The ideas that economists accept most widely are the ones the public most resists. I was reminded of this by recent calls from politicians for energy standards on items from autos to home ceiling fans. Such proposals rub economists’ noses in their failure to convince the public or policymakers of better alternatives.
Just as economists have failed to convince much of the public of the net benefits of international trade, they also have failed to convince people that targeted taxes are the cheapest way to deal with many pollution and conservation issues.
Whether they are Republicans or Democrats, whether from the Keynesian , Monetarist, Rational Expectations or Supply-Side schools of thought, economists overwhelmingly agree on energy issues. They know the remedy for situations where producing or using some product, such as oil or electricity, imposes costs on society that aren’t paid directly by either producers or consumers.
But they cannot sell the idea.
Take two news items: First, a group of conservative foreign policy experts headed by former Reagan adviser Robert McFarlane called for higher vehicle fuel efficiency standards and for subsidies for alternative fuels.
Second, some in Congress want to require energy-efficiency standards on ceiling fans similar to those on other appliances.
Economists across the political spectrum think both these initiatives are bad ideas. It is not that they are against energy efficiency, reducing energy use or developing alternative fuels. Their objection is about the best means of achieving a desired end. Efficiency standards and subsidies are a costly way of reducing energy use, pollution, and the foreign policy complications of importing large quantities of oil. There is a simpler and cheaper way to do this. It is taxing oil and other fossil fuels.
If producing or using some good — whether it be gasoline, electricity or baked beans — imposes costs on society beyond those borne by the producer or consumer, then society will use more of this product than is optimal. Reducing such use to some degree will make society better off. The best way to reduce such excessive use is to tax goods that involve these “external costs.”
Impose a tax per gallon, ton or kilowatt-hour, economists argue, equal to the external harm done to society by that unit. Facing appropriate incentives, people will reduce use to levels where the benefit to society from using one more unit is at least equal to the total cost — market price plus tax — of that unit.
The choice is between centralized and decentralized decision-making. The standards approach assumes Congress or Department of Energy and Environmental Protection Agency engineers can identify fuel standards that are optimal for everyone. The tax approach tells people: “Here is the true cost of this resource. You weigh all the alternatives that matter to you, and find the cheapest way to adjust.” The second approach is more effective.
Here are a few examples why: New fuel standards affect only new cars. It takes 10 to 12 years for the national fleet to turn over. The standards don’t motivate any changes for owners of existing vehicles. There is no incentive to drive less, carpool, take the bus or junk an old gas guzzler. In fact, the higher cost of new, more-efficient vehicles tells people to keep the old beasts rolling longer.
Fan efficiency standards similarly affect only new fans. Many fans are used even longer than cars, so it takes a long time for the new standards to affect many households. Households with existing fans have no incentive to buy the more efficient alternatives. And people who want to buy a fan for a spare bedroom that is hot in summer but is only used a few weeks of the year still have to buy a more expensive fan, even if the savings in electricity are minimal.
Research repeatedly shows that taxes providing incentives to households cause greater energy savings or pollution reductions at lower cost than any alternative. The problem is that the cost of a tax is very evident, while those of standards or subsidies to specific technologies are hidden. Politicians much prefer costs to be hidden.
Democrats have an excuse for supporting bad energy policies. They have a long economic control-freak tradition that scorns markets. Republicans should know better. Their current anti-tax-no-matter-how-much-it-hurts-the-country approach backs them into a corner.
They are unwilling to accept the truism that what you tax and how much you tax are two separate questions. Imposing taxes on energy does not necessarily mean increasing total tax revenues.
Republican economists, including Nobel winners like Milton Friedman, James Buchanan, Gary Becker and Robert Lucas oppose the standards approach, preferring market-based approaches like taxes. So do conservative think tanks like the American Enterprise and Cato Institutes. If only the Republicans in power listened to the sages in their party.
© 2005 Edward Lotterman
Chanarambie Consulting, Inc.