Sunday, July 15, 2007

The T-word and the Pigou Club

There are few words in the English language that can engender equal rancor with that of the term “taxes,” and that, the T-word, has long been considered the equivalent of the “third rail of politics.” After all, colonial Americans initiated a political revolution based in part on resentment over British taxation without representation. Yet, therein lies the problem; representation requires politicians, and few politicians have the courage to suggest tax increases since it is a surer path to election or re-election to cut, not implement taxes.

Of course, most individuals (including myself) don’t mind taxes imposed on others. “When it comes to taxes” said Russell Long, the legendary Louisiana politician who was Chairman of the Senate Finance Committee as he described the difficulty in passing tax reform legislation: “Don’t tax me, don’t tax thee, tax the man behind the tree.” The only taxes the public might tolerate are those that are considered “sin” taxes (as long you are not the sinner). That applies to cigarettes, alcohol, gambling, prostitution, etc.

Then too, much depends on who is defining what sin is worthy of a tax. Some states seem to have wacky ideas that nevertheless provide much needed revenue. For example:

Tennessee and North Carolina instituted a tax for possession of illegal drugs. You must report the purchase and pay for a stamp that you paste on the illicit substance. Obviously, there are few takers, yet substantial revenue is derived from those caught with an illegal substance who are then forced to pay a sizeable tax. Utah applies a tax on businesses where “nude or partially nude individuals perform any service” — in essence a sex tax. Now that might be worthwhile. Most states with a professional sports team levy a tax on income earned by athletes, and entertainers. This is known as a “jock tax.” In other states there are taxes on playing cards, furs, fountain soda drinks, and amusement taxes on stadium seats prevail.

Is Gasoline Sinful?

Until recently, gasoline is one product on which everyone pays taxes, but this has not often been thought of as a sinful item. In fact, federal gasoline taxes are primarily paid into the Highway Trust Fund and the Mass Transit Account. Thus it is not a sin tax but it is essentially a “use” tax. The more recent view however, that gasoline is indeed a sinful commodity, is fast gaining momentum. After all, it would undoubtedly benefit the country if less gasoline and other fossil fuels were consumed. This is where a long forgotten economics professor has been resurrected and once again becomes relevant.

What’s a Pigou?

With an unlikely name, Arthur Cecil Pigou was a brilliant economist who taught at Cambridge University in England from 1908 to 1943. It was Pigou who essentially rationalized and defined the concept of the “sin tax.” He and the more famous John Maynard Keynes frequently clashed and criticized each other’s theories. Pigou believed economic analysis could be justified only if it brought social welfare into its scope. He is responsible for the concept that governments can, via a mixture of taxes and subsidies, correct failures that occurred in the market place — these failures were termed “negative externalities.”

He warned that prices determined by competitive markets might not reflect the full cost of making goods if some of those costs were not borne by producers. A typical example of this theory is the pricing of cigarettes. No one could argue the fact that the price of cigarettes does not reflect the true societal costs associated with smoking. A recent study found that when added to the cost of cigarettes at the retail level (including taxes), the excess cost of health, life and property insurance; medical costs, drug, hospital and rehabilitation costs; and lost earnings, increase the true cost of a pack of cigarettes to an astounding $39.88. Ironically, the true cost would be even higher except for the fact that because smokers tend to die at a younger age, they don’t benefit from Social Security or Medicare. Obviously, taxes that are now levied on cigarettes are nowhere near high enough to compensate for the detrimental economic and social effects.

Unfortunately, the same argument can be made for the price of gasoline. In a study titled, “The Hidden Costs of Oil,” as reported to the Senate Foreign Relations Committee, the external or “hidden costs” of oil imports were calculated. The results clearly indicate that regardless of the pump price of gasoline, that price is only a fraction of the real cost to the domestic economy.

The True Cost of Gasoline

Here again the numbers are more than troubling. The Senate Committee was told that the total “import premium” or “hidden cost” for oil in 2006 was $825 billion. That adds $5.04 to the real price of a gallon of gas. For Persian Gulf imports, the premium would be $8.35. As mentioned above, since current federal gasoline taxes are by law required to go directly into the Federal Highway Trust Fund, used to build and maintain the federal highway system, there has been no effort (yet) to apply what is termed a Pigouvian Tax to correct this significant shortfall. Amazingly, the current federal gas tax is a measly 18.4 cents a gallon, and the last time it was increased was 14 years ago. Even when local and state taxes are added, the average tax is only some 50 cents a gallon. Remember too, this degree of taxation was applied when gas prices were in the one dollar a gallon range. Not so incidentally, gasoline taxes in the largest of the European countries are all in the four dollar range — that’s why the vast majority of Europeans drive small, fuel efficient vehicles — cause and effect? You betcha!

As indicated earlier, nobody likes taxes, and for politicians the subject is radioactive. This is especially true of Republican politicians who have never met a tax cut they didn’t like, so any tax to them is anathema. That’s why traditional Republican orthodoxy has been upset by a large group of highly respected economists, many of them staunch Republicans, who have strongly endorsed the implementation of a Pigouvian tax on gasoline.

Republicans For a Gas Tax — Remarkable

The group leader, and self-appointed president of what he calls the “Pigou Club,” is none other than George W. Bush’s former head of the Council of Economic Advisors, N. Gregory Mankiw, professor of economics at Harvard University. Professor Mankiw’s prescience relating to the subject can be established by the fact that seven years ago, in an article in Fortune magazine, he strongly urged the imposition of a gasoline tax to lessen consumption, force the manufacture of more fuel efficient vehicles, lower carbon dioxide emissions and help the country limit the importation of foreign oil. That article went unnoticed and largely forgotten — until…

Last October, in an article on the editorial page of The Wall Street Journal, he repeated that same recommendation under the title. “Raise the Gas Tax,” but this time other economists (including many fellow Republicans, as well as Democrats) joined the cause. He suggested increasing the gasoline tax by $1 a gallon over a ten-year period. This would eventually provide over $100 billion dollars in tax revenues that will help offset what he terms is “a federal budget that is on an unsustainable course.”

Most interesting (and impressive) are the reputations and credentials of those who are considered members of Professor Mankiw’s Pigou Club, all as advocates of a gasoline tax. The most famous is Alan Greenspan, the recently retired head of the Federal Reserve. However, the most influential (amongst those in the know) is Martin Feldstein, currently, a Harvard professor who is considered the intellectual godfather of a generation of Republican economists. He has also laid out a plan for reduced usage of gasoline in a Wall Street Journal editorial.

Other famed economist members include, Lawrence Summers, former Secretary of the Treasury; Paul Volcker, Alan Greenspan’s predecessor at the Federal Reserve; two Nobel Prize Laureates, Gary Becker and Joseph Stiglitz; Kenneth Rogoff, former chief economist at the International Monetary Fund, currently at Harvard as a professor; Robert Frank, professor at Cornell; plus many other university professors including Hal Varian, Paul Krugman, Nouriel Roubini, Robert Stavins, and William Nordhaus.

In addition however, there are other luminaries who agree that a gas tax is desirable including George Schultz, former Secretary of State; Al Gore (you remember him); and several well known journalists including Thomas Friedman, Greg Easterbrook, Joe Klein, Charles Krauthammer and others from such conservative publications such as Forbes, The Wall Street Journal, The Financial Times, and Business Week.

Andrew Samwick, former chief economist on the Council of Economic Advisors and currently a professor at Dartmouth has said, “If you are concerned about the external consequences of imported oil, then you should raise the cost of it,” a position that more and more free market economists are embracing. It is recognized that a gasoline tax is regressive and would unfairly impact low-income workers. Writing in the New York Times, Professor Frank (mentioned above) suggested an additional $2 a gallon tax, with “all revenue going into a common pool, which would be returned on an approximately equal per capita basis by reducing payroll taxes.” He provided solutions to shortcomings in that plan related to compensating retirees, businesses and automakers. He also cites a recent New York Times/CBS News poll showing 55 percent of Americans would be willing to support a higher gasoline tax if it reduced dependence on foreign oil.

That poll raises questions about the trepidation of politicians relating to the imposition of a tax (no matter how sensible). Professor Mankiw writes in his Wall Street Journal editorial, “Is it conceivable that the policy wonks will ever win the battle with the campaign consultants? I think it is. Even after a $1 hike, the U.S. gas tax would still be less than half the level in, say, Great Britain, which last I checked is still a democracy. [Gas prices in Britain are approaching $7.00 a gallon.] But don’t expect those vying for office to come around until the American people recognize that while higher gas taxes are unattractive, the alternatives are worse.” Now, how can we get our politicians to come around to that view?


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