Browsing the blog archives for December, 2008.

The Gas Tax

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A couple of recent gas tax proposals have caught my attention. The NY Times called for a fluctuating gas tax, permitting the federal government to set the price of gas in the $4-5 range. In the Weekly Standard, Charles Krauthammer called for a $1 increase in the federal gas tax offset by reductions in the FICA tax. Let’s take a closer look at this tax.

 

A strong economy needs a transportation infrastructure, and you can pay for it either with general funds or through a usage tax. Financing transportation projects from the general fund hides the real cost of transportation, whereas usage fees through tolls or a gas tax link the cost of the activity to those who benefit from it. The more you drive or purchase (in the case of transported goods), the more you pay. Tolls simply are not feasible for most roads, so the gas tax seems to be the best alternative. It’s relatively cheap to collect and requires users to pay in rough proportion to their consumption. Environmentalists should like the fact that it favors consumers with fuel efficient vehicles because it is charged by the gallon, not the mile.

 

If we agree that a gas tax is necessary, then the next question is HOW MUCH? Ideally, the gas tax should be set precisely at the level required to build and maintain our roads—no more, no less. Charging MORE than this level is a bad idea because it unnecessarily punishes economic activity, limiting our personal liberty and threatening growth. Charging LESS is generally not a good idea either because it encourages people and businesses to use roads at the expense of the general taxpayer. You might argue, however, that allowing general tax funds to subsidize a small portion of the transportation infrastructure would be acceptable because this subsidy would encourage activity that benefits the economy as a whole. Nonetheless, it makes sense for the tax level to be set at or slightly below the level necessary to generate the needed funds.

 

A brief political comment is necessary at this point. The federal government takes in about $30 billion in gas taxes annually from its levy of 18.4 cents per gallon. These funds are supposed to be “deposited” into the highway trust fund and used exclusively for roads. However, revenues from the tax are used to offset government spending unrelated to transportation. This is a political problem akin to social security. We should insist that gas tax revenues be set aside and used exclusively for roads. The lack of political trust involved with this taxing bait-and-switch has led some conservatives and libertarians to call for greater privatization of our highways. Others call for the cuts in all taxes—including the gas tax—because the big spenders in Washington don’t seem to be good stewards of any of it. These are real concerns, but I’ll leave them for another day and return to the issue of tax level.

 

So why do some call for hiking the gas tax well above the level required for maintaining our roads? Some want to artificially discourage driving as a means of combating global warming. I am not convinced that human activity contributes to any significant change in atmospheric temperatures, but I’ll leave this topic for another day as well.

 

Others claim that drivers must compensate society for the “indirect” effects of their driving, such as lower air quality, increased “noise pollution,” and the like. The problem with this argument is that ALL ECONOMIC ACTIVITY HAS NEGATIVE, INTANGIBLE SIDE-EFFECTS. People who don’t like the pollution or noise associated with cars and trucks can leave the city for the solitude of country life. Some do, but most of the complainers don’t because they realize that these “negative externalities” are linked to the economic activity that supports the lifestyle they enjoy. Besides, it just makes no sense to get caught up in costing these negative externalities. My neighbor disturbs me whenever he cuts his lawn, but it would be ridiculous for me to ask for compensation to cover the noise pollution it generates.

 

There is a somewhat noble argument for raising the gas tax, however, the idea that doing so would reduce overall gas consumption and consequently our dependence on imported oil. This argument is usually a ruse designed to appeal to conservatives. I might be sympathetic if its proponents were equally as vigilant when it comes to drilling off-shore and in ANWR. There are other ways to reduce dependence on imported oil without punishing economic activity, especially in an economic downturn.

 

What can we make of the NY Times’ proposal? Using the gas tax to punish economic activity would decrease the very activity required to turn this economy around. In addition, allowing the tax to fluctuate inversely with wholesale oil prices so that the price at the pump remains stable reduces incentives for oil companies to cut production costs. In a more general sense, it removes market forces from the price of gas. Market forces—lower demand and a global recession—have contributed to the decline in gas prices we’ve experienced over the last few months, a reduction that can contribute to our economic recovery. If the NY Times plan had been in place throughout 2008, we would not be able to enjoy this relief.

 

What about Krauthammer’s revenue-neutral proposal to raise the gas tax and cut income taxes? He argues that a higher gas tax would reduce consumption, thereby lowering world demand for oil and subsequently the market price for a barrel of oil. There is some economic logic to this argument, but not enough. The tax would only affect US consumers, which account for about 25% of world consumption. His proposal also ignores the fact that the “market” price for a barrel of oil is not entirely generated by a free market; it is greatly influenced by OPEC, a group whose collusion results in production increases and decreases specifically designed to manipulate the price. In other words, most of the $1 per gallon increase in the gas tax would end up in the price consumers pay at the pump. It would also stifle economic activity by raising transportation costs.

 

Back to politics…Krauthammer’s proposal gives politicians another bait-and-switch opportunity. Raising the gas tax while cutting FICA sounds like an even trade, but income tax levels are used to redistribute income. It would only be deemed “fair” if “working people” pay substantially less than “the rich.” Liberals might even call for a “transportation tax credit” linked to income. The end result would likely be middle and high income earners subsidizing the travel of low income earners. This might be the greatest drawback of the proposal.

 

Where do we go from here? Maintaining the current gas tax level is probably the best we can do in the current environment. Raising it makes no economic or political sense. All things equal, a simple tax is better than a complicated one, and a usage tax is also preferable to a general tax (when feasible). Broad, a complex tax scheme allows politicians to manipulate the system to benefit special interests or “spread the wealth.” This is part of the reason why an overhaul of the entire federal tax system is needed. Replacing the income tax with a national sales tax is a great idea, another topic left for another day.

 

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Bailout 101

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A few months ago we were told that a financial industry bailout was required to avert a repeat of the Great Depression. While some government intervention was probably necessary, the blank check that Congress passed and President Bush signed is the best definition of a “slippery slope” I’ve seen in a long time. $700 billion dollars later, we hear that the credit markets are still frozen and more bailouts are necessary to save the economy from catastrophe. The bailout du jour is the U.S. auto industry. President Bush recently announced $17.4 billion ostensibly designed to get GM and Chrysler through early 2008. The Bush band-aid is not a long term solution. It looks like Obama and the incoming Congress to decide what to do long term.

 

How GM, Chrysler, and (to a lesser extent) Ford got to brink of bankruptcy has been well documented. Poor management decisions, heavy government regulation, high labor/union costs, fuel prices, and the poor economy all contributed to the malaise. The bottom line, however, is that the Big Three have not produced enough cars and trucks that consumers want to purchase.

 

In a capitalist society, companies come and go. The strong survive and must constantly improve to stay on top, while the weak must retool or drop out altogether. Economist Joseph Schumpeter referred to this as “creative destruction,” and it is the very process that drives economic growth. In other words, the economy improves because less efficient firms are replaced by more efficient ones. Stated yet another way, the departure of noncompetitive companies is good for the economy because it enables new competitors to enter the market and provide better products and services.  Following this logic, the real question we should be asking about the prospective auto bailout is simple. “Why should the federal government interfere with the market by providing emergency funding to automakers that investors are not willing to provide?” 

 

Those in the “mainstream” media have posed another question, however: “Should we allow the carmakers to fail?” Perhaps some frame the question this way because they simply don’t understand how the economy grows. However, such a question also puts the onus on society, not the auto companies. Think about it this way. If you and your friends choose to eat at Dave’s Drive-In instead of Harry’s Hamburger Hut, you are forcing Harry to offer better food, improve service, or cut prices to lure in customers. If he doesn’t, Harry’s business will fail, not because you “allowed it to fail,” but because he couldn’t figure out how to run a successful restaurant. When he closes, someone else would probably move in and give it a try. This is the market in action, and this process gives us the best choices in restaurants, dry cleaners, service stations, and yes, automobile manufacturers.

 

Preventing capitalism from running its course lessens some short term pain but creates greater long term problems. Specifically, I am fascinated with three arguments I heard in favor of the bailout.

 

“If we can give the banks $700 billion, then why not give something to the Big Three?” If you don’t see the flaw here, look up “slippery slope” in the dictionary.

 

“If the carmakers go under, then hundreds of thousands of Americans will lose their jobs.” There are two problems with this argument. First, if GM and Chrysler file for Chapter 11 bankruptcy, they won’t go under, at least not now. Chapter 11 can bring about leadership changes and allow these companies to renegotiate unfavorable contracts that weigh them down. These companies could emerge from Chapter 11 stronger than ever. Second, even if the Big Three eventually file for Chapter 7 bankruptcy and liquidate, they would leave a production gap in the market. Foreign carmakers like Toyota and Honda might expand their manufacturing presence in the U.S. American entrepreneurs might purchase the auto plants at fire sale prices and produce their own cars. In other words, the industry collectively would fill the gap left by the departing competitors. In the end, the net effect would likely be a loss of jobs (which is already occurring), but certainly not the catastrophe proponents of the bailout forecast.

 

“Under a bailout, government watchdogs will make sure that these companies make the changes necessary to succeed.” Are politicians and bureaucrats capable of running a company successfully when seasoned business leaders have failed? Have you been to the Post Office recently? Do you really want American companies to be “accountable” to politicians?

 

The economic reality is clear. If the government must intervene to save jobs that would otherwise be lost, then taxpayer money is being spent so that inefficient carmakers can continue to produce vehicles that a sufficient number of Americans are not willing to buy. Chapter 11 bankruptcy exists to allow struggling companies to reorganize before they go under, and this could be a good option for the carmakers. On the other hand, a government bailout allows politicians to play Santa Claus, save the union contracts, and push the production of “green” cars like never before. Unfortunately, a bailout squanders both billions of taxpayer dollars and an opportunity for the Big Three to make the kind of serious changes that are sorely needed. The same is true for the others waiting in the bailout line, from insurance companies to state governments.

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