I believe we need more bipartisanship in Congress, so in principle, I was pleased that Democrats Tim Walz and Colin Peterson joined Republican John Kline in supporting measures that would promote offshore drilling for oil. History shows we can get needed oil offshore. It also shows that considerable environmental damage can occur if sufficient safeguards are not taken. So I am not opposed to greater drilling, offshore or on land and under the right conditions.
I bridle, however, when anyone claims that increased drilling in the United States will both secure “energy independence” and lower prices for consumers. That is patently impossible.
To his credit, Walz openly repudiates that claim. Kline champions it. Peterson is largely silent. All three, however, should study up on the economics of markets for all fungible commodities that are internationally traded.
That is because markets for agricultural commodities like corn, wheat and soybeans are very similar to that for crude oil. Moreover, the question of whether we should encourage more drilling is close to the questions of whether to end special tax breaks enjoyed by the oil industry or crop subsidies to farmers.
A “fungible commodity” is a uniform or unbranded one for which any unit, like a bushel of wheat or barrel of oil, is indistinguishable from any other. Crude oil, refined petroleum products and the major crops are all fungible commodities.
All of these are traded internationally in complex and efficient markets, although not entirely insulated from manipulation.
When you have such products in such markets, it is impossible to contain the effects of government efforts to foster or retard production within the geographic jurisdiction of that government.
That is a complicated way of saying that if you increase oil production off U.S. shores, there is no way to reserve the effects of the resulting price decrease to U.S. consumers or businesses. To the extent that the increase in output marginally increases global supply, global oil prices will drop. Thus so will U.S. domestic prices, but not much more than world prices. Yes, there are some effects of changes in “basis” or geographic differences in product prices due to transportation costs, but those are minor.
The same is true with repealing the effective government subsidy embodied in special tax treatment for oil companies like “percentage depletion.” This tax rule allows oil companies to overstate the effect of the decline in value of the oil deposits they own or lease when computing taxable profits. (By way of disclosure, I benefitted from percentage depletion on income from gravel I sold from our farm in 1980 and 1993.)
Like any other subsidy, this tax subsidy increases incentives to produce in the United States and so, at least very marginally, decreases prices. But the decrease in price does not accrue only to U.S. consumers. It is dissipated to the rest of the world.
South Dakota congressman John Thune was correct when he spoke for Republicans in arguing that repealing this tax break for oil companies won’t lower gasoline prices to consumers. But it would remove an egregious government intervention in free markets that misallocates resources and makes society as a whole poorer than it would be otherwise. That is an action Republicans claim to favor.
Though some see government subsidies delivered via tax breaks as somehow morally different from subsidies delivered by writing checks, economists are united in scoffing at this, and the more conservative economists are generally the greater their scorn. So to economists, a special tax break for oil works out in almost exactly the same way as a direct subsidy to a crop producer.
Crop subsidies also are government interventions in markets that induce the waste of resources just like tax breaks for oil companies. To the extent they increase output, they similarly decrease prices, at least marginally. But that decrease accrues to the whole world and not just to U.S. households. To the extent that they don’t even increase output, they are just a “job-killing” source of increased inefficiency in the U.S. economy as well as an unjust transfer of income from poorer to richer.
Our economy would be more efficient if we abolished special tax breaks for oil and crop subsidies for farmers. This would reduce annual deficits by $2 billion to $3 billion for oil and $15 billion to $20 billion for agriculture. Both ought to be axed, but both are drops in the overall budgetary bucket.
To the extent that easier permits for offshore drilling increase environmental damage, they also are an implicit subsidy to producers, not at the cost of taxpayers, but rather at the cost of those who suffer from the pollution.
Domestic subsidies for fungible commodities traded in international markets are dissipated globally, period. There is no magic that will somehow confine the benefits of such subsidies to domestic consumers. That is about as close to a law as one gets in economics. Politicians who claim to favor an efficient, productive economy should learn this lesson.
© 2011 Edward Lotterman
Chanarambie Consulting, Inc.