The Heritage Foundation

Backgrounder #943 on Taxes

May 26, 1993

May 26, 1993 | Backgrounder on Taxes

Taxing America's Energy and Vitality

(Archived document, may contain errors)

943 May 25,1993 TAXING AMERICA'S ENERGY AND VmAI.,ITY WTRODUCTION President Bill Clhton has hcluded a t&c on enefgy in his bidget deficit reduction plan.

The stated purposes of the new tax are to reduce the budget deficit, conserve energy, protect the environment, and reduce foreign imports of oil. The Clinto n energy tax was included in the budget package just passed by the House Ways and Means Committee, as part of the Revenue Reconciliation Act of 1993, and is scheduled to go to the House floor this week for debate.

Under the measure passed by the Ways and Means Committee, a tax on the heat generat ing capacity of different fuels would be phased in over three years. This would mean a 26.8 cent tax on each million British thermal units (mmbtu) of energy consumed by Am e ricans from coal, natural gas, oil, and other sources. If the measure becomes law, a 34.2 cent "sup plemental tax, will be placed on oil (except home heating oil for a maximum total tax of 61 cents per mmbtu. In addition to this tax, Clinton proposes in t h e same package a gasoline tax of 2.5 cents. This would take the form of extending the existing tax, which is scheduled to terminate in 1996 r The energy tax has attracted widespread criticism, especially from those who fear that it will weaken the economy - the rationale for the entire package is that it will strengthen the economy. Pressure from industry and many Members of Congress already has forced the Administration to make numerous concessions in an effort to win sufficient support in Con gress. But al t hough numerous exemptions from the tax have been granted, the projected rev enue (calculated by the Administration) remains unchanged at $7 1.5 billion over five years to 26.8 mmbtu In particular it will Cu-Se-the base tWi%tij hjiSbt%X~ fiWd-f&iii25.7-cen s-per mmbtu-in-therorigind-pmpsal Despite the changes, the Clinton energy tax still will be harmful to the economy.

Another criticism was that the tax would cripple domestic refineries. Domestic refiners would have paid a tax on the substantial amounts of energy consumed during the refining process itself as well as the Btu value of their refined fuel. But foreign refiners would have been taxed only on the energy level of their refined fuel when it crossed the U.S. border.

Such criticisms led the Ad minis tration to try to reduce the cost disadvantages to domestic producers and refiners. For do mestic producers, the Adminis tration exempted fuels used for enhanced recovery" of heavy oils. For refiners, the tax collec tion point was moved to the re finery " tailgate"-the term de noting the point after refining is completed. However, unlike their foreign competitors, her ican refiners still will be taxed on the transportation fuel needed to bring the crude oil to the refineries.

The Administration also granted a partial exemption from the tax to the aluminum industry. The reason: The tax would have been extremely damaging to the aluminum in dustry, which is highly energy 3 intensive 3 The tax exemption does not specifically target the aluminum industry. Rather , it exempts the non-fuel uses of electricity during the electrolytic process, which is the technical name far the manufacturing process used. About half of the energy in this process is not consumed, but rather is converted into solid fm by "transferring" electrons to the aluminum. Since about 60 percent of the energy used in making aluminum is during this process, only about 30 percent of the aluminum industry's energy use will be exempt 3 While other industries also will benefit, the aluminum industry wi l l be affected most by the change. Prior to the exemption, the tax would have raised the production cost of alumi num by $289 million or 4 percent each year. This cost increase would have been burden some to an already struggling industry. The number of do m estic primary plants have de creased by over 20 percent in the last decade, and while world prices are now 52 to 54 cents per pound, due in part to Russias increased aluminum sales U.S. costs of production range up to 60 to 62 cents per pound. With the ex emption, however, the tax still will impose a cost of more than $220 million on the industry.

The Administration has agreed to numerous other exemptions. For instance, the White House acceded to demands by electric utilities to pass through the price of th e energy tax to the consumer without approval from local rate commissions In addition, home heating oil has been exempted from the supplemental oil tax (thus, home heating oil will be taxed at the 26.8 cent per mmbtu rate Another new provision exempts fro m the tax fuels used in en hanced oil recovery-for instance, pumping natural gas into the ground to generate steam pressure to force oil to the surface Significant Opposition. Despite these and other changes, the Administration still faces significant oppo s ition to the proposed tax. Although certain industry groups have been con tent merely to obtain a special exemption, other groups have remained firmly opposed to the tax. A coalition, known as the Affordable Energy Alliance, has been formed to oppose the Btu tax. In addition, the most prominent farm lobby is actively fighting the entire tax bill.

Declares Dick Newpher, Executive Director of the Farm Bureaus Washington office, Ef forts will be made to exempt agricultwe from the tax. The Farm Bureau position is one of complete opposition to the tax rather than pushing for an exemption We oppose the tax in its entirety and are not seeking an agricultural exemption. This tax is bad and the whole thing must be defeated.A Despite the Fann Bureaus position some l a wmakers are trying to appease farmers with exemptions. Senators in many farming states, such as North Dakota-where the cost of growing 2,000 acres of typical crops would rise by an estimated $4,789-will not want to outrage farmers? The fanning community a l ready has been granted some major exemp tions. Farmers have been freed from the supplemental oil tax on diesel fuel, for instance, as well as for gasoline used for off-road equipment, such as tractors. There may be a push to grant further farm exemptions.

The problem for the Administration is that the entire tax could collapse under the weight of a growing list of exemptions. Many industry groups, such as the American Gas Associa tion, have begun to realize that they suffer a competitive disadvantage with every new ex emption. In addition to creating competitive disadvantages, the increasing number of exemp tions led to the base tax on energy being raised by more than a penny, from 25.7 cents to 26.8 cents, to make up for the revenue lost.

After exemption upon exemption, the claimed benefits of the tax are more in question than ever. Each exemption seem to have merit, because it relieves some industries of un 4 5 Internal Farm Bureau memo, May 7,1993.

Numbers prepared by Nodak Mutual Farm Bureau, April 1993 I 4 How justifiably burdensome taxes. But the same rationale then applies to other industrial sectors.

Instead of relieving these industries as well, their tax is raised even higher IXE TAX NEEDLESSLY WILL DESTROY JOBS The Clinton Administrations claim that the energy tax will raise $7 1.5 billion over the next five years, or $22 billion annually when fully phased in, is wildly optimistic. According to the Institute for Research on the Economics of Taxation, income and payroll taxes will de cline as a r e sult of the job 1osses;and this means nettax revenues will be about $10 billion per year less than the Treasury Department estimates, when the tax is fully phased in6 RET estimates, moreover, that when the revenue shortfall is combined with welfare increa ses in tended-ineffectively-to eliminate the tax burden on poor families, the total net income from the Btu and gasoline taxes, when fully phased in, will be a mere $5 billion per year.

The annual loss of GNP, on the other hand, will be about one percent, or $50 billion each year? Thus, the tax will reduce private sector output by $10 for every dollar of net revenue raised. Moreover, IRET estimates these taxes will cause roughly 500,000 job losses. There fore, the Btu tax will throw one American out of wor k for every $10,000 of net revenue it raises.

The impact will vary by region. For instance, Oklahoma will lose an estimated 11,OOO jobs, or 1 percent of the states work force As IRET notes, the federal deficit easily could be lowered by $5 billion without job losses and the resulting contraction in the economy simply by reducing spending by that amount?

Bipartisan Alternative. Recognizing this economic truth, and how damaging this tax would be to his home state, Senator David Boren, the Democrat from Oklah oma, along with John Danforth, the Republican from Missouri (both members of the Senate Finance Commit tee announced a bipartisan deficit reduction plan on May 20,19

93. Their plan would strike the Btu tax, as well as so me others, and replace them with spending cuts. The Administra tion called this an unacceptable alternative will not hurt the economy. Energy Secretary Hazel OLeary stated in February on NBCs Today show that the tax will enrich the nation and create jobs. 1 o But asThomas Dhrenzo, Professor of Economics from Loyola College in Baltimore explains, if that were true, one wonders why the Clinton Administration doesnt propose a tax of $6,000 per million Btus instead of a measly 60 cents, thereby enriching the nat ion even more.1 Despite the wealth of evidence, the Administration clings to its belief that the energy tax 6 lREZ,opcir 7 Ibid 8 9 IRET,opcif 10 NBC Today Show, February 22,19

93. This assertion has been made repeatedly since then by both Secretary OLeary and Treasury Secretary Lloyd Bentsen 11 Thomas DiLorenzo, Clinton Attacks Energy, The Free Marker, May 1993 Robert Dauffenbach, David knn, and William Talley, Impact of the Proposed Btu Tax on Oklahoma and Oklahomans. Center for Economic Research, Univer s ity of Oklahoma, May 1993 5 HOW U.S. COMPETITIVENESS WOULD SUFFER The tax also will hurt domestic producers relative to foreign competitors. The original Ad ministration plan intended that the tax would not apply to the energy used in goods manufac tured a broad, only to domestic products. The Ways and Means Committee bill will tax the most energy-intensive imports, but the majority of Btus consumed to make all imported goods still will not be taxed Since most foreign countries subsidize energy used in indu s trial sectors, the Clinton tax would give foreign manufacturers an additional competitive edge myth that foreign manufacturerspay heavymces stems from the (correct) notion that many foreign countries impose heavy taxes on gasoline. But industrial energy s ubsidies more than offset the impact of these high gasoline taxes. HOW PRICES WILL RISE The energy tax will hurt all sectors of the U.S. economy. The reason: The price of virtu ally every domestic product will increase as a result of this tax because all g oods, and even services, require energy for their production or delivery. Even those industries that would be partially or fully exempt from paying a tax will bear higher costs due to other energy used in production and the transportation of their product s to market. Items requiring the most en ergy consumption to produce will tend to experience the biggest price hikes. The tax will raise the cost of new cars substantially and even increase the cost of simple household items such as cans of soda.

I The Cos ts to American Families The tax would not be easy on family budgets. The cost of the tax will be about $1 12 per capita annually, for a total cost of about $450 for a typical family of four. l3 But the cost to particular households will vary, depending on the size of the household and on the region of the country.

The Administration maintains that the tax will cost just under 1 percent of a familys bud get. But this figure obscures the fact that 90 percent of the average family expenditures are on basic go ods such as housing, clothing, and food. Spending on these items cannot easily be reduced. Only 10 percent of most families expenditures are luxury items, such as vaca tions or going to the movies. Thus, it turns out that the Btu tax will extract almost o n e-tenth of the typical household budget after the family pays for basic goods. Of course, those fami lies already unable to afford luxury items will be forced to cut down on basic purchases such as clothes 12 This provision, with its inherent problems of c alculation, will encourage trade retaliations 13 Shanahan, op. cit. Note that the cost per capita for family will probably decline with each additional family member since not all energy usages are proportionally increased with the addition of each family member. Also, note that many experts claim that the tax will only cost about $310 to $320 per household. The reason far the difference in the stated household cost is that those claiming the $320 cost are basing their figure on a household of 2.7 people ( t he national average while this paper bases its figure on a household of four to conform with the Department of the Treasurys cost presentation 6 Hurting the Poor rector of American Public Power Association, puts it this way: An energy tax is a Marie Antoi nette levy: its a piece of cake for the economic upper crust, but slices significant dough out of the pockets of daily breadwinners.

By choosing a Btu tax to raise revenue, the Administration surprisingly has chosen a re gressive tax. The Administration fr eely confesses to this, but insists that the poor will not be hurt by:the tax because.much ofthe revenue raised by the tax will be returned to the poor through an expansion of earned income tax credits (EITC food stamps, and energy assis tance payments In short, the Administration will increase the number of the welfare recipients and work ing poor by reducing their standard of living through indirect taxation. It will then return some of their lost disposable income in the form of welfare payments and oth er assistance.

Those working poor or retirees who are too proud to accept hand-outs or who do not qualify for the earned income tax credits, simply will be saddled with the tax Misleading Claim. Clinton claims that the taxes of those making under $30,000 p er year will be offset by these increased welfare programs. This claim is so misleading as to be false. One reason for this is that the White House definition of income differs widely from the ordinary definition of gross income reported by a family to th e IRS. For example, the White House includes in its def~tion of income such items as the rentable value of the home the family owns, and the value of employer-provided fringe benefits. Thus when Clin ton says the tax will affect only those making over 30,0 00, he means it will affect families that, according to the definition of income used by ordinary families and the IRS, make nearer to $20,000.

Perhaps more important, and contrary to Clintons assurances, millions of low-income families will be burdened by this tax. Over 40 percent of families earn less than $25,000.

Even if, in the aggregate, the government gives more assistance to this income group, and so offsets all the other amount this group pays in taxes, individual families will not fare as well.

Families that commute long distances to work or live in rural areas, for instance, will be es pecially hit hard by the Btu tax. The Btu tax will amount 10 to 12 cents per gall~n and when the 2.5 cents from Clintons gasoline tax extension is added, every g allon of gasoline will cost an additional 12.5 to 14.5 cents. Thus, high mileage families will pay a higher share of the tax.

Similarly, low-income families will differ in the amount of additional government assis tance they receive. Families already recei ving food stamps will not benefit much from an ex pansion in program eligibility because they will not receive more food stamps. Nor should they, since the program already is designed to ensure that each family eats nutritiously. Yet the tax will reduce t h eir real income. On the other hand, those newly eligible will see their income (cash plus in-kind benefits) increase The energy tax will be particularly burdensome to the poor Larry Hobart, Executive Di 14 The Clinton BtuTax hpsal, Cambridge Energy Resear ch Associates, February 19

93. The Administration assumes that the additional tax on gasoline will be only about 8 cents. This figure is rejected by Cambridge Energy Research Associates. Regardless of which fiw is correct, the argument outlined in the text holds 7 Those hit hardest of all will tend to be the high mileage working poor living in rural areas who must travel long distances to work but who already receive benefits or only narrowly miss eligibility. These families will experience much higher cos ts without offsetting welfare transfers In contrast, low mileage families newly eligible for benefits potentially will gain a windfall because their costs will not increase greatly, but their income will rise.

The real tragedy is that economic growth will be stifled. Since the poor are the most de pendent on growth, they will suffer the economic consequences of this tax the most HOW THE TAX WILL HURT SOME STATES DISPROPORTIONATELY The tax burden would vary across the country because of the differences in d e mographics climate, and state sizes. If enacted, the tax will range from just $60 per capita in New Hamp- shire to $280 per capita in Alaska, according to theTax Foundation. Other states in which citizens will be most heavily taxed include, in decreasing order of severity, Wyoming, Loui siana, Texas, North Dakota, West Virginia, Indiana, Oklahoma, Montana, and Kansas.

A corollary of this is that more populated states will bear a much larger portion of the en ergy tax burden. For instance, Texas and Califor nia, the most heavily taxed states, would pay the federal govemment $2.7 billion and $2 billion, respectively. In contrast, Washing ton, D.C and Vermont will pay only $47 million and $35 million, respectively. Other hard hit states include, in decreasing o rder, Ohio, New York, Pennsylvania, Illinois, Louisiana Florida, Michigan, and Indiana.16 TURNING ENVIRONMENTAL POLICY ON ITS HEAD Despite the Administrations assertions to the contrary, the tax also will be bad for the en vironment. The Administration co n tends that the tax will encourage energy conservation. In fact, it estimates that the nation will reduce energy usage by 1.9 percent ann~ally Ironi- cally, part of the attraction to the White House is that consumption would not fall very much, thus genera ting maximum tax revenue.

Energy conservation, however, is not always a benefit. As a general rule, the scarcity value of energy resources is already built into the market price of that good. This means that consumers have the incentive to avoid energy sources that are relatively s carce, and use sources that are relatively plentiful. But when government interferes with this market mea sure of the conservation worth of a resource, by applying a tax, it distorts the market In the process it can encourage fums to avoid more plentiful fuels and to over-consume scarcer resources in order to make the same g00ds.l~ The new mix of resources being consumed in 15 16 17 18 19 Proposed Energy Tax Hits States, Sectors Unevenly, Tax Foundation, April 22,1993.

Ibid The Energy Department admits that energy use will continue to grow in absolute tenns. The 1.9 percent figure refers to the percent of energy consumption that will not occur, given the tax, as compared to consumption levels in its absence.

For a good discussion of why government mandates cannot save resources, see John Shanahan, A Plain Mans Guide to Garbage: The Reauthorization of the Resource Conservation and Recovery Act, Heritage Foundation Issue Bufferin No. 172, March 30,1992, p. 19.

This comment holds true for any given level of o utput. Some of the increased resource usage will be raw resources. but some of the increased resource usage will be labor. But this does not mean that employment will increase because the 8 variably is more valuable than the energy saved or businesses wou ld have used that mix of resources in the first place.

The better argument for conservation of energy rests on the argument that certain fuels will reduce pollution. The externality pollution cost is not automatically built into the mar ket price of a fuel . But this argument fails unless there is a uniform reduction among all fuel sources, or unless the tax falls more heavily on the fuels causing more pollution. Under the Administrations proposal, however, reductions will not be uniform because of distorti o ns created by the tax For instance, the purchase of natural gas, which is a clean-burning source of energy, will be discouraged. In the co-generation market, in which waste energy can be used to produce electricity, renewable waste products such as wood c hips will gain market share from natu ral gas. Yet renewable fuels do not bum as cleanly as natural gas, and thus they pollute the air more.

Similarly, the tax will discourage potential markets in less-polluting gas heat pumps and natural gas vehicles. Per versely, it also will cause a loss of market share for natural gas in favor of electricity This is counterproductive from an environmental viewpoint, because using natural gas directly to generate heat is typically more energy efficient than using elec tr icity generated from natural gas.

Another damaging environmental result of this tax is that it will cause high-sulphur eastern coal to gain market share relative to low-sulphur western coal. Both utilities and in dustrial firms will be motivated to substit ute eastern for western coal. This is because the Btu tax will significantly increase the costs of transportation. Western coal, which is the nations cleanest, must be brought long distances to market. Since the Btu tax will apply to those transportation c osts, western coal will suffer a competitive disadvantage relative to the dirtier eastern coal.m CONCLUSION The energy tax on the heat content of fuels should be eliminated from the tax package be fore Congress. The package unfairly taxes some industries w hile exempting others. The tax will not raise the projected revenue, nor will it help the economy. It will hurt American fami lies, cost jobs, undermine U.S. competitiveness, and slow growth. Moreover, contrary to President Clintons assertions, it will hu rt the poor and the environment.

Specifically, the Btu tax will Cost500,OOOjobs Raise only 5 billion per year lO,OOO for every job lost Increase the trade deficit by penalizing domestic producers new mix of resources will by definition be less than optimum , thus, output will contract from its optimal state 20 See testimony of Philip Verlenger of the Institute of International Economics before the U.S. Senate Committee on Energy and Natural Resources, February 24,1993 9 .

Burden low-income families; in fact , they will bear a disproportionate share of the tax relative to their income Hurt the environment by discouraging use of cleaner fuels such as natural gas and low-sulphur western coal (relative to high-sulphur eastern coal Many lawmakers understand that the energy tax is bad deficit-reduction policy. They need to consider the tax's damaging effects on the economy, and on ordinary Americans when they debate theflawed measure John Shanahan Policy Analyst 10

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