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.
Rubbish back at you T.F. The rebate goes to the consumer not the producer. The producer is pricing at cost-of-goods-sold (COGS). Since the tax is part of the COGS, it goes into the multiplier. Sheesh.
It depends surely at which point the tax is applied. I understand that carbon taxes are supposed to be an end user tax in order to change behaviour.
In that case they can be applied, like value added tax, after the supplier has built his price. Also, as with VAT, carbon tax paid by a supplier on anything purchased in connexion with his business could be netted off against carbon tax collected, the difference remitted to Government, or refunded by Government depending whether positive or negative.
In that way carbon tax would not be a cascade tax and play no part in the selling price of goods or services at the end of the chain.
To make it revenue neutral, the public would, at least in theory, receive it back through the taxation system in the form of credits or reduction in taxes somewhere else.
This was the proposed legislation in France where I live but was ruled unconstitutional by the Constitutional Court and struck down, because it would be impossible to ensure all citizens were treated equally in terms of the application of the tax in the first instance – country-dwellers more reliant on fossil fuels than town dwellers for example – and refund of taxes elsewhere would be complex and unlikely to be fair, in the second place.
The Court also found that so many exemptions and exceptions were required so as not to destroy the economy, that the proposed tax could never achieve what it was supposed to.
The French Government bemoaned the fact this would leave a 4 billion euro hole in the budget – so much for intended revenue neutrality.
Meanwhile a 3% de facto carbon tax has been imposed on electricity this January to compensate EDF for the cost of the high feed-in tariffs it has to pay to buy back electricity from solar installations, and to comply with EU rules that carbon taxes must fall on the end user.
France of course makes about 90% of its electricity from non-fossil fuels – mostly nuclear – the balance being from gas, has an overcapacity and sells off 18% of its production to other European Countries, and still has its generating capacity underutilised.
It has just stopped subsidising new solar installations but it is ironic that those heating their homes with oil-fired boilers are paying no green tax, but those using ‘clean/green’ electricity are; and France now has even more and expensive electricity that it cannot use.
Funny old World.
Dr Curry is my hero. Truly.
If Mr Willis respects her blog, that says everything.
No?
Regardless of how a tax is applied it has the same result, increased price to the consumer and a negative effect on the economy. The key difference is with hidden taxes the consumer incorrectly blames the producer while with visible sales taxes they correctly blame the government. This is the key reason governments want hidden energy taxes and things like the VAT, the cost is still passed on to the consumer but the government escapes the brunt of the blame since the consumer thinks the producer is “gouging” them.
Even without taxes you can have the same problem as we are now with government interference in energy markets (such as restrictions on supply from regulations and monetary inflation) which result in higher energy prices (gas costs more). The consumer will shortly be attacking evil oil companies and speculators for “price gouging”.
There is no such thing as “price gouging” BTW, it is an emotional construct that is based on subjective interpretation of people’s “feelings”.
Here in Australia, we are in a pitched batttle with the government over a carbon [dioxide] tax. But not all Aussies are fooled. We video interviewed people in the street in Sydnety CBD and it is clear to everyone that we will pay and pay – for virtualy no benefit. The greenies however think the symbolic act of a 5% CO2 reduction is worth the pain.
See Here.
As a glass craftsman/Artist (with fairly high energy useage) I don’t produce widgets, but the same principles apply. First, a nitpick; the 2x cost principle would relate to the wholesale price, not retail, and that 2x would be at minimum. The reason is that there are a whole truckload of costs which aren’t included in the production cost, including what has been invested in equipment and maintenance/repair of same, R & D costs, sales/marketing (yes, it does cost money to sell at wholesale), profit margin (without which a company would go bankrupt), and production losses (not all widgets make it all the way through the production process, and some will get weeded out for various reasons – quality control).
Now, about that $10 energy tax, and why I hate it. Firstly, the reason I would have to include it in my production cost, which gets doubled (at least) to arrive at the wholesale is because 1) each “widget” gets charged that, whether or not it makes it to the shipping room, and 2) that money is now tied up in inventory, which is an investment, and another cost factor. As has been mentioned, that 2x cost factor (for wholesale) isn’t set in stone, so maybe I could reduce it a little bit, as I am just trying to recoup my costs, not gouge my customers. So, maybe I could cop $5 off of that wholesale price, making the wholesale price $15 higher, instead of $20. Now, what happens to the wholesale price? It depends on the industry, and the cost of sales in that industry, but to get the retail, you would need to at least double it (I won’t go into why), so the $15 energy cost increase has now become $30. The retail customer would probably balk at that, even though they’d (supposedly) get $10 back. Perhaps they’d buy something lower-priced of mine, or even someone else’s “widgets”, or something made overseas, or just go without (widgets not really being a necessity, but nice to have nonetheless). I’d write more on this, but have to go and make my own “widgets”.
John Johnston, “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”
There is a simply reason for that, the economically illiterate Richard Nixon introduced price controls. That was the real problem not OPEC. If prices are not allowed to rise based on supply and demand then you will wind up with shortages, thus the gas lines. Consumption had no incentive to be reduced because the price still artificially looked affordable. Increased prices send the signal to consumers to reduce their consumption and for producers to increase their production. If the government stayed out of it, producers would have moved to find alternative sources of oil sooner as they eventually did with the North Sea and Prudhoe Bay. All OPEC can do by raising prices is make sources of oil that were not economically viable before now become economically viable. Thus the market forces OPEC to keep their prices lower not higher.
This same problem will happen again if our economically illiterate president starts pushing “price gouging” laws.
Does anyone really think the government is going to distribute the tax revenue fairly? Of course not. It won’t be two seconds before it’s diverted to vote-buying pork. A completely “fair” and frictionless revenue return scheme is nonsense anyway if the objective is to limit energy use. If the net cost is zero, why not continue as if nothing has changed? It’s all PR for the economically clueless.
mod could you delete my first post thanks 😉
I don’t think the example stacks up, there is still that extra $10 the widget company has which will ultimate be passed on to the consumer, as other people point out due to competition.
secondly, ummm I think people are missing the BIG point about a carbon tax – i.e. the widget maker will be forced to find ways to use less energy, after all he is competing with overseas manufacturers also – and there are always ways to improved efficiency. Less energy use = less oil dependence, less pollution, less handing over barrels of money to middle eastern countries …
as for the widget manufacturing going overseas, don’t you worry about that- the price of energy is going up and with peak oil it will go up still, companies that have implemented energy efficient manufacturing are going to have a huge advantage in the future, while inefficient companies are going to struggle
Ira Glickstein, PhD says:
March 18, 2011 at 5:24 am
Any tax based on a lie (AWG) should not even be considered.
Let’s not ignore opportunity cost to the consumer. Consumers would pay at the pump, home heat, all products they buy, etc ergo would have less pocket money to buy other products, put in savings/IRA, give to charity, better food etc. Getting the money back at the end of some time interval does not negate the harm prior.
Taxing energy is the worst. We need more less expensive energy.
Regardless of who gets the rebate, an unavoidable consequence of the increased cost of the product is fewer sales. As a result, the producer has to increase how much he charges per unit to make up for the decrease in volume. This leads to a spiraling effect of an even greater decrease in sales, which in turn leads to a greater incentive to increase prices.
And then, all too often, this spiraling decrease in sales and increase in prices leads to a total collapse of the supply and demand dynamic, with the consequent closing of businesses and the disappearance of entire professions. Anyone who has been paying attention can give a long list of such products and services that have essentially disappeared in the past 50 years. And a large percentage of those losses have been caused or accelerated by government regulations and taxes. Revenue neutral taxes are part of that government induced gangrene that kills business.
Revenue neutral tax is the gov’ts perpetual motion machine. Every engineer learns in basic thermo that there are losses associated with every process, NOTHING is 100% efficient. This is the same principal central to lean manufacturing, every time there is movement, storage or operation there is a cost and waste associated with it. This “tax” is no different, it is the movement of money from one place to another. There has to be a system to move the money, people to account for the money, people to audit the accountants, people to regulate the auditors etc etc etc. Every one of those people have to be paid so every one takes a chunk. Finally, who gets the rebate? The consumer who bought the widget? Or someone the gov’t feels “needs” the rebate more?
Its a scam, there is no such thing.
I think Willis was using a simple example to show that revenue-neutral taxation isn’t really possible (and I strongly agree with him).
Anyone I know who runs a successful business (including myself) bases his/her prices on costs with some form of markup (Willis used 100%). Yes there is the issue of supply and demand but you can’t run a business where the demand forces you to charge only a 10% mark-up. Supply and demand is the differential to your cost+markup. And 100% markup is fairly conservative especially where there are high up front capital costs or long inventory times.
Another way to look at this is to assume your gross margin should be about 50% (direct costs taking up only half gross revenue). Then you subtract fixed costs (such as overhead), then depreciation, amortization and taxes.
If you run a business where a tax has been buried into your direct costs, you have to factor that in to your price. Just think about your cost of capital, for example.
This ignores the fact that implementing a tax is not 100% efficient. It costs the government money to implement it.
So why not just charge people an energy tax directly but make it lower. People can see the tax, they can relate it to their energy consumption, and then they can vote you out of office at the next election. Oh…
NO ENERGY TAXES NOHOW NOWHERE. We must stop this nonsense and stop finding excuses why both energy companies and the government should be gifted any of our hard earned income. Like Willis says taxing energy is taxing development. And there are much better ways to “solve” pollution problems — do it directly. After all this discussion about CAGW and the many sciences about which we have been priviledged to renew knowledge/learn for the first time (Anthony, I am as grateful for this opportunity as for any other), we must stop this stupidity about the damage “people”/”developed societies” do to Earth. Our eyes have been opened widely as to what Earth does to us: constant plate movements with 9.0 earthquakes, massive tsunamies, destructive volcanic eruptions; also cold periods as well as warm (and now we know a cold one is coming soon), droughts, floods, etc. Not only adapting for Earth’s vagaries is essential, but the consequenses of our Sun’s path through the Milky Way needs research.
We must give these “Third Way” people who are arguing for a version of fascism (see E.M. Smith, Fascist Doctrine, 3/15 — http://chiefio.wordpress.com/page/2/– very important reading for everyone here) that gives elites (including crony corporations) our money and prevents democratic affluence and stops our ability to prepare for the worst Earth can bring us. No government (elites and their “control”) can help us plan wisely and develop “democratically”. They are all in it for themselves and their (thuggish) followers with only the dregs left for us. Yeah, free market entrepreneurs want control, too, but competition prevents this. No energy taxes.
I’m largely in agreement with Dr. Glickstein regarding the superiority of a “carbon” tax over a cap-and-trade as a practical matter , but the most charitable thing that could be said about his conclusion “Thus, the economy will not suffer” is that it is based on an unstated assumption.
As I explained above, such taxes tend to displace capital and labor toward less productivity and thus less progress and human welfare–unless, that is, they accurately price in an erstwhile externality (damage caused by CO2 enrichment of the atmosphere). Dr. Glickstein’s implicit assumption is that the tax will do so.
But many of us believe that CO2 enrichment actually is a benefit, in which case the proper way to price in the externality would be to subsidize (although, for the reason given below, I do not favor that, either) fossil-fuel use rather than tax it.
Even if you believe that CO2 enrichment is a net harm, you have way too much faith in politicians if you believe they will come anywhere near to pricing the externality correctly.
Willis,
Unlike all your other articles, I am not buying this one, mate. Not for $80, not for $60, not even for free. Yours is the kind of lopsided (in favour of the capitalist) thinking that enrages Labor unions and causes socialist revolutions.
In your calculation, you seem to think the labor will just meekly accept the $10 offered by the businessman as the wage part of the production, whereas both the consumers (who are mostly labourers and small businessmen anyway) will not be happy to pay the new $80 price for the widget. And the only one to blame for this will be the government and the energy/carbon tax, not the businessmen who act unconscionably and jack up the price to $80 instead of $70 at the most.
No thanks, mate. This would not happen in Australia. If it were to happen, the government would be perfectly justified to jack up the tax rate imposed on the businesmen’s profits in order to ensure the businessmen don’t enrich themselves out of a scheme that’s supposed to aid the consumer.
Willis, why not this:
Widget Production Cost = $10 materials + $5 labor + $15 energy = $30 total cost
Widget Sales Price = 2 * Widget Production Cost = $60 per widget
where the reduction in labor cost is from eliminating payroll taxes.
Then add that as prices go up due to inflation rate the value of the $10 rebate go down since it’s a fix number and not a percentage.
So by every year the government’s “kind hearted” hand out of a fixed number earns the government more and more, partly by handing out less and partly by raking in more from taxing company earnings. And after five years the government can scrap the subsidy without anyone giving a damn since by then the subsidy is so small percentage wise compared to the now inflated futuristic price.
The off-set of carbon tax in EU is the trade market of carbon rights. Which, of course, just happens to be, to the glee of any coke snorting yuppy puppy, very unregulated.
A rough translation from my language calls it the green hippie socialist tax redistribution trick. By taxing the “evil doers” more they can “kind heartedly” “reduce” tax for the “do gooders”. Of course then they just go right a head and make sure that the “evil doers” can off-set their tax cost, twice, no less, once from charging more per unit, and once from some new and approved made up trade market that’s ever so good for society. One could call it the Red Hood society, i.e. good old communists centralization of money to a few really “honest” and “trustworthy” organizations and companies, in which they themselves tend to end up working for. One knows that ones society has gone socalistic when you can’t remember if the person being interview on telly this term is the honcho politician of the ruling body, or head of some government body, or the VP of some financial institute or some other authoritative organization or some such. It’s like greedy people can’t but convert to some sort of authoritarian socialism.
Sadly, this post shows exactly what is wrong with “skeptics”.
Willis applies “common sense” to economics. But if you could do economics by common sense, then no one would pay economists. If Willis were to try harder, he could probably come to an analysis of the situation which would agree with economists, and rather more closely match reality. If he tried really hard, he might even show that some economists are wrong, in some minor way that doesn’t really matter, but wrong none the less.
This is, of course, exactly the tactic that “skeptics” have used against the science of AGW. First they tried “common sense”, and were shown to be wrong. Then they tried to go toe to toe with climate scientists – e.g. by claiming that many terrestrial temperature measurements were corrupted by local warming. The end result? Little if any difference. Why? Because the scientists, being professionals, had thought this stuff through and allowed for it already.
So, how about you stop doing “amateur hour” here. If you want a post about the effect of a revenue neutral carbon tax, get an economist to write it. That way we can all be enlightened, which is so much more interesting than having a bloke who knows no more than us tell us what he thinks.
Only politicians and Govn’t will benefit from this tax. Just another “hand” in our pockets! IMO it’s like GST and VAT. I was a GST collector in New Zealand, and once earlier a VAT collector in the UK. No benefit to me as a “producer”, it was a cost and no benefit to my customers as a “consumer”, they could have gone elsewhere (Cheaper). Simply put, an indirect tax collecting and redistributing system aimed at slowing economies down, read reducing “carbon” emissions. The economy slows, emissions fall (Apparently. Doesn’t seem to be happening in the EU) but tax revenue streams are maintained or, likely, increased.
I have no problem with taxes, provided the Govn’t does what it should with them (Yeah we know it doesn’t) however, I would support a “carbon” tax, which is after all a consumption tax, if all other taxes were abolished.
Lets have a referendum PM Brown, errrr….I mean Gillard, our “PM”…lol…
There is a lot of myopia in Eschenbach’s blogpost.
It is true that the carbon tax puts a burden on businessmen. They have to consider a tradeoff between paying to emit CO2 into the atmosphere, or investing in clean energy technology to avoid this.
The purpose of the tax is to make the consumer change life style and reduce the consumption of energy or energy sources which emit GHG’s. If one accepts the necessity for doing this, there is no “free lunch”. Adding bureaucracy for this function is unavoidable.
In fact if we look at the state of economic affairs today, the wealthy capitalist has been getting the main benefit of the improvement in productivity in the US economy, while general public has lost ground. The distribution of wealth has continually been skewed toward the wealthy. They can afford a lower rate of return and live well, while reducing the burden on climate change of the industry that they own and control. In addition the life style they have does increase the emission of GHG’s.
I understand that Eschenbach doesn’t believe that GHG emissions are a problem but that is another discussion.
Mr. Eschenbach writes:
–
Yeah, but the politicians are all on acid.
Where in the US constitution is the government given the power to do this? I can’t see it. The states can do it. But, I can’t see where the federal government has the authority.
Tax anything, and you’ll get less of it. The Watermelons want to tax ‘carbon’ in order to force people to use other, less-efficient, more costly forms of energy (like windmills and solar panels), because of the dogma that carbon dioxide is bad for the Earth. The socialist politicians never met a tax (or a tax-collecting bureaucracy) they didn’t like. That’s a match made in Hades. Were it not for the obvious fact that more expensive, less efficient energy means more expensive products and services, i.e. fewer of them, and that means a drag on the economy as a whole—were it not for that, and a few elected representatives who understand it, we would already be saddled with such taxes.
The concept of ‘revenue neutrality’ applies only to government: what the left hand taketh, the right hand giveth away (not counting the cost of administration). But unless the right hand gives the tax back to the same pocket the left hand took it from (in which case, what’s the point?), the effect on the overall economy can’t be neutral; the increased costs of goods and services, multiplied down through the chain, are not going to be simply offset by a rebate to consumers. Yes, the tax cost on business might depress economic activity, and a tax rebate to consumers might increase it, but they act in different ways. There is no one-to-one relationship, and the net effect overall would be hard to calculate.
It’s up to us to convince our elected representatives that we don’t want less energy at higher cost. We want more energy at lower cost, because that’s the key to growth and prosperity. And we must fight the Watermelons who, if the truth be told, want growth and prosperity stopped in their tracks, in order to return to some mythical bucolic days of yore.
/Mr Lynn
Re: SideShowBob
If that where the case then ultimately the widget maker would end up using no energy.
The reality is that every business looks at its costs and works out what is best for them. This includes energy efficiency. We have just being going through a pretty bad recession and businesses have been looking at anything they can do to survive, do you really think they will have ignored energy savings?