Enterprise, Energy, and Climate: A Conservative's Approach

I had the pleasure of meeting and hearing Bob Inglis, former SC Rep and Executive Director of the Energy & Enterprise Initiative the other day at a lecture he gave. He presented his 3 point plan, which by the way, made him popularly called the Al Gore of the Republican Party. An outline of the plan:

1. Change what we tax from current income to emissions. We want more income and less emissions...so why are we taxing income and not emissions.
2. Eliminate all subsidies for all fuels.
3. Attach all costs to all fuels. (Account for all externalities).

Most conservatives these days seem to be against any sort of carbon tax. So how does this fit into a conservative ideology?

Accountability: The energy sector is one in which profits are privatized but the costs are socialized. You might not view climate change as being real, however the health cost associated with pollution from the creation of energy are quantifiable. In economics this is called a negative externality (there are positive ones as well). And in order for resources and capital to be allocated most efficiently, all costs of production need to be included in the price consumers pay. So the typical way of dealing with this is levying a tax equal to the cost society at large is paying. Inglis says this should be a rattling issues amongst social issue conservatives.

Liberty. Changing to a consumption tax allows energy producers to choose their own tax rate which is a value near and dear to conservatives in favor of the flat sales tax approach.

Budget Neutral: This one for fiscal conservatives. A carbon tax would be coupled with a decrease in one of the income taxes. Inglis' choice is the payroll tax due to the progressivity problem of lowering income tax rates but he said he'd be for a deal either way. The problem with this is that conservatives will view it as simply another revenue stream for the government which will increase all taxes over time. Grover Norquist suggested he eliminate a tax entirely to get around this problem.

National Defense conservatives should be happy with it as lowering our dependence on foreign oil would make us safer. The military cost of protecting our supply lines of oil would also be included in those externalities mentioned above.

The tax would be increase every year up to a threshold to give a steady stream of revenue as production substitutes away from carbon intensive production. It would also be border adjustable (the tax would be removed on exports and imposed on imports).

The problem of course is that implicit in this is the acceptance that climate change is real...so conservatives will have to change their minds.

Another problem I see is that free market conservatives have a hard time accepting, or at least reconciling, the concept of the externality (and the need to correct for it) with free enterprise. Some may say this is just more government involvement. In my mind, however, you can't have real free enterprise without correcting for externalities. Not correcting for the externality is essentially a subsidy. In this case correcting for the externality creates a playing field that is fairer for both producer and consumer. Fairer for the producer in that we won't be subsidizing dirty energy. Fairer for the consumer in that as emissions go down, illnesses and premature deaths caused by pollution would decrease and the subsidization of those health care costs would decrease.

But as Inglis suggests, perhaps the greatest argument for placing a price on carbon is reasonable risk avoidance. Liability insurance companies hire actuaries. The actuaries listen to scientists...carefully. In many ways the federal government is just a large insurance company and it should do the same.

Bob Inglis, US Rep (R-SC4 1993-1999, 2005-2011) was voted out by a Tea Party candidate, targeted for his energy bill summarized above and his vote for the TARP program. He said if he had to do it again, he would still have voted for TARP.

Marginal Tax Rates and Unemployment

This is an interesting article by Joshua A. Cuevas from Counterpunch

                “Unemploymentand Marginal Tax Rates”

When the top marginal tax rates are compared to unemployment rates for the same year, one year later, two years later, and three years later, nearly identical results emerge. Not only is there a negative relationship in each case, with low tax rates correlating with high unemployment and vice versa, the magnitude of each relationship is nearly identical. So between 1948 and 2011, there appears to be a clear and consistent relationship between top marginal tax rates and the unemployment rate. And since unemployment rates cannot dictate tax rates, any influence must go in the opposite direction, with tax rates influencing the unemployment rates. Because we are dealing with correlations, there is a possibility that a third variable or more variables are also at play, particularly in a dynamic as complex as the U.S. economy. Indeed, it is almost a certainty that other factors are involved. But the unmistakable and highly uniform pattern revealed in the analyses reported here would lead us to believe that the relationship between top marginal tax rates and unemployment is in fact present, even if other factors are also involved.

What we can say with absolute confidence, though, is that there is no evidence here that low tax rates are associated with low unemployment, and by extension, a healthy economy. Similarly, there is no evidence that high tax rates are associated with high unemployment, and by proxy a weak economy. There is simply no empirical basis to make those claims based on this historical data. In fact, everything we see here suggests that just the opposite is true. Low marginal tax rates do not appear to be beneficial to employment rates, and if they are in fact detrimental to employment rates one would be hard pressed to make the case that they are helpful to the economy. In the most basic terms, a healthy economy is one in which the vast majority of citizens who want to work can find that work.

If one were to accept the common contention these days that we must wait until we again have a strong economy before we are able to collect the tax revenues needed to adequately fund public sector services, the data simply does not support that claim. These numbers tell a far different story. They instead suggest that while tax rates remain at historical lows we will continue to have a weak economy and high unemployment. There is no data to suggest that by keeping top marginal tax rates low it will improve the economy or decrease unemployment. For those who insist on low taxes at all costs, it would be worthwhile for them to look at the numbers and realize that pursuing low marginal tax rates, and gutting education and other social services in the process, is not the answer to a weak economy. It may be one of the causes of it, and certainly appears to be a prime factor in the equation. If we continue on the trajectory that we as a country have been on for more than 30 years of demanding lower and lower tax rates in the hopes that it will keep money in our pockets and food on the table, the data tells us we are more likely to have empty pockets and less on the table.

 

So let’s think about the intuition behind this. How could higher tax rates theoretically encourage employment? If tax rates are higher, the opportunity cost of hiring someone is smaller, and therefore, a higher top marginal tax rate may encourage hiring, not discourage it as popularly thought.

Let’s say a business person is deciding whether or not to hire someone or just do the work themselves. Hypothetically we will assume this business owner makes $300,000 per year. Let’s assume their tax rate is 25%.

If they pay someone $40,000/year the opportunity cost is salary - salary*tax rates = $30,000. This is what the employer would have netted after taxes had he not hired someone.

Now let’s assume tax rates are 40%. The opportunity cost then would be salary – salary*tax rates = $24,000, which is much lower than $30,000.

This is basically the same intuition behind IRA contributions rising when tax rates rise as well.

Two Good Posts

One from Economist's View:
'The Outlook Has Already Improved'

And another from Paul Krugman's NY Times blog:
"Against Willful Denseness, The Gods Themselves Content In Vain"

Appalachia - A History of Mountains and People

Just finished this video about a region near and dear to me. I highly recommend you rent it from your library. It does a great job of highlighting how the environment and economy are tied together. Environmental Sustainability = Economic Sustainability.

From Agee Films

 

Appalachia is a national treasure. It is a region stretching from New York to Alabama, comprising the oldest mountains in North America. It is home to the most ancient forest in the world and one of the greatest collections of mineral wealth on the planet. From the early sixteenth century when the region's name first entered the historical record, Appalachia has been a place of mystery and mythology. It has been romanticized, maligned, discovered, rediscovered, exploited, redefined, but only vaguely understood. In fact, more is known about Appalachia that is untrue than about any other region of the country.

APPALACHIA: A History of Mountains and People is the first film series ever to chronicle the riveting history of one of the oldest mountain ranges on earth and the diverse peoples who have inhabited them. Ten years in the making, this four-part series weaves the insights of both the sciences and the humanities into a spellbinding portrait of one of the world’s great ecological treasures.

The central characters of the series are the Appalachian Mountains themselves. The central theme is the story of how the mountains have shaped the people and how people have shaped the mountains — the dynamic interaction of natural history and human history.

 

Appalachia is unlike any other region in America. Nowhere else in America is the ancient history of the earth so openly revealed as in these mountains. And nowhere else in America is the story of man’s interaction with nature so dramatically evident.

At the same time, Appalachia is quintessentially American. Surrounded by half the population and two-thirds of the industry in the United States, Appalachia has experienced in full force the impact of humans on a mountain ecosystem. Here in Appalachia, the tensions between private ownership and public good have been played out over and over.

The story begins with the birth of the mountains during what the writer John McPhee has termed “Deep Time.” It chronicles the spectacular geologic upheavals which created an immense treasure of minerals carpeted by the richest temperate forest in the world. The story continues with those who came seeking the treasures of the land — from the first nomads ten thousand years ago to today’s hikers on the Applachian Trail.

 

APPALACHIA is the story of the Shawnee, the Iroquois and the Cherokee; the story of the first Spanish explorers and the early settlers: German, French, Scotch-Irish and African. APPALACHIA is the story of larger than life characters such as Daniel Boone, Attacullaculla, William Bartram, Mother Jones, and Thomas Wolfe. It is the story of the black bear, the white-tailed deer, the spotted salamander, and the American chestnut tree. It is also the story of mountaintop removal mining, the most destructive mining practice the world has ever known.

Above all, APPALACHIA provides a window onto the defining question of our age; how to use the land to provide the needs of today and at the same time preserve it for the future. The story of Appalachia is the story of our struggle as a people to find our true and proper relationship to the natural world.

Bye Bye Fishy Fish

Environmental Sustainability = Economic Sustainability

Tim Beardsley from the American Institute of Biological Sciences has some sobering stats on freshwater fish extinctions. This from Economist View:

North American freshwater fish diversity is in decline:

North American freshwater fishes race to extinction, EurekAlert: North American freshwater fishes are going extinct at an alarming rate compared with other species, according to an article in the September issue of BioScience. The rate of extinctions increased noticeably after 1950, although it has leveled off in the past decade. The number of extinct species has grown by 25 percent since 1989.

The article, by Noel M. Burkhead of the US Geological Survey, examines North American freshwater fish extinctions from the end of the 19th Century to 2010, when there were 1213 species in the continent, or about 9 percent of the Earth's freshwater fish diversity. At least 57 North American species and subspecies, and 3 unique populations, have gone extinct since 1898, about 3.2 percent of the total. Freshwater species generally are known to suffer higher rates of extinction than terrestrial vertebrates. ... Burkhead concludes that between 53 and 86 species of North American freshwater fishes are likely to have gone extinct by 2050, and that the rate of extinction is now at least 877 times the background extinction rate over geological time.

Enjoying What You Do: A Valuable Asset

Worker Satisfaction → Productivity → Living Standards

There is an old saying that time is the only truly limited resource in your life. Money can come and go, but time will only go. Therefore, it is of the utmost importance to spend your time doing what you want to do and who you want to spend it with. This can have very beneficial effects regarding personal finances but certainly has beneficial effects on the overall economy.

Regarding personal finances, there are two basic ways in which this can help. Loving what you do (or at least feeling good about it) will make you less inclined to stop working. Delaying retirement for a few years can be the difference between success and failure in a retirement plan. Gallup studied employee satisfaction and found that highly satisfied employees often exhibit above average levels of customer loyalty, productivity, employee retention, safety records, and profitability. Whether you are self employed or not, this is likely to translate into a higher level of career success and pay over the long haul. (There are bound to be exceptions of course. It would seem some careers that people love do not pay well and others people loathe pay very well.)

For the overall economy, highly satisfied employee groups are often 50% more productive and increase profitability by 33%.[1] Productivity (output per unit of input) is understood to be the most important determinant in the standard of living of a country. This is clearly a win-win.

It does highlight the importance of worker mobility. A more mobile worker can realize his or her own highest and best use faster. Many workers these days have impaired mobility due to job-lock or the inability to sell their house.

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[1] “Creating A Highly Engaged and Productive Workplace Culture,” The Gallup Organization. www.gallup.com

A Libertarian's Approach to Drug Legalization

Professor Jeffrey Miron of Harvard University recently spoke at the National Economists Club about drug legalization. I summarize his remarks below:

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All told, the United States spends $41 billion on drug prohibition every year. There are 1.6 million drug related arrests every year. And as the jails overflow and expenses mount, the US government is forgoing $47 billion in tax revenue every year. There are also multiple unquantifiable costs to prohibition such as the opportunity cost of allocating resources to enforce the law. Advocates argue that prohibition reduces use and crime. But is this really the case? Professor Jeffrey Miron of Harvard University argues that the costs of prohibition far outweigh the benefits. The solution…a laissez faire approach to legalization.

Miron concedes that prohibition does in fact lower demand modestly, but it does not eliminate the supply and demand for drugs. The expected penalty is rather low which has negligible effects on demand. Advocates also argue that prohibition makes production more expensive, driving up the price, decreasing consumption. Certainly producers have to keep operations on the down low. However, since the early 80s, prices are down 80%. Miron argues that if producers and dealers are involved in an illegal activity, they aren’t going to be paying income taxes, or abiding by child labor or minimum wage laws, etc. Therefore, a producer’s marginal costs are extremely low, relative to legal businesses.

For anyone who has seen an episode of Boardwalk Empire recently, the comparison between the War on Drugs and the prohibition of alcohol in the 1920s is an easy one. Looking at data on deaths from cirrhosis of the liver, Miron suggests consumption only decreased 20%. Meanwhile violence increased. Producers and dealers can’t settle their disputes by legal means so they resort to violence. The same goes for other prohibited activities such as prostitution and gambling. Quality control, the spread of HIV through dirty needles, corruption, and a litany of other issues arise when a black market is created.

Miron suggests there are four ways of looking at legalization. (1) Rational Drug Consumption: Without making judgments on drug use one could say that people gain utility out of it, otherwise they wouldn’t use drugs. In this respect prohibition is a utility cost, not a benefit. (2) Paternalism: If we decide to discourage drug use, a Pandora’s Box of government intervention is opened. One should be able to respectfully differ in their opinion of drugs. At any rate, alcohol is an easy substitute for drugs. (3) Externalities: Advocates of prohibition argue that negative externalities of drug use such as the effects on unborn children and the strain on the health care system are significant. Miron argues the magnitudes of these externalities are highly exaggerated, particularly when compared to alcohol. When a question about the effects on kids of having meth addicted parents was brought up, Miron suggested irresponsible parents will be irresponsible with or without access to drugs. The policy must balance costs and benefits. (4) Morality: Advocates of prohibition argue that drug use is immoral and has undesirable side effects. While this may be the case, Miron notes that many of the side effects of prohibition are also considered immoral; the increase in violence being the most notable. Surprisingly, Miron suggests prohibition creates a redistribution of wealth in the direction of producers and dealers due to the fact that income taxes are not being paid. With a little smirk, Miron suggested most people would not want to subsidize this type of activity…

Jeffrey Miron is a Senior Lecturer and Director of Undergraduate Studies in the Department of Economics at Harvard University, as well as a Senior Fellow at the Cato Institute. His field of expertise is the economics of libertarianism. He has advocated for many libertarian policies, including legalizing all drugs and allowing failing banks to go bankrupt. He has written four books including "Drug War Crimes: The Consequences of Prohibition" and "Libertarianism, from A to Z." He served as the chairman of the Department of Economics at Boston University from 1992 to 1998.

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It is my own personal opinion the the costs of prohibiting and incarcerating people for some drugs probably outways the benefits. However, I don't think a blanket laissez faire approach is appropriate. For instance: I don't think Meth has done anyone any favors. A drug by drug approach is probably best. It should be noted that I don't use drugs.

Savings, Interest Rates, and Money Illusion

It’s been well documented that the personal savings rate of Americans has dropped precipitously over the past few decades. The changes are shown in the chart below:

Macroeconomic theory suggests that this is related to the real interest rate (after inflation rates). A higher interest rate implies that the return on savings is higher, so that more future consumption goods can be obtained for a given sacrifice of current consumption goods.[1] Is this really the case? Is the savings rate related to real interest rates? I tested the relationship between savings and real interest rates from January 1959 to March 2012 to find out. I used the 10 Year Treasury real rate and found the correlation between the two to be 0.00. That implies that there is no relationship between real rates and savings rates.

There does, however, seem to be a stronger relationship between nominal rates and savings rates. When you take inflation out of the picture, the chart looks like this.

This implies that something called money illusion exists. Money illusion is when people mistake nominal changes for real changes. If your savings after taxes rise 2% and inflation is 2% you will think you are better off when in fact you are no better or worse off than before.

There are two main problems with this.

(1) If consumers were completely rational, they would take inflation into account when they make their consumption/savings decision. Obviously they are not completely rational as they take cues by nominal rates instead of real rates. This poses a problem for economic modeling. Should we not use nominal rates instead of real rates when modeling expected savings to get a more accurate result?

(2) When real interest rates go down savings needs to go up, not down. Consider someone facing retirement in 20 years. They want an income of $30,000 ($2,500/month) over 30 years in retirement. If their real rate of return is 5%, they will have to save up $465,704.04 in today’s dollars to make that happen.[2] They will need to save $1,940.43/month. However, if their real rate of return is 1% they will need to save up $777,267.67 in today’s dollars by retirement. That’s a monthly savings need of $2,926.89/month, a significant difference! Consider what you will need to save if the real rate of return is negative! The average American household would be hard-pressed to come up with the difference, particularly given the fact that most aren’t even saving for retirement.

To sum up: what actually happens and what needs to happen are at complete polar opposites. What actually happens is that when nominal interest rates go down, savings decreases. What needs to happen is that when REAL interest rates go down, savings needs to INCREASE.

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[1] Williamson, Stephen D. Macroeconomics. 4^th Ed. Pg 283.

[2] All projections in real terms, taxes not included, volatility not factored. Rates of return are assumed to be the same before and after retirement of illustrative purposes. I realize that retirement portfolios aren’t entirely in 10 Year Treasuries and the real rate actually experienced will differ. This was just for illustrative purposes.