Oil’s ‘Swoon’ Is Not an Argument for Carbon Taxes

It was inevitable. As soon as consumers and the economy start to enjoy significant relief from a decade of pain at the pump, the political class clamors for higher gas taxes and new carbon taxes.

The recent reduction in energy costs is remarkable. The U.S. Energy Information Administration (EIA) reports a 43% decline in the energy component of the Goldman Sachs Commodity Index during 2014. According to EIA, the drop in fuel prices was not due to “strong underlying trends in global economic growth” but rather to “supply-side factors unique” to energy-related commodities.

Fuel prices are down because the revolution in unconventional hydrocarbon production increased crude oil and natural gas supplies, and Saudi Arabia has failed to persuade other OPEC members and Russia to behave like a cartel and cut output. Crude oil spot prices recently dipped below $54 per barrel.

As a result, regular gasoline is now selling for about $2.20 a gallon — roughly one-third less than in Jan. 2014.

Credible estimates of the direct and indirect consumer benefits vary, but they’re all substantial.

AAA: Americans saved $14 billion on gasoline in 2014 compared to 2013, with many drivers saving $15-$30 every time they fill up, compared to a year ago. As of Dec. 31, 2014 gas prices declined a record-breaking 97 days in a row, with further decreases predicted “as retail prices catch up with the steep declines in the cost of crude oil.”

Bloomberg: “Plunging fuel prices will free up as much as $60 billion over the next year that the consumer can spend on a fall jacket, a movie ticket or just more groceries.” That was in October, when gas prices were still north of $3.00/gal.

WSJ: Falling gas prices will give consumers the equivalent of a $75 billion tax cut. The tax cut is progressive because low-income households pay a larger share of earnings on energy. “Households earning less than $50,000 annually spent around 21% of their after-tax income on energy in 2012, up from 12% in 2001, according to analysts at Bank of America Merrill Lynch.”

NPR: If current gas prices continue, the typical household will have an extra $1,500 to save or spend in 2015. Already, “The average American is seeing a much bigger boost from falling gas prices than from pay raises. Cheap energy could finally put the U.S. economic recovery over the top.”

So naturally, ‘progressives’ now claim that, more than ever, a carbon tax is an idea whose time has come. Harvard economist Lawrence Summers, for example, argues in the Washington Post that “Oil’s swoon creates the opening for a carbon tax.” Does it? More importantly, should it?

Is carbon energy a tax haven?

Summers begins by declaring that although there is “room for debate about the size of the [carbon] tax and about how the proceeds should be deployed, . . .there should be no doubt that, given the current zero tax rate on carbon, increased taxation would be desirable.”

A strange argument. If there is currently a zero tax rate on something, then increased taxation is undoubtedly desirable. How far is Summers willing to push that? Somehow I doubt he would support China’s one-child tax policy, or taxes on educational achievement, even though emissions derive from consumption, and consumption tends to increase with population and human capital formation.

Although there is no federal carbon tax rate, companies that mine, process, and utilize carbon-based energy pay lots of taxes. ExxonMobil, for example, paid $31 billion in corporate income taxes in 2012 and more than $1 trillion in total taxes during 1999-2011, paying $3 in taxes for every $1 in profits.

Oil, gas, and coal companies also incur substantial implicit taxes in the form of regulatory compliance expenditures, as do companies that combust fossil fuels to generate power or manufacture products. For example, EPA estimates that its Mercury Air Toxics Standards (MATS) rule will cost electric utilities $9.6 billion in 2016 (77 FR 9306), and that its proposed revised national ambient air quality standards (NAAQS) for ozone will cost $3 billion to $39 billion in 2025 (RIA 7-33). Dozens of other major air rules for energy-intensive facilities could be cited (see Appendix A of this report).

Some EPA rules explicitly target CO2 emissions. EPA estimated that its May 2010 greenhouse gas/fuel economy Tailpipe Rule would cost the auto industry $67 billion during 2012-2020 (75 FR 25515). EPA estimates that its Clean Power Plan (CPP) to control CO2 emissions from existing power plants will cost utilities $7.3 billion to $8.8 billion in 2030 (RIA ES-7). Actual costs could be substantially larger. Virginia’s State Corporation Commission staff estimates that one utility — Dominion Power — will have to spend $5.5 billion to meet the State’s CO2 reduction target. NERA Economic Consulting estimates the CPP will cost states $41 billion in 2030 and $336 billion over 15 years.

In addition, as of Jan. 2012, 30 states and the District of Columbia had mandatory renewable electric generation policies. Such measures, which make electricity more costly and less reliable, are a roundabout way of putting a cap on CO2 emissions and function as a covert CO2 reduction tax. Federal and state policies impose numerous energy-efficiency standards, which also aim to limit CO2 emissions.

A significant portion of all federal and state tax and regulatory costs affecting carbon energy are passed on to consumers, who also pay federal and state motor fuel taxes at the pump. At 49.28¢ per gallon, the current average combined federal and state gasoline tax is equivalent to a carbon tax of nearly $50 per ton. The idea that ‘carbon’ is a tax-free zone just because there is no explicit carbon tax rate is ludicrous.

At no point in his op-ed does Summers suggest that carbon taxes should replace greenhouse gas regulations, fuel economy standards, renewable electricity mandates, or energy efficiency programs. Apparently, he wants to layer carbon taxes on top of carbon regulations.

Do we overuse fossil fuels?

Summers goes on to make the usual externality argument for eco-taxes: “The core of the case for taxation is the recognition that those who use carbon-based fuels or products do not bear all the costs of their actions. . . .All of us, when we drive our cars, heat our homes or use fossil fuels in more indirect ways, create these costs without paying for them. It follows that we overuse these fuels.”

That’s more than Summers or anyone else can know. Evidence abounds that tax and regulatory burdens have grown beyond economically-optimal levels. By slowing income growth and increasing the cost of final goods and services, high taxes and regulatory excess limit consumption, including consumption of energy-related products and services.

Energy consumption is more directly constrained by specific infringements of economic liberty. For example, in most countries, subsurface mineral rights are owned by the state. That restricts market entry, which limits supply, which in turn increases prices and curbs consumption. As my colleague William Yeatman recently observed, “because private parties in such countries don’t have ‘skin in the game,’ they’ve every incentive to oppose drilling below their lands, as they’d bear the burden of drilling (i.e., proximity to an industrial practice) without any of the direct benefits.”

State ownership of subsurface mineral rights also reduces the transaction costs required to cartelize energy producers, restrict output, and increase prices. Government monopoly control of subsurface minerals is the sine qua non of OPEC. Oil prices would be lower, and people would consume more, in a free market.

Although the right of private persons to own subsurface minerals is a bedrock of U.S. energy policy (pun intended), federal energy law infringes another basic liberty: the right to compete for customers. For 40 years, Congress has banned exports of crude oil. This policy, too, limits supply, raises prices, and discourages consumption.

IHS Global Inc. estimates that lifting the ban and allowing free trade would:

Increase U.S. production from 8.2 million B/D currently to 11.2 million B/D, generating nearly $750 billion in investment and cutting the U.S. oil import bill by $67 billion per year.

Lower gasoline prices by an annual average of 8 cents per gallon, saving motorists $265 billion during 2016-2030.

Support an average of 394,000 additional U.S. jobs during 2016-2030, with highs of 811,000 additional jobs supported in 2017 and a peak of 964,000 jobs in 2018.

Increase average disposable income per household by $391 in 2018 as benefits from increased investment, additional jobs and lower gasoline prices are passed along to consumers.

Would a carbon tax make energy markets more efficient?

In the imaginary universe of blackboard economics, corrective taxes by definition improve the efficiency of capital investment. But in the real world of political economy, the social cost of carbon (SCC) — the alleged damage to be corrected by carbon taxes — is an unknown quantity, and SCC analysis has become a menace to society.

SCC analysts can get just about any result they desire by fiddling with non-validated climate parameters, made-up damage functions, and below-market discount rates. Through garbage-in, garbage-out computer modeling, SCC analysts can make carbon energy look unaffordable no matter how cheap, and renewable energy look like a bargain at any price. They can also dupe themselves and others into believing that carbon taxes will make us richer, healthier, and more ‘energy secure.’

Environmental guru Paul Ehrlich infamously said that “Giving society cheap, abundant energy at this point would be equivalent to giving an idiot child a machine gun.” Considering the political sector’s appetite to spend beyond our means, the alarmism of the global warming movement, and the illusion that only ‘corporate polluters’ would bear the cost, what Ehrlich mistakenly says about cheap energy goes in spades for carbon taxes. The power to tax is the power to destroy — especially if the tax is touted as an economic benefit rather than a cost.

Summers might respond that even if we don’t know the optimal carbon tax price, CO2 emissions obviously do more harm than good; hence, any ‘moderate’ carbon tax is bound to improve economic efficiency. Not so.

The Obama administration uses three integrated assessment models to estimate SCC values: FUND, DICE, and PAGE. When Heritage Foundation analysts David Kreutzer and Kevin Dayaratna ran the FUND model with two plausible alternative assumptions — a 7% discount rate and updated climate sensitivity estimates — the model “at times suggests net benefits to CO2,” implying that government should subsidize hydrocarbon energy.

Climate researcher Craig Idso, using Food and Agriculture Organization economic data on 45 major food crops and yield data from decades of CO2 enrichment experiments, estimates that rising CO2 concentrations boosted global crop production by $3.2 trillion during 1961-2011, and will increase output by another $9.8 trillion between now and 2050. Those huge benefits are absent from most — or all — SCC estimation models. What would happen to SCC estimates if ‘damage functions’ incorporated those benefits? My hunch is that most SCC values would be negative (i.e. indicate net benefits) over several decades.

Summers writes that, “While the recent decline in energy prices is a good thing in that it has, on balance, raised the incomes of Americans, it has also exacerbated the problem of energy overuse. The benefit of imposing carbon taxes is therefore enhanced.” He does not confront the obvious implication of that statement: Taxes that increase energy costs will, “on balance,” lower the incomes of Americans. Is “energy overuse” really a worse problem in our still struggling economy than low incomes?

As the NPR, WSJ, and Bloomberg articles all make clear, savings from lower fuel costs allow households to spend more on everything from restaurant meals and movies to rent and mortgage payments to education and new cars. Carbon tax proponents claim the only judgment they are making is a technical one about economic efficiency. In fact, they implicitly assert that society will be better off if people have less money to spend on meals, movies, rent, homes, education, and cars.

‘Progressives’ for regressive taxation?

Summers is aware of the criticism that carbon taxes impose disproportionate burdens on low-income households and workers with long commutes. But, he contends, “Now that these consumers have received a windfall from the fall in energy prices, it would be possible to impose substantial carbon taxes without them being burdened relative to where things stood six months ago.”

Translation: Taxing carbon will leave consumers better off than they were six months ago, even if worse off than they are now — what’s not to like! Plenty, actually. For consumers, a carbon tax would increase the risks of energy-price volalitity while reducing (confiscating) the benefits.

When gas prices passed $3 and even $4 a gallon, there was no mechanism in the law adjusting gas taxes downward to alleviate the windfall losses consumers incurred at the pump.

What happens if crude oil and gas prices shoot back up? Since Summers does not say otherwise, we may infer that consumers would be stuck with the carbon tax adopted when gas prices were low.

More precisely, consumers will be stuck with a carbon tax that grows over time, whether oil prices rise or fall. As Summers puts it, $25 a ton is just a “reasonable start.” Heads Big Government wins; tails, consumers lose.

Will it cost only quarters on the gallon?

Noting that gas prices have “fallen by more than a dollar” in 2014, Summers estimates that a $25-a-ton carbon tax would raise more than $1 trillion in revenue over the next decade yet “would lift gasoline prices by only about 25 cents.” Such a deal! For a mere 25 cents a gallon, ‘we’ can raise $1 trillion.

In 2012, the EIA analyzed the impacts of a similar proposal — a carbon tax that starts at $25 per ton and increases by 5% per year after inflation. Kreutzer and his colleague Nicolas Loris wrote a commentary on EIA’s carbon tax analysis. Compared to the baseline (no carbon tax) case, the policy would:

Cut the income of a family of four by $1,900 per year in 2016 and lead to average losses of $1,400 per year through 2035;

Raise the family-of-four energy bill by more than $500 per year (not counting the cost of gasoline); and

Lead to an aggregate loss of more than 1 million jobs by 2016 alone.

Twenty-five cents here, twenty-five cents there, and pretty soon we’re talking real money.

How much climate bang for carbon tax buck?

Exactly what climate benefit would we get for those job and income losses? Cato Institute scientists Patrick Michaels and Chip Knappenberger have constructed a ‘handy-dandy carbon tax calculator‘ based on MAGICC, a climate model developed with EPA support. Let’s generously assume the carbon tax would reduce U.S. CO2 emissions 80% by 2050, and that climate sensitivity is 3ºC for a doubling of CO2 concentrations (even though recent studies indicate lower values). The policy would avert 0.042ºC of warming in 2050 and 0.106ºC in 2100.

The hypothetical change in temperature in 2050 would likely to be too small to detect or verify. In the National Oceanographic and Atmospheric Administration’s monthly estimates of global average surface temperature, the margin of error is +/- 0.07°C. In other words, the impact of the carbon tax is smaller than NOAA’s ability to reliably measure temperature. Such an undetectably small change in global temperature could have no discernible impact on sea-level rise, tropical storm behavior, polar bear populations, or any other climate-related phenomenon people care about.

Conclusion

Summers makes a clear, concise, but unpersuasive case for a carbon tax. The holes in the argument are not his doing but rather arise from the thesis he propounds. The case for a carbon tax fails because: