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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Business do tend to price in percentages and do try to pass double the cost though. I have worked at a couple of hard good manufactures/distributes and so will try to explain why it is percentage based.
First, A retailer such as Dillards will oftend demand a say 10% rebate to cover advertising-costs/stocking-fee/shelf rental-fee. The name changes, but the backcharges are normally there.
Second, you can easily lose 5% to early payment discounts (2%/10, net 60) and short pays. The short pays are for various causes such as broken merchandise, customer returns, violations of shipping policies.
Thirdy, you have a sales or broke to sell your product. He is paid a % of gross margin, and i have often seen 25% to 35% of gross margin. So, this translates to say 15%.
So, 30% of my 50% markup is variable and usually in written contracts. This encourages business to agressively defend the 2 to 1 markup over the manufacturing costs. There are mostly fixed costs such as freight, adminstrative costs, warehouse costs, but the internal financial reports often show them as % of sales, not as fixed/variable costs breakout, so management thinks of them as variable.
At 603 AM on 18 March, Bruce Cobb had written:
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Gawd, is anybody else reminded of that one single greatest scene – as a snotty professor in a business course begins to lecture about a hypothetical manufacturing enterprise – in Rodney Dangerfield’s Back to School (1986)?
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The criminal predators – and that includes the officers of civil government – make their demands, and the honest businessman must budget the costs imposed thereby.
The alternative is to be destroyed by those predators, pour encourager les autres.
Don’t be a sucker…
Don’t believe Willis…
Send me that ten bucks instead…
I promise I’ll give it right back..
[and if you believe that you will believe anything]
Interesting but it would be better if it was possible to find examples in reality. If the taxes have been raised in one country but not the neighbor, it should be possible to see if companies have increased their profit.
The tax ends up to be a compound tax on energy.
For example, I will use the Natural Gas production and transportation system.
Producer extracts the Natural Gas from the ground , and pays a Carbon Tax on the energy he use’s , he add’s tax to price of Natural Gas.
Processor , who removes impurities from the Narural Gas pays Carbon Tax on the energy he use’s , he add’s tax to price of Natural Gas.
Transportor provides the energy required to move the Natural Gas to market , he pays a Carbon Tax on the energy he use’s , he add’s tax to price of Natural Gas.
Distribution company delivers Natural Gas to end user , and pays a Carbon Tax on the energy he use’s , he add’s tax to price of Natural Gas.
End user and pays a Carbon Tax on the energy he use’s , he can not pass this Carbon Tax on , which has compounded in price , but may receive a unknown value in form of a rebate , as decided by the Tax collector.
What Tax collector would not buy into this Carbon Neutural Tax system ?
[I’m sorry, Paul, but I have to turn you in to the apostrophe police. Every apostrophe in your post should be deleted. Otherwise, good comments. ~dbs]
Free junk for junkies – just say NO
Free guns for crazies – just say NO
Free alcohol for alcoholics – just say NO
Free money for governments – just say NO
You know it makes sense.
“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.”
Please keep saying this as often as possible.
Even dumber is the idea of taking part of the tax and giving it to the government for more research on “green energy” and “sustainable energy” frauds.
The article is basically acurrate on pricing, but many of the commentors don’t agree. I hope this real pricing information of plastic bags from about 10 years ago will help the discussion.
We normally sold the bags in the $12 to $18 dollar per box range. The sales manager would price as follows:
Factory Price $6.50 per box + Freight per unit from factory to customer $1.00 for $7.50 direct costs. These are all hard costs that he looked up.
Next he would look up the payment history of the big box retailer. He would find that last year, they paid 89 cents for every dollary billed to them. He then looked up percentage promised to the outside broker (15%). We had a standard markup for the distribution of 17%. He then added the numbers (11%+15%+17%) for 43%. He then divided 7.50 by .57 for a price of $13.16 per box. This 13.16 price is close to double the 6.50 factory costs, and this is where the rule of thumb comes from.
Now lets add energy tax. Since plastics bags are mostly resin (natural gas) costs, the factory costs would now be near $10.50. (This is a 10 pound box, with 40 cents per pound resin, 25 cents per conversion costs. The resin is double in price.) And i will Assume freight goes up from 1.00 to 1.50) The new base cost of $12.00 is divided again by .57 for a new selling price of $21.50. This price is again near double the factory costs of 10.50. Also note a $4.00 change in manufacturing costs resulted in a little over a $8 increase in selling costs.
These are real numbers that were typical for a plastic bag seller, that produced interally, purchased from domestic manufactures, and imported bags. I hope this illustrates why a 2 to 1 markup is a common rule of thumb, and best simplified way to estimate retail price changes due to energy cost changes to manufacturing. These examples are for the United States, and other markets may be organized in a different manner.
There is another ‘unintended cost’.
If you want to make energy efficient vehicles then you need to use lightweight materials.
Making Aluminum and Carbon Fiber takes a lot more energy than making steel.
So by taxing energy, we increase the price differential between vehicles made with lightweight materials and those made with steel.
In effect, we end up discouraging energy consumption today at the cost of increased energy consumption tomorrow.
@ur momisugly Don K, and Willis
If the government tries to add a $10 tax to the price of a $30 good then the seller will try to pass on the tax to the customer. Initially the good sells for $30 + $10 tax = $40. However, some customers will no longer buy the good because the price is higher, which creates some inventory builid up. Faced with rising inventories, sellers must lower their price, for example by $5, to $35. Furthermore, the industry is selling a smaller quanitity than they did before the tax, because as the price falls, some sellers decide to sell fewer units, or drop out of market.
The result is that sellers in the market who were getting $30 before the tax, are now getting $35 at the cash register, but must send $10 to Uncle Same, so sellers’ after tax take home $25. $5 less than before the tax. The customers are paying $35 which is $5 more than before the tax.
Thus, the buyers and sellers split the $10 tax. Both are worse off, until the government spends the tax revenue.
If the government gives $10 back to the customer, then customers are $5 better off after the tax, and some sellers will have to shut down.
A win win for progessives. Redistribute some income from capitalists to potential voters and reduce carbon emissions by driving some sellers out of business.
The only neutral tax I am aware of is NO tax.
“based simply on their carbon content.”
bioenergy.ornl.gov/papers/misc/energy_conv.html –
coal (average) = 25.4 metric tonnes carbon per terajoule (TJ)
oil (average) = 19.9 metric tonnes carbon / TJ
natural gas (methane) = 14.4 metric tonnes carbon / TJ
You would immediately drive up the cost of electricity for 1/2 the population. This coupled with the just as dumb renewable energy requirements, that drove up electricity prices in various states, would put living expenses very high.
This idea of making the cost of energy higher to control how people live is nothing short of totalitarian. You cannot put a price on freedom/liberty. That is what many luke warmers don’t get. Control the cost and amount of energy people can have and you control the people and that is not acceptable. More energy less expenive = prosperity and freedom.
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.
=======================
first thing wrong with your alternate scenario is that the “energy tax” is $10 (“the US Government in its brilliant wisdom has decided to impose a $10 tax on the energy that’s used to make widgets”) so energy price will rise from $10 to $20 (not stopping at $15 as you try to do). So that alone makes your formula:
Widget Production Cost = $10 materials + $5 labor + $20 energy = $25 total cost
which is still and increase in total costs.
Presumably you did the $15 energy because you were attempting to “shave off” the cost of the tax with a matching reduction in payroll. In which case you’d have to shave off $10 in payroll to match the $10 increase in energy . Clearly that can’t happen, as the manufactur’s cost of labour is much more that the (relative) small portion that goes to the government in the form of the employers portion of the payroll tax (hint: it’s not anywhere near 50% of labour costs, as your formula has it) and as such could not possibly be $0 unless you are proposing that the goverment subsidizes the widget manufacturer for his labour costs.
And really, if the goverment is giving back to the widget manufacturer exactly as much as it’s taking away from him, then there’s *ZERO* point in taking it away from him in the first place.
Re: tom in indy
Sell fewer units = reduce workforce, become a smaller company.
drop out of market = go bankrupt
So the net effect of your idealised scenario is less industry and fewer jobs.
eadler says:
“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.”
That’s the cover story, my communist friend, but it isn’t true. The true agenda is to expand government power, and to increase dependence on the government. The predicted runaway global warming has not only failed to appear, there has been no statistically significant warming at all over the past decade, when harmless CO2 levels ramped up.
Therefore, the CO2 scare is a proven false alarm and the government should admit it. But since higher taxes and increased government regulation of the economy are the unspoken objectives, the government still demands more taxes and regulation, despite there being no legitimate reason for them. Further, it won’t make a bit of difference because China, India and a hundred other countries are ramping up their CO2 emissions, while U.S. emissions are declining – without the proposed government meddling, increased bureaucracy and taxation.
In your class envy and hatred of anyone who has earned more than you, you state:
“…the wealthy capitalist has been getting the main benefit of the improvement in productivity in the US economy, while general public has lost ground.”
Almost identical comments were made by Adolf Hitler in the 1920’s. Instead of pining away for totalitarianism, do what lots of folks do: buy shares in companies that that pay dividends. Then you can benefit from improved productivity in the economy, instead of sniveling that someone who works harder than you do earns more money.
Some people have engaged in some great fallacies here. First of all, a tax is a tax. There is not, and never will be, one kind of tax that reduces pollution, and another kind of tax that increases employment. ALL taxes reduce (private sector) employment. All taxes slow the economy. Taxes never have the DIRECT effect of reducing pollution.
The old “revenue-neutral” shell game… True enough. Unfortunately, it’s never “cost neutral”. As a business, whether one person or 1000, I still have a cost to collect, account and file/remit the “revenue-neutral” tax. The government has a cost to collect, account and distribute rebates. The $10 in – $10 out scenario is bollocks. The economy suffers because at the end of the day my business is poorer for having to do my end and the government is poorer after paying for their end.
Soon enough the people see the ridiculousness of the whole proposition and decide to cut-out the middle-man. This is how underground economies are founded and where-in they flourish.
Willis – as a generalist you are not bad! But reading through the comments, I found some who touched on parts of what I wanted to say (my education is economics, my occupation is network engineering). So I will just list the person who made a point, and then respond to each.
H.R. says:
March 18, 2011 at 2:11 am
HR was the first to bring up the overhead issue, and a very good one. Not the company overhead, but the bureaucratic overhead. There has to be mighty midgets in DC that adminster it and their cost will not be reimbursed. Hence it is a revenue hole just for that reason.
Willis Eschenbach says:
March 18, 2011 at 2:37 am
Ira Glickstein, PhD says:
March 18, 2011 at 5:24 am
I lumped these 2 together since they are really about the same issue – competition. Willis states the companies can increase the price since all are affected, and Ira disagrees for the same reason. Yet both missed an important supplier. WE (the USA) can go ahead and shoot ourselves in the foot with the tax. And it will nail every DOMESTIC manufacturer with the additional cost, so if they were the only ones supplying it works fine. Prices go up, the government remits a pittance, and the lemmings are happy “SEE what I got from the GOVERNMENT?”. (The same people who think they get a tax refund at the end of the year when they file).
In reality, we are a world market. So Joe Blow in Thailand makes the same product – there is no way to determine the energy he used, so sells it cheaper. And another job is shipped overseas. But-but-but you say (not you as in Ira oe Willis – the proverbial you)!!! We will charge tarriffs on the imports! Smoot Hawley anyone?
So the energy tax is great! For foreign manufacturers. not the US and not for our “suffering” manufacturing sector.
Tom in Florida says:
March 18, 2011 at 5:40 am
Tom brings up a very good point that is not rebatable and is in effect in almost all states. Sales tax! The price is higher, so the tax is more and again the consumer loses. The states are not going to lower their taxes! They are busted already!
And finally, the key idea that Willis over simplified but is highlighted here:
Allanj says:
March 18, 2011 at 3:36 am
Alln correctly points out that while we (the consumer) look at whole dollars, business does not run that way. They deal with margins. Why? If you make $1m on sales of $1b, you do not stay in business long. The investors will take their money to a 1% CD! So they have to get a decent return (as expressed as a percent since that is the way investment is rated) or people do not invest!
And while the tax is collected by the companies, they have to front the cost – so it is cost of doing business (money) and they have to get a return on it. So that extra $10 dollars in Willis original example is a return on the money people invested – in other words, their return for lending the business money (no one is going to get 100% return – Madoff is in jail – so that is why Willlis’ example is simplistic, but accurate).
Reading through the comments, I was worried that no one was going to get it. But many did as you see from the list of comments I noted – and I stopped on the first one I saw that made the points I brought together, so many more probably made the same points. For the ones that still do not get it – do you get any interest on your savings? Or do you pay the bank for saving your money in the institution?
Forget all that Willis — do you trust Congress to reduce other taxes by the same amount?
This country needs real tax reform and the only way that will come about is through a constitutional amendment.
Willis: You forgot the cost impact from government overhead. Our federal government consumes at least 50% of every dollar of tax revenue or borrowed money from the cost of its performance, duplication, inefficiency, incompetence and fraud. Thus, the government’s cost of redistribution of $10 is $15 that must come from other tax receipts or additional borrowing. Since the energy tax is regressive, lower income taxpayers get the double whammy.
If it’s truly neutral, how can any benefit be maintained? Is there an investment scheme somewhere? Unless the govt is investing the collection in a CD, I don’t see any benefit. And the cost of the “management” is huge (Admin fees, in Mutual fund parlance), esp when govt is involved!
I always translate “neutral” as “transfer.”
vindsavfuktare says:
March 18, 2011 at 1:52 am
“I choose decreased pollution over decreased employment any day.”
Unless it’s YOUR job, pal, right? Of course, you probably prefer that the government and the taxpayers take care of you from cradle to grave, so your indifference to the issue is even more criminal. Such fraudulent dichotomies as you present are the reason why we are in the state we are in America these days.
Willis, I liked your post, again. I would add to your example the following: what if the government picks and chooses to subsidize some of those competitors of yours (for whatever noble, environmental reason – /sarc), thus enabling their price to be $70 per widget instead of $80? And this widget in the absence of the subsidy would otherwise cost $100 per widget and not be as effective a widget as yours? That sounds familiar, doesn’t it?
Another Gareth says:
March 18, 2011 at 3:44 am
I understand perfectly what revenue neutral means, don’t be absurd. It means that the government neither makes nor loses money on the deal. My point is that despite being revenue neutral, it will cost me money, make someone else money, and slow the economy. So while it is neutral for the government, it is far from neutral for the economy. Or for the consumers, for that matter.
The problem is that many people think that if the tax is revenue-neutral, and all of the tax is returned to the consumer, that the consumer will break even.
But the consumer doesn’t break even on the deal, even though the government has returned the full amount of the tax (either as a $10 bill or a $10 tax reduction).
And that’s the part that I wanted to highlight.
w.
PS – strictly speaking, if the “revenue-neutral” tax slows the economy, tax revenues will fall for the government. So the only way to make the tax truly revenue-neutral would be if the government made a little money on the tax to make up the money it loses from the slowed economy.
In other words, the tax can only be revenue-neutral if and only if it is not revenue neutral …
Got it?
Don K says: “So, what we probably need to do is figure out how the tax shifts the supply and demand curves and see where the new equilibrium point is. I haven’t the slightest idea how to do that. I’m not sure that anyone does.”
As smokingfrog says, this is basic economics and not controversial.
If gov’t sets a tax on production, the whole supply-price curve moves up on that supply-demand curves you mention. The tax is then shared between suppliers and consumers, depending on their relative bargaining power. This is closely related to the slopes of the two curves.
The slope of the demand-price curve is called the “price-elasticity of demand”. If demand is highly elastic (a flat line), producers have no choice but to bear all of the tax. If they tried to raise prices, demand would be killed-off immediately. This may be analogous to the above comment that widgets would simply be imported (assuming the imports don’t bear the same tax on arrival).
If demand is highly inelastic (vertical demand-price curve), producers can pass all of the tax onto consumers. This is the case where consumers have no choice but to pay-up (e.g because the’re addicted). This case appears to be the underlying assumption of Willis’s analysis where a rise in prices can simply be imposed on consumers with no consequence on consumtion. But it is not genrally true and it’s where Willis’s analysis falls down.
Similar arguments can be made for the supply side (the slope of the supply-price curve being the price elasticity of supply). In the end, it is the relative slopes that determines who bears relative shares of the tax.
You will sometimes hear business people saying how taxation is killing their business. This is why.
In fact there is a completely different reason why Willis is basically correct, if the point were to be rephrased as taxation not saving CO2.
If the tax revenue was simply taken out of the economy (throw the tax raised into a furnace), demand would be reduced and CO2 could then fall. As soon as the gov’t spends any money (or however else it returns the cash to the economy), the resulting economic activity will result in CO2 emissions. The only question is who spends the cash and who is then responsible for the CO2 emissions.
If the gov’t spends all of the cash, the tax has simply “nationalised” CO2 emissions.
There is a fair point about administration costs above – even if the gov’t wanted to return the cash to consumers. In this case, part of the CO2 emissions would then be “nationalised”.
Craig says:
March 18, 2011 at 5:15 am
“Most successful businesses don’t price based on cost. Not that it doesn’t happen, but it is almost never the best way. Successful business price based on value (charging the customer the maximum willingness to pay), and taxes add no value.”
I don’t agree with this observation. A price decision is often mitigated by value as established in the market, but there is no businessman I know who is going to price their product below cost, unless it is used as a “loss leader” to induce buyers to obtain other products of reasonable cost and value to the buyer. And businessmen are VERY careful about what they use as “loss leaders.”