Guest Post 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.
Figure 1. The money doesn’t always end up where you think it will go.
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.
w.
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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Excellent, simple description. The pollies only talk about the part that relates to the business. So they hide the inconvenient truth that the consumer pays the tax – ie., increased price. Energy tax = reduced employment, lower profits, higher cost of living and thus reduced standard of living for all. Oh! you say they will provide compensation. That’s what is being said in Australia right now – no “generous compensation” is what they say – sorry its what Prime Minister Bob Brown says – Julia Gillard his Communications Secretary fronts the media.
Rubbish, Willis.
Cost = $30 + $10tax – $10rebate = $30.
Price = 2*cost (lucky you) = $60.
No change. U
Unless you think the government will renege on its promise to return the tax.
Superb, Willis.
You expose “Revenue Neutral” tax as an oxymoron. No tax can ever be truly revenue-neutral. I believe that a carbon tax is also utterly pointless, revenue-neutral or not.
The idea of it is to reduce carbon-dioxide emissions. Now if it were truly revenue-neutral, then generating carbon dioxide would be no more expensive, so it would not be a disincentive at all. The fact is, it will make energy more expensive. And inspite of that, will not reduce consumption one iota. The mechanics of inflation will kick in, making everyone suffer and reducing the value of their savings, and consumption will gaily gallop on.
I am old enough to remember the oil shock of the 1970s, when OPEC flexed its muscles and oil prices went through the roof. Funny, it didn’t reduce oil consumption.
Quite.
And then there’s the cost of salaries for the civil servants who administer the tax. So even more unproductive cost.
Energy taxes in the UK? Tell us about it. Road fuel is taxed at 170%
Willis,
In your example you have increased your return on capital. YOu may be running the same gross margin (Price/cost %), but ([price-cost]/capital employed %) has gone up.
You would find that you (and your competitors) would have their gross margins wittled down back to the point a point where the return on capital was restored to its original value. Assuming of course that there is sufficient competition, for example industries with extremely high barriers to entry might be able to maintain a higher return.
Sorry, but that is the difference between “business” and “economics”.
I’m probably missing something here, but won’t the widget maker be in competition with other widget makers, and won’t this competition drive the profit-margin down to $30 per widget, which it was in the first place? After all, the rule of thumb that you double costs to arrive at the sales price doesn’t have to be carved in stone, does it?
@ur momisuglyDave F
Surely that’s just it – competition, but in this case it may not keep the price down but drive the revenues from sales overseas. If a country applies this tax unilaterally and the company’s competition is from other local manufacturers, then they can each decide on their profit level and risk to their business. If the competition is from imports, either the tax becomes much more complicated to calculate/administer if it is also applied to imported goods (if legally it can be), or the imported product has an advantage and the tax is far from ‘revenue neutral’ to the overall economy.
I disagree. Taxing energy has the side effect of decreasing pollution (not talking CO2 here). Taxing labour has the side effect of increasing unemployment.
Any tax levied by the government will increase product cost more than the tax itself. Doesn’t matter if its energy, labour or corporate taxes. That is a reason to keep government small, but the taxes you do have to levy might as well be taxed on things that have nasty side effects. Any energy production (incl solar, wind etc) have severe environmental impact and is thus a good source to tax.
I choose decreased pollution over decreased employment any day.
There is a secondary effect as well. Think about the $20 that went to the energy company. The energy company has two choices:
1. Spend $10 on fossil fuel energy, and give $10 back to the government to redistribute to the end user
2. Spend $20 on wind / solar, and give nothing back to the government, in which case the end user gets nothing
So we have two possibilities. In the first case, which is the example Willis gives, he gets $10 back*, loses $10, and makes no change in CO2 (the whole point of the exercise). In the second case, we make an impact on CO2, but in this case, Willis is out of pocket to the tune of $20.
All of which begs the question: is the point of the tax the former (nothing to do with CO2, all about wealth redistribution), or the latter? (to do something about CO2 and make Willis pay for it through the nose)
*Oh, and you can bet of the $10 returned to Willis, there will be a $2 loss due to bureaucrats administering the scheme. So you only really get $8 back.
Willis,
Are you in a production line mode with all your frequent postings?
I find two problems with the idea of the energy taxes being proposed, whether they be called neutral or regressive or environmentally friendly or just baldly plain interventionist.
First problem is precedent establishment yielding government entitlement to escalate the taxes. The taxes negotiated initially will be threshold level in order to ease enactment of the law. But then, wham bam thank you mam (or man), the tax will escalate to suit the administration/congress/environmental fashion of the day. And more than that, the tax will introduce an economic distortion over what the free market behavior without the taxes would have been . . . . then government will intervene (again) to correct the distortion they caused thus escalating the distortion of what the free market would have done. This intervention, distortion, re-intervention, re-distortion, re-re-intervention, re-re-distortion endless cycle yields, inevitably, a totally controlled economy and authoritative government to implement it . . . . that is the path toward a total government scenario . . . . socialism=> of the totalitarian trending variety.
Thus, Ludwig Von Mises used to say,
The second problem is the proposed energy tax system is what I call the ‘USA’s social security system’ type illusion. The illusion I am referring to is that you give your money to the Social Security Administration, which according to government explanations, they will safely keep for you someplace. Then when you need it when you are old it is there waiting for you to reclaim. It is an illusion only, of course, the government spent the money you gave them for your social security on something else as soon as they got it. The government just raises taxes later on to actually give you the ‘neutral’ tax money back to you.
Willis, we haven’t even touched on the ever expanding bureaucratic mechanism that the government would propose to take and give you your money back. This of course will always evolve into big indirect costs.
I say forget all this energy tax stuff and give the energy industry entirely back to the free market and those lovely (in my view) capitalists.
John
Willis, don’t forget that there also will have to be a huge “Department of Carbon Revenue Neutrality” to take in and pay out the “revenue neutral” tax (and I’ll give you three guesses who pays for that).
I hope this is on topic as it is related to biofuel deception.
It also talks about the massive clearing of forests to make way for biofuel crops and farmers switching away from crops for food and onto crops for fuel – helping raise the price of certain cereals. The law of unintended consequences at work?
Further to my last comment many drivers in Germany are refusing to use the biofuel E10 as they are concerned that it may damage their engines. Sales of the fuel are apparently well below expectations. ;O)
And pray tell, who pays the administration costs, I would think that it would cost a minimum of $15.00 to collect the $10.00 and redistribute it !
Here in Australia, debate is raging about our governments proposed carbon (dioxide) tax.
The proposal by our Prime Minister Julia Gillard and her advisor the economist professor Ross Garnaut is as follows.
WHAT: The imposition of a tax on carbon (dioxide) of about $26 per tonne raising about $11.5 billion per annum rising by 4% plus inflation per year.
WHY: According to Gillard, it is to “transform Australia to a low carbon (dioxide) economy.”
HOW: According to Ross Garnaut, to make this tax politically palatable, the low income half of our community should be fully compensated.
In essence, using approximate figures, each year $600 will be taken from the well off half of the community, $300 of which will be given to the less well off half of the community to compensate for the $300 taken from them.
WILL IT WORK: Well let us see. The “Carbon Economy” began about 800,000 years ago when man first realised burning a fallen tree branch increases his waking hours and keeps predators at bay. Increasing his productivity in other words.
Our PM would have us believe that taking money from Peter, and giving some of it to Paul to compensate him for the money already taken from him, will transform a carbon economy that has been chugging along for 800,000 years.
We are truly led by imbeciles.
New Zealand also has an energy tax – the ETS, or Emissions Trading Scheme. This aims to “deliver emissions reductions in the most cost-effective manner”.
Right now, special ETS Review Panel is calling for submissions. Good thing too, you might say. New Zealand’s percentage of global CO2 emissions is 0.0078. Even if CO2 was a problem for the earth, that number is so small that the whole NZ ETS pointless. A review is definitely needed.
But don’t count on any sanity in the panels recommendations. The panel’s agenda specifically excludes any arguments over the ETS itself. The NZ Ministry of the Environment, which produced the agenda for the review, sets the terms: “In light of the panel’s terms of reference, the review will not be revisiting the need for an emissions trading scheme, or other responses to climate change outside the ETS”.
The madness is a global epidemic.
Allan;
yes, wouldn’t it be interesting to crank up one o’ them superduper economics models and try out the effect of eliminating “road tax” (called gasoline tax over the Pond, here).
There’d probably be a Laffer effect, and tax revenues overall would increase due to the increase in velocity of money! (Not to mention that of drivers and other consumers).
😀
DaveF says:
March 18, 2011 at 1:52 am
The problem is that it would be imposed nationwide, so the other widget makers would do the same thing, raise their prices to cover their costs. And as Verity Jones points out, that may drive people to buy their products overseas … and that’s about as non-neutral as an economic decision might be.
Regarding the rule of thumb, of course you can set your prices wherever you wish. The rule of thumb is there as a general guideline, and also to illustrate the fact that a businessman needs to make money on every penny that’s tied up in products. That includes money spent (directly or indirectly) on energy. The principle is the same whether the multiplier is 2 or 1.5 or 2.5.
Thanks,
w.
This could be avoided, by imposing that tax post-sales, as is already done in many taxation scenarios. You then get to sell your $60 widget with a declared $10 energy content, which will then attract an additional $10 ‘carbon tax’ (sorry, I had to say it).
Probably much harder to administer and collect, but possible…
Dave, what does matter is that the domestic widget maker is in competition with overseas widget makers.
Slap on an energy tax and the domestic widget maker is at an immediate competitive disadvantage.
They have 2 choices
1) Go bust
2) Outsource production overseas.
Welcome to the rustbelt!
Verity Jones and Willis Eschenbach:
Thanks for troubling to reply; I certainly appreciate the point that taxing a business gives an advantage to foreign competitors and I’m not in favour of such taxes generally; for one thing there’s an inevitable administration charge for taking the money and giving it to someone else (which would be at least 25%, probably). The point about the businessman having to make money on his investment including an energy tax depends on whether he pays it up front or it is levied at the point of sale, like a sales tax. If the former, then he will have to recoup more than he paid out, especially if it’s on borrowed money, so, yes, I take your points. Best wishes, Dave.
To take away with one hand and give back with the other costs money. Whatever a government does costs taxpayers money because governments are very inefficient at everything especially taxation. So any neutral tax is never neutral.
I’ve long since gave up any notion that these taxes are really about climate.
It’s about extend and pretend, the era of cheap energy is over because collective EROEI has dropped too low, the growth paradigm as we know it is over. At a fundamental level, these taxes are about usury IMO.
I remain perplexed as to why this is still a minority view.
That explains why the electricity producers are so happy to promote renewables. The demand for power is fairly inelastic. If you push up the cost, people will pay more. If people pay more, the utilities get a bigger cut along the way.
Also, if electricity producers shift to dearer renewable energy, the tax goes down, the rebates and give backs go down, but the power costs more so prices are still up. That’s the bad part. The more a tax works, the worse for people because the higher costs of alternative sources of power but there’s no tax raised for givebacks.
This depends on what ‘rule of thumb’ the businessman uses. He may use a ‘cost-plus’ rule, ‘charging cost + 30’ for the widget. In that case, he charges 70, the customer pays 70 and gets back 10, which would be revenue neutral.
The other point is markets are (supposedly) competitive so that the businessman charging by your rule of thumb will lose customers to the one charging on a ‘cost-plus’ basis. He will end up changing his rule of thumb quickly or else go out of business.
I’m not buying this analysis
DaveF says:
March 18, 2011 at 1:52 am
I’m probably missing something here, but won’t the widget maker be in competition with other widget makers, and won’t this competition drive the profit-margin down to $30 per widget, which it was in the first place? After all, the rule of thumb that you double costs to arrive at the sales price doesn’t have to be carved in stone, does it?
Experience in the UK after mass privatisation schemes in the 80s, well intentioned to create competition to drive costs down, free up marktes, increase freedom of choice, etc. The big muscle boys got in & gradually overtook all the others or drove them out of business, reduced cometition, & put up costs to increase profits. I have no objection to profit but were’s the competition? It was similar in the privatisation share options. Yes lots of peopl bought shares in BT, British Gas, et al. Very quickly those small investors saw the chance for a quick pound profit & sold out to the big boys, going back to square one in many ways!