March 18, 1993

March 18, 1993 | Backgrounder on Energy and Environment

The Flaws In Clinton's Energy Tax


(Archived document, may contain errors)

934 March 18,1993 THE FLAWS IN CLINTONS ENERGY TAX INTRODUCTION As part of his budget deficit reduction plan, President Bill Clinton has proposed a tax on the energy content of various fuels. The plan is to impose a 25.7 cent tax on cop, natural gas nuclear power, oil, and even hydropower, for every million Btus or mmbtus. The plan also calls for a 34.2 cent mmbtu Supplemental Oil Tax, which would make the effective tax on oil 59.9 cents. The only energy sources that would not be taxed are wind and solar power. The tax would be phased in over a three-year period beginning in mid-1994.

The proposed energy tax, which is designed t o raise approximately one-fourth of the total revenue for Clintons budget package, is ill conceived and is being sold to working class and poor Americans on false pretenses. The Administration is building support for this tax by maintaining that it will r educe dependence on foreign oil and that it will help the environ ment. Clinton also claims that the tax will not unduly burden middle-class families and will not affect the poor.

But the tax will have very different effects from those claimed by the White House specifically x Y x x x x The cost to the average family will be about 40 percent higher than Clinton claims Millions of poor families will be worse off if the tax is enacted The economy is likely to be dampened by this taxs negative effect on inter national trade Fareign refiners will gain at the expense of domestic refiners.

Fareign oil dependence likely will increase because domestic production will fall The environment may be hked because greater use ofhigh-sulph&eastern.coal will be encouraged 1 British thermal units, which is the amount of energy consumed to warm a pound of water one dw Fahrenheit at 39%.

The Clinton Administration thus is attempting to push through Congress a huge new energy tax, claiming that it will bring benefits while impos ing little or no burden on Americans with low or modest incomes. But the benefits BT~ unlikely to occur, and the cost will be much higher to families than the Administration claims. Even worse, the tax will increase depen dence on foreign oil, while doing little or nothing to help the environment HOW THE WHITE HOUSE HIDES THE COST In his February 17,1993, speech to a joint session of Congress outlining his economic strat egy, Bill Clinton proposed a new tax on energy to raise funds for his deficit reductio n pack age. He promised that the tax would cost families making over $30,000 only $17 a month (or 204 per year He further promised that those making under $30,000 would feel no tax bite due to offsetting government spending.

Both of these promises were fal se Soon after the speech, it became clear that the White House definition of income is very different from that understood by average Americans. For instance, the Administration counts as household income the rentable v ue of the home the family owns, as w ell as the value of employer-provided health benefits. Thus, when Clinton says the tax will apply only to those families making over $30,000, he means that it will apply to those families whose gross in come dg to the IRS is nearer to $20,O00 The Administ r ation also began to shift ground on the size of the tax. Energy Secretary Hazel OLeary now says that the average family o four making $4O,OOO would feel a tax bite of $320 a year when the tax is fully implemented And even this much larger figure under sta tes the true impact of the energy tax. Figures prepared by the American Petroleum Institute API for instan4ce, indicate that the annual tax bite on an average family of four actually would be $47

1. Why the discrepancy?

The Administrations estimate of a $320 cost far the average family of four is likely to be well below the true cost. One reason for this is that in calculating the cost the Administration uses a novel economic theory which assumes that not one penny of the energy tax will be passed on to c onsumen through higher prices. The White House is telling industry a very dif fmnt story. As Kenneth Lay, Chairman of Enron, the countrys largest natural gas company said earlier this month within hours of meting with Secretary Ohary, The Administration h a s assured [the energy industry] at every turn that the tax [is designed] 8 be passed on to the cons umer that this is to be a tax on energy, not on the energy industry P E 2 3 4 For a list of items the White House uses to compute income, see Daniel J. Mit chell, Taxes, Spending, Gimmicks, and Snalre Oil: Why Clintons Budget is Bad for America, Heiitage Foundation Buckgrounder No. 932, March 16,1993.

NBC Today Show, February 22,1993.The precise figure being put forth by the Administration, to which Sezretary 0- was referring, is $322 for a family of four making $4O,OOO.

The government and the American Petroleum Institute both used a family of four to calculate the effect of the energy fax on households. API calculated the per capita effect of the tax and the n multiplied this by four. This method does slightly ovmtate the effect of the tax on an average family of four because larger families usually use less energy per person than smaller families.The average Size hmhold is 27 people.The exact methodology use d by the Adminisaation to arrive at the cost for a family of four is unknown.

Speech at a CAT0 Institute conference on Nawal Gas Deregulation, Washington, D.C., March 4,1993. 5 2 $461 per household.

Household costs would, of course, vary by region For ins tance, a four-member household in Rhode Island could expect to pay only up to $285 in direct and indirect energy taxes, while a household in Montana, a state with cold, long winters and lox population density, would pay up to $5

66. Unfartunate Alaskans w ould pay up to $1,407 HOW THE TAX HELPS FOREIGN COMPETITORS Refined gasoline coming over the border would cost less to produce than gasoline refined in the United States. So foreign suppliers of refined petroleum would have an advantage over domestic supp l iers. The reason? Approximately 42 vnt of the costs of refining are due to the energy content that is used in the refining pmcess. Thus, while both fareign and Ameri can refiners would pay a tax on the energy content of the refined gasoline, the American refin ery would be saddled with an additional tax on the energy used in the refhg process. Thus on average, American diners would pay much mare tax than their foreign counterparts.

Since only the part of the tax that both countries llefiners pay could be passed on to consum 6 If all the Administrations assumptions m correct, then there will be an almost $30 billion reduction in gross wages for employees. But the net reduction in sal a ries would be just over $22 billion because the federal government would have taken back 25 percent through incame tax anyway. Ironically, if these assumptions are carrect, the lower middle class will be hit with the lions share of the tax burden. Since t h e proauCtivity of labor will be reduced due to increased energy costs, wages will be lowered primarily in the unskilled labor sector. Even if the Administrations economic assumptions were correct, the White House estimate would understate the impact of th e tax by about 10 percent.

Telephone interview with Philip Verlenger,Visiting Fellow at the Institute for Inteanational Economics. Note that the range indicated is a conservative estimate.

Based on per capita expenditures, adjusted downward to account for average tax costs absorbed as wage suppsion multiplied by four.

This energy used in the refining process is approximately 6 percent to 8 peat of the energy recoveffd. But it is over 40 percent of the total costs of refining 7 8 9 3 ers, American refiners would be forced to absorb much of the additional tax This tax will be on an already overburdened industry. An ongoing National Petroleum Council study re portedly finds that U.S. refiners now face a penalty of about 7 cents a gallon (when compared with f oreign refiners) due to environmental compliance costs. Within six or seven years, mm over, this penalty will increase to 13 cents a gallon.

Other foreign companies supplying the United States also would gain a competitive advan tage from the energy tax. T he tax would not apply to the energy used in goods manufactured abroad, only to domestic products. Since most foreign countries subsidize energy used by their industrial sectors, the Clinton tax would give foreign manufacturers an additional com petitive e dge." As Michael Schuyler, Senior Economist at the Washington, D.C.-based Insti tute for Research on the Economics of Taxation, wrote in 1990 It seems bim to propose a tax that would raise production costs of American businesses across the bod. The tax wo u ld penalize U.S. exports d invite the substitution of foreign for American production in the do mestic U.S. market lh WHY THE TAX IS REGRESSIVE The Administration candidly admits that the energy tax is regressive, but claims to have off set its impact on f amilies making under $30,000 a year. This is not accurate Many Americans, and lawmakers, have the wrong impression that this tax operates like a flat, proportional tax on income. In reality, it taxes the spending of the poor more than the wealthy. The rea s on is that poarer families, and to a lesser extent middle-class families, spend disproportionately more of their annual budget (including government entitlements) on basic goods such as heating and gasoline than do wealthier fa mi lie Hence, an increase i n the price of energy would harm them disproportionately.

Clinton claims that the burden on the poor will be offset by other policies, such as an in crease in the food stamp and earned income tax credit programs. However, even if there were a full offset, the Administration's assertion that families making up to $30,000 will be spared the effect of the tax is based on the inflated income statistics discussed earlier. Mareover 10 11 12 u Another problem of the tax centers on the tax's incidental effect 0x1 dome8tic refinenr exports. In essence, the tax would impose tariffs on exports of $3.15 on a barrel of gasoline and $350 ab1 on distillate fuel and crude oil.Thus, refiners would suffer an world markets.

The myth that foreign manufacm pay heavy energy taxe s stems fmm the co~fect notion that many foreign COIlIltries impose heavy taxes on gasoline. But indusoial energy subsidies offset, and often more than offset. the impact of high gasoline taxes. Because of foreign competition, U.S. industries that are ene r gy intensive could not simply pass on all costs. A business also might not be able to raise prices simply because people forego or substitute the good when small increases in price occur. A potential example of one of these phenomena might be the airline i ndustry. It would see its jet fuel cost rise by 12 percent, or $800 million per year, according to Philip Verlenger, Visiting Fellow at the Institute for International Economics, in testimony before the U.S. Senate Committee on Energy and Natural Resource s, January a 19

93. If the tax were passed through to consumers, the costs for air travel would increase dramatically domestically and US. airlines would lose business on some intednal mutes.

Michael Schuyler Energy Taxation is Not the Answer Institute for Research on the Economics of Taxation IRET Byline, No. 90, July 20,1990.

Based on calculations by author using data from the Bureau of Labor Statistics 4 when the offsets proposed are examined, it appears that millions of lower income families will not be protected from the taxs effect This means that the assertion that low-income families will not fact? added financial bur dens is untrue. Almost 50 perceyi of families earn less than $30,000 annually (and over 40 percent earn less than $25,000 The Admin i stration intends to inmase government income assistance programs, such as food stamps, earned income tax credits, and energy assistance to this group In the aggregate, spending increases on this income group may indeed equal the amount this group pays in t axes-although the Administrations underestimate of the tax bur den means this assertion probably is not true. Nevertheless, individual families will not all fare as well For instance, some families live in rural areas or must travel long distances to work . These high mileage families buy mm gasoline and will pay a higher share of the tax. On these families, the additional 10-12 cents a gallon due to the Clinton energy tax will be a greater burden than on those families living in cities. Similarly, low-inco m e families will differ in the amount of additional government assistance they receive For instance, those families al ready receiving food stamps axt unlikely to benefit from an expansion of the food stamp pro gram, because food stamp benefits are not lik ely to increase significantly. Rather, the in creased funding mostly will be used to expand eligibility. Thus, those newly eligible will bene fit greatly.

When the disparate impacts of the tax and the entitlement benefits are combined, the effects will dif fer widely. Those facing the highest burdens will be the unfortunate high mileage or other energy-intensive families currently receiving welfare, who will see their additional costs far outstrip their increased benefits Those experiencing windfall benefit s will be the low mileage families who will become eligible for welfare for the fvst time, and who will enjoy larger benefits than their increased costs A BLOW TO ENVIRONMENTALISM The energy tax has also been touted as a way to protect the environment. But rather than helping the environment, it will be neutral -m even harmful.

It is true that some conservation will take place because of the tax. The Administration esti mates that this conservation will reduce energy usage 1.9 percent by 1997 over the energ y use that would have occd without the tax. While this may be slightly optimistic, it is plausible.

But conservation should not be looked at as an end in itself. Arguments that energy needs to be conserved are based on a fundamental misunderstanding of th e underlying economics. The scarcity of energy resources is already incorporated into the market price. Any attempt to in 14 The 40 percent fw is given because Clinton defines income differently than does the rest of the United States Government Thus, his offsets actually will be to those making several thousand dollars less than the $25,OOO and below category released by the Census Bureau.

IS Ihe Clinton BtuTax Pr oposal. Cambridge Energy Research Associates, February 1993.The Administration assumes that the additional tax on gasoline will be only about 8 cents. This figure is mjected by Cambridge Energy mearch Associates.The Cambridge figures, however, seem mote c r edible since they reflect the amount of the tax on crude which can only be passed on to light fuels, rak than to heavy residuals. Regardless of which figure is correct, the argument outlined in the text holds 5 crease energy conservation by raising a tax e ncourages finns to increase their use of other re sources Thus the argument for conservation rests on the contention that it will reduce pollution. Nat urally, a reduction in the burning of fossil fuels would reduce air pollution, if there were a uni form reduction among all fuel sources. However, the reductions would not occur uniformly due to distortions created by the tax In seeming deference to the power of Senator Robert Byrd of West Virginia, high-sulphur eastern coal has been granted a competitive a d vantage not only against oil, but also against low-sulphur western coal. As Philip Verlenger of the Institute for International Economics who is no foe of higher taxes-noted in his January 24,1993, testimony before the U.S. Sen ate Committee on Energy and NatmdResources, This tax will push electric utilities and in dustrial firms to use more eastern coal. This will happen, said Verlenger, because the Btu tax would almost double the cost of coal at the mine mouth as well as increase already burden some tran s portation costs. The effect of the tax is to make the nations cleanest coal (western coal) less competitive with dirtier eastern coal. Demand for eastern coal could very well in crease under the new cost strucm. The potential result: a net increase in pol l ution because of a switch to high-sulphur coal AN INCREASED DEPENDENCE ON FOREIGN OIL The most ironic of all Clintons rationales for an energy tax is his claim that a Btu tax will reduce U.S. dependence on fareign oil. If the tax is imposed, America in fa ct could become more dependent on fareign oil.

As discussed in the previous section, the level of energy conservation would be very mod est, possibly 2 percent if the Administration projections are correct. Thus, the energy tax will reduce dependence on fa reign oil only if domestic production =mains constant or falls by less than 2 pexent.16 But a tax on energy will likely discourage domestic production because it will raise substantially the costs of using enhanced recovery methods to extend the life of o i l fields. These are methods, such as pumping natural-gas-generated steam into oil fields, that require a large amount of energy to exuact oil that otherwise could not be pumped. Since the tax would apply not only to the final product-oil-but also to the e n ergy used in produc tion, total costs would rise substantially. This could particularly be a problem for produders in such places as the San Joaquin Valley in California, where costs would rise by 50 cents per barrel, and in Alaska, where total costs coul d rise $100 million a year. The effect of the tax would be so profound that Verlenger predicts that California production will decline by 10 percent to 20 percent. This states reduced production alone would probably mare than offset any reduced overall dem and for imports.

Thus total domestic production of oil will fall as a result of this tax-and will probably mare than offset the modest conservation gains due to the tax. Consequently, foreign oil de pendence will likely increase 16 Actually, demand for ene rgy is expected to increase overall, but other fuel soutces are My to be substituted for oil.

Additionally, fmign producers still would compete under the same cost structure despite changes in demand.The important point thus is what level of domestic prod uction will occur in relation to fmign oil competition 6 CONCLUSION The energy tax proposed by the White House should be stricken from the budget package None of the Administrations grocery list of reasons why the tax will benefit the country J Benefit th e economy now before Congress are valid. The White House has asserted that the energy tax will In fact, the U.S. trade balance will suffer because American goods will be less competitive. U.S. refiners will be burdened, moreover, and many will fail J Cost o nly $322 per family of four In fact, the cost will be around $450 J Not affect the poor because of increased welfare In fact, millions of poor families Will pay more for fuel and other goods with out offsetting increases in welfare benefits J Benefit the e nvironment In fact, increased burning of high-sulphur eastern fuel will be encouraged and fossa fuel burning overall will be decreased by less than 2 percent J Decrease foreign oil dependence In fact, domestic production is likely to fall by more than dem a nd-thus oil This tax should be rejected far any one of these reasons. It certainly should be rejected when all are considered. This is not an investment in the American economy. It is a tax on Americas economic growth imports will likely increase John Sha n ahan Policy Analyst 7 934 Maxh 18,1993 THE FLAWS IN CLINTONS ENERGY TAX INTRODUCTION As part of his budget deficit reduction plan, Resident Bill Clinton has proposed a tax on the energy content of various fuels. The plan is to impose a 25.7 cent tax on co p , natural gas nuclear power, oil, and even hydropower for every million Btus or mmbtus. The plan also calls for a 34.2 cent mmbtu Supplemental Oil Tax, which would make the effective tax on oil 59.9 cents. The only energy sources that would not be taxed a re wind and solar power. The tax would be phased in over a three-year period beginning in mid-1994.

The proposed energy tax, which is designed to raise approximately one-fourth of the total revenue for Clintons budget package, is ill conceived and is being sold to working class and poor Americans on false pretenses. The Administration is building support for this tax by maintaining that it will reduce dependence on foreign oil and that it will help the environ ment. Clinton also claims that the tax will no t unduly burden middle-class families and will not affect the poor.

Specifically But the tax will have very different effects from those claimed by the White House X The cost to the average family will be about 40 percent higher than Clinton claims X Milli ons of poor families will be worse off if the tax is enacted X The economy is likely to be dampened by this taxs negative effect on international trade X Foreign refiners will gain at the expense of domestic refiners X Foreign oil dependence likely will i n crease because domestic production will fall X The environment may be harmed because greater use of high-sulphur eastern coal will be encouraged 1 British thermal units, which is the amount of energy consumed to warm a pound of water one degree Fahrenheit at 399.

I I tax, claiming that it will bring benefits while imposing little or no burden on Americans with low or modest incomes. But the benefits rn unlikely to occur, and the cost will be much higher to families than the Administration claims. Even wors e, the tax will increase depen- dence on foreign oil, while doing little or nothing to help the environment The Clinton Administration thus is attempting to push through Congress a huge new energy HOW THE WHITE HOUSE HIDES THE COST In his February 17,1993 , speech to a joint session of Congress outlining his economic strat egy, Bill Clinton proposed a new tax on energy to raise funds for his deficit reduction pack age He promised that the tax would cost families making over $30,000 only $17 a month (or 204 per year). He further promised that those making under $30,000 wouldfeel no tax bite due to offsetting government spending.

Both of these promises were false.

Soon after the speech it became clear that the White House defmition of income is very different from that understood by average Americans For instance, the Administration counts as household income the rentable v ue of the home the family owns, as well as the value of employer-provided health benefits. Thus, when Clinton says the tax will apply onl y to those families making over 30,000, he means that it will apply to those families whose gross in come according to the IRS is nearer to $20,000 The Administration also began to shift ground on the size of the tax. Energy Secretary Hazel OLeary now says that the average family of four making $4O,OOO would feel a tax bite of 320 a year when the tax is fully implemented And even this much larger figure under states the true impact of the energy tax. Figures prepared by the American Petroleum Institute API for instance, indicate that the annual tax bite on an average family of four actually would be $47 1 Why the discrepancy?

The Administrations estimate of a $320 cost for the average family of four is likely to be well below the true cost. One reason for th is is that in calculating the cost the Administration uses a novel economic theory which assumes that not one penny of the energy tax will be passed on to consumers through higher prices. The White House is telling industry a very dif ferent story. As Ken n eth +ay, Chairman of Enron, the countrys largest natural gas company said earlier this month withjn hoyrs of meeting with Seaetary OLeary, he Administration has assured [the energy iridust;Y] dt every turn that the tax [is designed] to be passed on to the consumer that this is to be a tax on energy, not on the energy industry 9 2 3 4 For a list of items the White House uses to compute income. see Daniel J. Mitchell, Taxes, Spending, Gimmicks, and NBC Today Show, February 22,1993.The precise figure Wing put forth by the Administration, to which Secretary OLeary was referring, is $322 for a family of four making $4O,OOO.

The government and the American Petroleum Institute both used a family of four to calculate the effect of the energy tax on households. MI c alculated the per capita effect of the fax and then multiplied this by four.This method does slightly ovetstate the effect of the tax on an average family of four because larger families usually use less energy per peason than smaller families. The averag e size household is 2.7 people. The exact methodology used by the Administration to arrive at the cost for a family of four is unknown.

Speech at a CAT0 Institute conference on Natural Gas Deregulation, Washington, D.C March 4,1993 Snake Oil: Why Clintons Budget is Bad for America, Heritage Foundation Buckgrowrder No. 932, March 16,1993 5 i 2 :I The cost to families depends greatly on whether the tax will be passed on to the consumer or absorbed by the energy industrj. If the tax is absorbed by the industr y , the money would come from pre-tax income either by suppressing wages for workers or income and dividends in the industry. If passed on, it would come out of the after-tax incomes of consumers-im plying a higher effective burden If a larger share of the t ax is not passed on, then the Administrations figures would be fairly accurate-although still about 10 percent too low be cause the Administration ignored its own projections of future energy consumption! How ever if tax costs are substantially passed on to the consumer, then the tax bite to the average American could be over 40 percent higher than the White House claims.

While not all costs of the tax would be passed through to the consumer, previous experi ence, as well as standard economic analysis, sug gests that most of the tax would be passed on to the consumer in the form of -higher-prices-on almost all-goods and-services;-Although esti mates vary, the percentage of the energy tax likely to be passed on to the consumer is between 60 percent and 80 pe rcent. Thus, most of the tax will be on consumers after-tax incomes rather than, as the Administration claims, on their before-tax income (due to lost wages).

Using this more realistic assumption, the total tax collected would be $29.3 billion to $30.9 billion (or $109 to $1 15 per capita For a typical family of four, this works out to be $437 to 461 per household.

Household costs would, of course, vary by regi on. For instance, a four-member household in Rhode Island could expect to pay only up to $285 in direct and indirect energy taxes, while a household in Montana, a state with cold, long winters and lox population density, would pay up to $5

66. Unfortunate Alaskans would pay up to $1,407 7 I HOW THE TAX HELPS FOREIGN COMPETITORS Refined gasoline coming over the border would cost less to produce than gasoline refined in the United States So fareign suppliers of refined petroleum would have an advantage over domestic suppliers. The reason? Approximately 42 pe ent of the costs of refining are due to the energy content that is used in the refining pmcess. Thus, while both foreign and Ameri- can refiners would pay a tax on the energy content of the refined gasol ine, the American refin ery would be saddled with an additional tax on the energy used in the refming process. Thus on average, American refiners would pay much mare tax than their foreign counterparts.

Since only the part of the tajc that both countries r efiners pay could be passed on to consum F 6 If all the Administrations assumptions are correct, then there will be an almost $30 billion reduction in gross wages for employees. But the net reduction in salaries would be just over $22 billion because the f ederal government would have taken back 25 percent through income tax anyway. Ironically, if these assumptions are correct, the lower middle class will be hit with thelions share of the tax burden. Since the productivity 0f.k will be reduced due to.ind en ergy costs, wages will be lowered primarily in the unskilled labor sector. Even if the Administrations economic assumptions were cmect, thewhite House estimate would understate the impact of the tax by about 10 percent.

Telephone interview with PhilipVerlenger,Visiting Fellow at the Institute for International Economics. Note that the range indicated is a conservative estimate.

Based on per capita expenditures, adjusted downward to account for average fax costs absorbed BS wage suppression multiplied by four.

This energy used in the refining process is approximately 6 percent to 8 percent of the energy recovered. But it is over 40 percent of the total costs of refining 7 8 9 ers, American refiners would be forced to absorb much of the additional tax This t ax will be on an already overburdened industry. An ongoing National Petroleum Council study re portedly finds that U.S. refiners now face a penalty of about 7 cents a gallon (when compared with foreign refiners) due to environmental compliance costs. With in six or seven years, mm over, this penalty will increase to 13 cents a gallon.

Other foreign companies supplying the United States also would gain a competitive advan tage from the energy tax. The tax would not apply to the energy used in goods manufactu red abroad, only to domestic products. Since most fareign countries subsidize energy used by their industrial sectors, the Clinton tax would give foreign manufacturers an additional com petitive edge." As Michael Schuyler, Senior Economist at the Washingt o n, D.C.-based Insti tute for Research on the Economics of Taxation, wrote in 1990 It seems bizarre to propose a tax-that would raise production-costs of American-businesses across the board. The tax would penalize U.S. exports d invite the substitution of foreign for American production in the do mestic U.S. market 1Y WHY THE TAX IS REGRESSIVE The Administration candidly admits that the energy tax is regressive, but claims to have off set its impact on families making under $30,000 a year. This is not accu rate.

Many Americans, and lawmakers, have the mng impression that this tax operates like a flat, proportional tax on income. In reality, it taxes the spending of the poor more than the wealthy. The reason is that poorer families, and to a lesser extent mid dle-class families, spend disproportionately more of their annual budget (including government entitlements) on basic goods such as heating and gasoline than do wealthier fa mi lie Hence, an increase in the price of energy would hm them disproportionately .

Clinton claims that the burden on the poor will be offset by other policies, such as an in crease in the food stamp and earned income tax credit programs. However, even if there were a full offset, the Administration's assertion that families making up t o $30,000 will be spared the effect of the tax is based on the inflated income statistics discussed earlier. Moreover 10 11 12 13 Another problem of the tax centers on the tax's incidental effect on domestic refmers exports. In essence, the uur would impo se tariffs on exports of $3.15 on a barrel of gasoline and $3.50 a barrel on distillate fuel and crude ail.Thus, refinen would suffer on world madcets.

The myth that foreign manufacturers pay heavy energy taxes stems from the correct notion that many forei gn counaies impose heavy taxes on gasoline. But industrial energy subsidies offset, and often more than offset, the impact of high gasoline taxes. Because of foreign competition, U.S. industries that are energy intensive could not simply pass on all costs . A business also might not be able to raise-prices simply because people forego or substitute the good.when small increases in price occur. A potential example of one of these phenomena might be the airline industry. It would see its jet fuel cost rise by 12 percent, M $800 million per year, according to Philip Verlenger, Visiting Fellow at the Institute for International Economics, in testimony before the U.S. Senate Committee on Energy and Natural Resources, January a 19

93. If the tax were passed through to cbnsumers,'the costs for air travel would hawse dramatically domestically and U.S. airlines would lose business on some international routes.

Michael Schuyler Energy Taxation is Not the Answer," Institute for Research on the Economics of Taxation IRET Byline, No. 90, July 20,1990.

Based on calculations by author using data from the Bureau of Labor Statistics 4 when the offsets proposed are examined, it appears that millions of lower income families will not be protected from the taxs effect This means that the assertion that low-in c ome families will not face added financial bur dens is untrue. Almost 50 percent of families earn less than $30,000 annually (and over 40 percent earn less than $25,000).14 The Administration intends to increase government income assistance programs, such as food stamps, earned income tax credits, and energy assistance to this group. In the aggregate, spending increases on this income group may indeed equal the amount this group pays in taxes-although the Administrations underestimate of the tax bur den me ans this assertion probably is not true. Nevertheless, individual families will not all fareas well.

For instance, some families live in rural areas or must travel long distances to work. These high mileage families buy mm gasoline and will pay a higher sh are of the tax. On these families the additional 10-12 cents a gallon due to the Clinton energy tax will be a greater burden than on those families living in cities. Similarly, low-income families will differ in the amount of additional government assista n ce they receive. For instance, those families al ready receiving food stamps are unlikely to benefit from an expansion of the food stamp pro gram, because food stamp benefits are not likely to increase significantly. Rather, the in creased funding mostly will be used to expand eligibility. Thus, those newly eligible will bene fit greatly.

When the disparate impacts of the tax and the entitlement benefits are combined, the effects will differ widely. Those facing the highest burdens will be the unfortunate high mileage or other energy-intensive families currently xtceiving welfare, who will see their additional costs far outstrip their increased benefits. Those experiencing windfall benefits will be the low mileage families who will become eligible for welf a re for the first time, and who will enjoy larger benefits than their increased costs I A BLOW TO ENVIRONMENTALISM The energy tax has also been touted as a way to pmtect the environment. But rather than helping the environment, it will be neutral -or even harmful.

It is true that some conservation will take place because of the tax. The Administration esti mates that this conservation will reduce energy usage 1.9 percent by 1997 over the energy use that would have occurred without the tax. While this may be slightly optimistic, it is plausible.

But conservation should not be lodked at as an end in itself. Arguments that energy needs to be conserved are based on a fundamental misunderstanding of the underlying economics. The scarcity of energy resources is a lready incorporated into the market price. Any attempt to in 14 The 40 pemt figure is given because Clinton defines income differently than does the rest of the United States Govemment.Ihus, his offsets actually will be to those making several thousand do l lars less than the $25,000 and below category released by the Census Bureau. 15 The Clinton Btu Tax Proposal, Cambridge Energy Research Associates, February 1993.The Administration assumes that the additional tax on gasoline will be only about 8 cents. Ih i s fgure is rejected by Cambridge Energy research Associates.Ihe Cambridge figures, however, seem more credible since they reflect the amount of the tax on crude which can only be passed on to light fuels, rather than to heavy residuals. Regardless of whic h figure is correct, the argument outlied in the text holds 5 b.. crease energy conservation by raising a tax encourages hs to increase their use of other re sources.

Thus the argument for conservation rests on the contention that it will reduce pollution. Nat urally, a reduction in the burning of fossil fuels would reduce air pollution, if there were a uni fm reduction among all fuel sources. However, the reductions would not occur uniformly due to distortions created by the tax In seeming deference to th e power of Senator Robert Byrd of West Virginia, high-sulphur eastern coal has been granted a competitive advantage not only against oil but also against low-sulphur western coal As Philip Verlenger of the Institute for International Economics who is no fo e of higher taxes-noted in his January 24,1993, testimony before the U.S. Sen ate Committee on Energy and Natural Resources, This tax will push electric utilities and in dustrial fms to use more eastern coal. This will happen, said Verlenger, because the B t u tax would almost double the cost of coal at the mine mouth as well as increase already burden some transportation costs. The effect of the tax is to make the nations cleanest coal (western coal) less competitive with dirtier eastern coal. Demand for eas t ern coal could very well in crease under the new cost structure.The potential result: a net increase in pollution because of a switch to high-sulphur coal AN INCREASED DEPENDENCE ON FOREIGN OIL The most ironic of all Clintons rationales for an energy tax is his claim that a Btu tax will reduce U.S. dependence on foreign oil. If the tax is imposed, America in fact could become more dependent on foreigh oil.

As discussed in the previous section, the level of energy conservation would be very mod est, possibl y 2 percent if the Administration projections are cmt. Thus, the energy tax will reduce dependence on foreign oil only if domestic production remains constant or falls by less than 2 percent.16 But a tax on energy will likely discourage domestic productio n because it will raise substantially the costs of using enhanced recovery methods to extend the life of oil fields. These are methods, such as pumping natural-gas-generated steam into oil fields, that require a large amount of energy to extract oil that o t herwise could not be pumped. Since the tax would apply not only to the final product-oil-but also to the energy used in produc tion, total costs would rise substantially. This could particularly be a problem for producers in such places as the San Joaquin Valley in California, where costs would rise by 50 cents per barrel, and in Alaska, where total costs could rise $100 million a year. The effect of the tax would be so profound that Verlenger predicts that California production will decline by 10 percent to 20 percent. This states reduced production alone would probably more than offset any reduced overall demand for imports.

Thus total domestic production of oil will fall as a result of this tax-and will probably more than offset the. modest conservation gains due to the tax. Consequently, foreign oil de pendence will likely increase 16 Actually, demand for energy is expected to increase overall, but other fuel sources are likely to be substituted for oil.

Additionally, fmign producers still would compete under the same cost structure despite changes in &mand.The important point thus is what level of domestic production will occur in relation to foreign oil competition 6 CONCLUSION The energy tax proposed by the White House should be stricken from the bud g et package None of the Administrations grocery list of reasons why the tax will benefit the country J Benefit the economy now before Congress are valid. The White House has asserted that the energy tax will In fact, the U.S. trade balance will suffer beca u se American goods will be less competitive. US. refiners will be burdened, moreover, and many will fail J Cost only $322 per family of four In fact, the ccwt will be around $450 J Not affect the poor because of increased welfare In fact, millions of poor f amilies will pay more for fuel and other goods with out offsetting increases in welfare benefits J Benefit the environment In fact, increased burning of high-sulphur eastern fuel will be encouraged and fossil fuel burning overall will be decreased by less than 2 percent J Decrease foreign oil dependence In fact, domestic production is likely to fall by more than demand-thus oil This tax should be rejected for any one of these reasons. It certainly should be rejected when all are considered. This is not an investment in the American economy. It is a tax on Americas economic growth imports will likely increase.

John Shanahan Policy Analyst

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