Friday, March 18, 2011

Taxing energy is a bad plan for a host of reasons.

Why a “Revenue Neutral” Energy Tax Isn’t

Posted on March 18, 2011 by Willis Eschenbach

Over at her excellent blog, Judith Curry is hosting a discussion that in part is about “revenue-neutral” carbon (in reality energy) taxes. This is another example of where being a generalist is an advantage. I’ve started and run businesses, so I know why revenue neutral isn’t neutral at all when it comes to an energy tax.

The reason that energy taxes are not revenue neutral is that although the government does indeed return the taxes to the consumers, there is a hidden effect working under the radar that most folks don’t think about.

A businessman prices any product based on how much money he has in it. A typical rule of thumb for manufactured products, for example, is that your product should sell for around twice what you have directly invested in producing it.

So a typical product cost analysis might look something like this:

Widget Production Cost = $10 materials + $10 labor + $10 energy = $30 total cost per widget

Widget Sales Price ≈ 2 * Widget Production Cost ≈ $60 per widget

The businessman has to do that, he or she has to get a percentage return on the money that they have tied up in the product. So I go in and buy a widget, I pay $60, and go home happy.

Now, remember that the deal with a “revenue-neutral tax” is that the consumer is supposed to get the money back from the government. According to the pundits, this means that a revenue-neutral tax won’t slow down the economy, since the taxes aren’t removed from circulation, instead they’re returned right back to the consumers. We’ll ignore the details on how that is supposed to happen in a fair and equitable manner, although that’s another interesting can of worms. For our present purposes, we’ll leave that worm tin hermetically sealed and just assume that the US Government in its brilliant wisdom has decided to impose a $10 tax on the energy that’s used to make widgets. To balance that out and make it all revenue neutral, they’ll give you that money back as a crisp new $10 bill when you buy a widget. Perfectly revenue neutral. What’s not to like?

Here’s the difficulty. Let’s run the new widget costing numbers including the tax.

Widget Production Cost = $10 materials + $10 labor + $20 energy = $40 total cost

Widget Sales Price = 2 * Widget Production Cost = $80 per widget

So I go in to buy another widget, I give the widget man $80, and the Government gives me $10 and says everything is for the best in this, the best of all possible worlds. It’s all balanced since the tax was $10 and I got the $10 back, so the Government and I are exactly even, shake hands and part revenue-neutral friends …

Except for the part where I’m short ten bucks, and the widget maker has made ten dollars extra for the same widget. The revenue is neutral, but despite that, in the case of energy taxes the net effect is to slow down the economy.

Why will the economy slow? If we have the same amount of goods at higher prices, demand will fall and the economy will slow. It’s basic economics.

And that’s why a “revenue-neutral” energy tax isn’t neutral at all … and more to the point, it’s one reason why taxing energy in any form is a really dumb idea. Even when it’s revenue-neutral it slows the economic cycle, and when it’s not revenue-neutral, it slows it even more.


PS - In addition, an energy tax is a very regressive tax. An extra $10 energy tax for the energy used to commute to work means little to the CEO, but may break the bank of the janitor. Taxing energy is a bad plan for a host of reasons.

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