Fred Foldvary's Editorial
How Not to Tax Oil
In the November 2006 election in California, a proposition would have levied a tax on oil production and prohibited companies from passing on the tax to the buyers. This proposition was numbered 87 in the multi-election series of measures proposed to the voters. If passed, the revenues would have subsidized research and enterprise on alternative energy source such as wind and sunlight. Voters defeated this tax 55 to 45 percent.
by Fred E. Foldvary, Senior Editor
What is special about oil, that it should be singled out for a tax? Oil in the ground is a natural resource, a type of land. The market value of the oil, after subtracting out the normal costs of exploration and production, is an economic rent, a surplus that can be tapped for public revenue just like other types of land rent. Tapping this economic profit does not hurt enterprise, production, and investment, and does not change the price or quantity of production. That is the nature of a surplus, which is in effect a "free lunch."
Yes, contrary to the popular saying that there ain't no free lunch, there really are free meals in the economy, various kinds of "surplus." There is a surplus to consumers when they buy stuff at lower prices than the most they would pay. There exists a surplus in production, the price minus the costs of producing that extra amount of stuff. Most of this surplus is land rent, so it should be called the "non-producer surplus," as the title holders did not produce this land. But economists don't want this to appear too obvious, so they turn it around 180 degrees and gleefully call it a "producer surplus." Some naive graduate economic students don't understand the joke, so they really do believe it is a surplus that goes to the actual producers.
So, the extraction of oil, natural gas, coal, and other earthy organics, has a surplus, a rent that can be tapped for public revenue without hurting production. But to have a neutral effect, the revenue tap has to be done right. The ideal way to tap the oil revenue surplus is to first estimate the average cost of production, including the normal exploration costs and returns to investors. Then subtract the average cost per barrel of oil from the price of oil, and voila, that is the surplus. Tap about 80 percent of the surplus for public revenue, leaving some with the firm as a margin of error. For an oil field that has not yet been exploited, drilling costs are too uncertain to measure in advance, so some of the surplus can be tapped in advance by bidding for leases.
The revenue tap on the rental value of material natural resources is like a lump-sum levy. The tapping of the surplus from natural resources does not affect the marginal costs and revenues, the extra cost of producing more, or the extra revenue from selling more. It cannot be passed on to buyers and users. The tap has no deadweight loss or excess burden.
Therefore the provision in Proposition 87 that the oil tax not be passed on to consumers was both unnecessary and difficult to enforce. California oil sells at the global market price plus transportation costs. An oil tax cannot be passed on, because California producers are unable to sell oil above the world market price. If the market price of oil rose, some critics would have accused the California producers of passing on the tax, which would have led to litigation. The surplus would have been shifted to high-priced attorneys.
Both sides lied to the public in the Proposition 87 campaign. The pro side lied when it said that the firms would not be allowed to pass on the tax, misleadingly implying that without this provision, the firms would have passed it on. The anti 87 side lied when it said that the proposition would make oil more expensive.
Another bad aspect of Proposition 87 was that the tax revenues would have gone to subsidize alternative energy. The subsidy very likely would have been wasted, spent on bureaucracy and failing projects. The proposition presumed that some government officials have the incentive and the wisdom to know which types of energy and which research organizations and enterprises would be able to use the funds to best promote alternatives to oil. But in reality, this knowledge is not available and impossible to obtain. Only by market dynamics can we discover which energy resources are most efficient. Moreover, a subsidy implies that the resource is not cost effective, otherwise the market would use it with no subsidy.
The pro side had TV ads showing former president Clinton claiming that Proposition 87 would make California "energy independent." Evidently Californians are not as naive as the ads assumed, since they knew enough to realize that the subsidy would at best only add a small amount to alternative energy from wind, sunlight, ocean tides, and hot air from politicians. I have no data on this, but my guess is that the Clinton ads were counter-productive, as those who disliked the Clinton administration would react by voting against 87 as it became linked to the former President and his Waco disaster and war on Yugoslavia, let alone the scandals.
One can also question why energy independence should be desirable any more than food independence or banking independence. We live in a global economy. Energy independence for California makes no more sense than banana independence or shoe independence.
If the advocates were serious about tapping the oil surplus for public revenue, they would have drafted a simple green tax shift. They could have used the oil revenue to offset a reduction in the state sales tax by two percent. There would be no subsidy to windbags and sun worshipers, and no ridiculous attempts at price controls. That measure would have passed easily. Evidently the real aim of Proposition 87 was to finance boondoggles rather than an efficiency tax shift to tap a surplus and reduce the deadweight loss of taxing sales or wages.
The worst part of 87 is that it has tainted the concept of an efficiency tax shift, of tapping the rent of material as well as spatial land while reducing punitive taxes. The job of promoting free-market environmentalism as well as beneficial tax reforms has now gotten that much harder in California and the rest of the USA.
Green Tax Shifting
Foldvary on Efficiency Taxes
What's the Market Value of Polluting Your Atmosphere?
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