacts as carbon emitted from the combustion of foreign oil. So any carbon tax that is intended to mitigate climate change must be applied to both domestic and foreign oil. Frum can't logically use a carbon tax as a policy instrument for both mitigating climate change and achieving energy independence.

" 'Tax waste, not work' is not a bad slogan"

Frum is too modest; it's a great slogan. But slogans often disintegrate upon impact. Perfectly clean combustion yields only CO2 and water. Approximating perfect combustion has been the elusive (and hugely expensive) goal of air pollution policy for decades. Frum may not realize it, but he is proposing that the president say -- for purely partisan political purposes -- that this longstanding environmental policy goal is sinful. Waste is inherently bad; CO2 emissions are waste; hence, the emission of CO2 is inherently bad. Frum converts the thorny problem of figuring out how to internalize into the price of fossil fuel use the external damages caused by carbon dioxide emissions into a moral crusade.

The optimal amount of sin is always zero, and that means the optimal tax on carbon dioxide is a lot higher than $12 to $17 per ton, or 4 cents per gallon of motor gasoline. In the hands of an angry God (or Congress), there is no obvious upper bound that defines the optimal tax. Unlike divine taxes (set by statute at a flat rate of 10%), sin taxes are not established for the mundane purpose of correcting a market failure.

Sin taxes exist to punish sinners and, not incidentally, generate revenue. The best examples available are tobacco and alcohol. State excise taxes on cigarettes range from $2.46 per pack in Rhode Island (where smoking is punishable by both physical and financial death) to $0.07 per pack in South Carolina (where tobacco is a near-harmless recreational drug). Nationwide, state excise taxes raised $12.6 billion in 2004. State excise taxes on alcohol are substantial, and much higher on distilled spirits (very sinful) than on beer or wine (not nearly as bad, and maybe even good for you). They raised $5 billion nationwide in 2004. In 2003, the federal government collected another $7.9 billion from tobacco and $8.5 billion from alcohol. (Also in the category of sin taxes, the federal government collected $127 million in excise taxes on "gas guzzlers," which by their very name excoriates the remitters for their moral bankruptcy.)

At 4 cents per gallon, annual federal receipts from gasoline taxes could rise from $20 billion (2003) to about $30 billion. Frum says his proposed tax would raise $208 billion over 10 years, or $21 billion per year, but he's counting more carbon than we are. In any case, once we cross the threshold and start treating gas taxes as penance for sin, there is no end to how high they could go. Frum's figure should be interpreted as just the opening bid.

By making the reduction (elimination?) of carbon dioxide emissions a moral crusade, Frum is aligning himself with Al Gore. It is often said that politics makes strange bedfellows. Our post-election series on regulatory policy could not start out more interesting.

NOTES

1 g C = 0.083 mole CO2 = 3.664 g CO2
1/3.664 = % C = 27%

http://cdiac.ornl.gov/pns/convert.html

[add a comment]

Add a Comment