Tag Archives: Lawrence Summers

Markets Deal With Scarcity, Left Screams “Price Gouging”

11 Monday Apr 2022

Posted by in Antitrust, Environmental Fascism, Oil Prices

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Democrats claim profiteering by oil companies is responsible for the sustained rise in oil prices since Joe Biden’s inauguration (really, his election). That’s among the more laughable attempts at gaslighting in recent memory, right up there with blaming market concentration for the sustained increase in inflation since Biden’s inauguration. At a hearing this week, congressional Democrats, frightened by the prospect of a beat-down just ahead in the mid-term elections, couldn’t resist making “price-gouging” accusations against oil producers. These pols stumble over their own contradictory talking points, insisting on more oil production only when they aren’t hastily sabotaging oil and gas output. Their dishonestly is galling, but so is the foolishness of voters who blindly accept the economic illiteracy issuing from that side of the aisle.

Break It Then Blame It

Those who level “price gouging” charges at oil companies are often the same people seeking to eliminate fossil fuel consumption by making those energy choices unaffordable. The latter is a bad look this close to mid-term elections, so they follow the playbook I described recently in “Break the Market, Blame It, Then Break It Some More“. And this post is instructive: “House Dem: Big Oil is profiteering by, er … doing what we demanded”.

Not only have the Democrats’ policies caused oil prices to soar; for many years they’ve been undermining the stability of the power grid via forced conversion into intermittent renewable energy sources like wind and solar, all while preventing the expansion of safe and carbon-free nuclear power generation. It’s ironic that these would-be industrial planners seem so eager to botch the job, though failure is all too typical of central planning. Just ask the Germans about their own hapless efforts at energy planning.

As economist Lawrence Summers, former Treasury Secretary under Barack Obama, said recently:

“Look, the net effect of the things the administration talks about in terms of micro policies to reduce inflation, this gouging talk is frivolous, nonserious, and utterly ineffectual. A gas price holiday would, ultimately, push up prices by raising demand. … The student loan relief … is injecting resources into the economy at a hundred billion dollar a year annual rate when the economy needs to be cooled off, not heated up. … The administration could be much more constructive than it has been with respect to energy supply.”

The market functions to allocate scarce resources. When conditions of scarcity become more acute, the market mechanism responds by pricing available supplies to both curtail use and incentivize delivery of additional quantities. That involves the processing of vast amounts of information, and it is a balancing at which the market performs extremely well relative to bumbling politicians and central planners, whose actions are too often at the root of acute scarcities.

Antitrust Nonsense

Of course, the Democrats have seized upon the inescapable fact that soaring oil prices cause profits to soar for anyone producing oil or holding stocks of oil. But oil company profits are notoriously volatile. Margins were negative for most of 2020, when demand weakened in the initial stages of the pandemic. And now, some companies are bracing for massive write-downs on abandoned drilling projects in Russia. The oil and gas business is certainly not known for high profit margins. Short-term profits, while they last, must be used to meet the physical or financial needs of the business.

The threats of antitrust action by the Biden Administration are an extension of the price-gouging narrative, even if the threat reflects an injudicious grasp of what it takes to prove collusion. It takes a fertile imagination to think western oil companies could successfully collude on pricing in a market dominated by the following players:

Fat chance. In any case, it’s a global market, and it’s impossible for western oil producers to dictate pricing. Even the OPEC cartel has been unable to dictate prices, not to mention keeping it’s members from violating production quotas. But if a successful conspiracy among oil companies to raise prices was possible, one would guess they’d have done it a lot sooner!

Nor is it possible for the oil majors to dictate prices at the pump, because retail prices are set independently. While the cost of crude oil is only about 54% of the cost of refined gas at retail, fluctuations in prices at the pump correlate strongly with crude oil prices. Here is a ten-year chart of daily price data, where the blue line is the price of West Texas Intermediate crude oil and the orange line is the average price of regular gas in the U.S.:

Here are the same two series for 2022 year-to-date:

Coerced Scarcity

Again, oil prices have been under upward pressure for over a year until a break in early March, following the steep run-up in the immediate wake of the Ukraine invasion. First there was Biden’s stultifying rhetoric, before and after the 2020 election, assisted by radical members of Congress. Then there were executive orders halting drilling on federal lands, killing the Keystone pipeline, efforts to shut down several other existing pipelines, and the imposition of regulatory penalties on drillers. In addition, unrest in certain parts of the Middle East curtailed production, compounded this year by the boycott on Russian oil (which, as a foreign policy matter, was far too late in coming).

However, existing facilities have been capable of squeezing out more oil and gas. Lo and behold, supply curves slope upward, even in the short-run! Despite all of Biden’s efforts to cripple domestic oil production, higher crude prices have brought forth some additional supplies. Biden’s raid on the Strategic Petroleum Reserve has also boosted supply for now, but its magnitude won’t help much, and it must be replaced for use during real U.S. national emergencies, which the war in Ukraine is not, as awful as it is.

That said, investing in new drilling capacity is not wise given the political climate created by Biden and the Democrats: they have been quite clear that they mean to crush the fossil fuel industry. For some time, the oil companies have been busy investing cash flows in “green” initiatives in an effort to bolster their ESG scores, a dubious exercise to say the least. Arguably, in this policy environment, the most responsible thing to do is to return some of the capital over which these firms are stewards to its rightful owners, many of whom are middle-class savers who hold oil stocks in their 401(k) funds. That approach is manifest in the recent stock buybacks and dividend payments oil companies have announced and defended before Congress.

Conclusion

A forced shutdown of fossil fuel energy was much ballyhooed by the Left as a part of Joe Biden’s agenda. Biden himself bought into the “Green New Deal”, imagining it might win him a vaunted place alongside FDR’s legacy in American history. The effort was unwise, but Biden is trying to hang onto the narrative and maintain his punitive measures against American oil companies. All the while, he begs OPEC producers to step up production, bending a knee to despots in countries such as Iran and Venezuela. Why, it’s as if their fossil fuels are somehow cleaner than those extracted in the U.S! The feeble Biden and congressional Democrats are proving just how mendacious they are. They can rightfully blame Vladimir Putin for the recent escalation in oil prices, but they bear much responsibility themselves for the burden of high gas prices, energy bills, and the unnecessary, ongoing scarcity victimizing the American public.

Labor Shares the Burden of the Corporate Income Tax

03 Friday Nov 2017

Posted by in Taxes

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As expected, a reduction of the corporate income tax rate from 35% to 20% is included in the GOP’s tax reform bill, a summary of which was released today. That rate cut would be a welcome development for workers, consumers, and corporate shareholders. It should be no surprise that the burden of the U.S. corporate income tax is not borne exclusively by owners of capital. In fact, it might hurt workers and consumers substantially while imposing relatively little burden on shareholders.

John Cochrane’s post on the incidence of the tax on corporate income is very interesting, though by turns it rambles and may be too technical for some tastes. He notes that the incidence of the corporate tax can fall on only three different groups: shareholders, workers and customers:

“As an accounting matter, every cent [of taxes] corporations pay comes from higher prices, lower wages, or lower payments to shareholders. The only question is which one.“

Cochrane quotes Lawrence Summers and Paul Krugman, both of whom are of the belief that the incidence of the corporate tax must fall primarily on capital and not on labor. That’s consistent with their view that a reduction in corporate taxes amounts to a gift to shareholders. But Cochrane isn’t at all convinced:

“The usual principle is that he or she bears the burden who can’t get out of the way. So, how much room do companies, as a whole, have to raise prices, lower wages, lower interest payments, or lower dividends?”

In fact, owners of capital can get out of the way. Capital is very mobile relative to labor. Here’s a counterfactual exercise Cochrane steps through in order to illustrate the implications of ownership bearing the incidence of the tax: if equity markets are efficient, share prices reflect all available information about the firm. If wages and product prices are unchanged after the imposition of the tax, then shareholders would suffer an immediate loss. Once the tax is discounted into share prices, there would be no further impact on current or future shareholders. Thus, future buyers of shares would escape the tax burden entirely. As a first approximation, the share price must fall to the point at which the ongoing return on the stock is restored to its value prior to imposition of the tax.

Cochrane notes that evidence on the reaction of stock prices to corporate tax changes is mixed at best, which implies that the incidence of corporate taxation falls more weakly on shareholders than many believe. That leaves consumers or workers to bear a significant part of the burden. Workers and consumers are mostly one and the same: economy-wide, higher prices mean lower real wages; lower wages also mean lower real wages. So I’ll continue to speak as if the incidence of the tax falls on either labor or capital, and we can leave aside consumers as a separate category. Cochrane says:

“It used to be thought that it was easy to lower payments to shareholders — ‘the supply of savings is inelastic’ — so that’s where the tax would come from. The newer consensus is that companies as a whole have very little power to pay less to investors, … so the corporate tax comes from lower wages or, equivalently, higher prices. Then, indirectly, reducing the corporate tax would increase capital, which would result in higher wages.”

Cochrane’s post and another on his blog were prompted by an earlier piece by Greg Mankiw showing that real wages, in an open economy, will have a strong negative response to a corporate tax increase. Here is the reasoning: the tax reduces the return earned from invested capital in the short run. Ideally, capital is deployed only up to the point at which its return no longer exceeds the opportunity cost needed to attract it. Given time to adjust, less capital must be deployed after the imposition of the tax in order to force the return on a marginal unit of capital back up to the given opportunity cost. That means less capital deployed per worker, and that, in turn, reduces labor productivity and wages.

Another issue addressed by Cochrane has to do with assertions that monopoly power in the corporate sector is a good rationale for a high tax on corporate income. You can easily convince me that the “average” firm in the corporate sector earns a positive margin over marginal cost. However, a microeconomic analysis of monopoly behavior by the entire corporate sector would be awkward, to say the least. Despite all that, Cochrane notes that monopolists have more power than firms in competitive sectors to raise prices, and monopsonists have more power to reduce wages. Therefore, the “tax the monopolists” line of argument does not suggest that labor will avoid a significant burden of a corporate tax. A safer bet is that firms in the U.S. corporate sector are price-takers in capital markets, but to some degree may be price-makers in product and labor markets.

Cochrane also emphasizes the inefficiency of the corporate tax as a redistributional mechanism, even if shareholders bear a significant share of its burden. It is still likely to harm workers via lost productivity, as discussed above. It is also true that many workers hold corporate equities in their retirement funds, so a corporate tax harms them directly in their dual role as owners of capital.

The cut in the corporate tax rate is but one element of many in the GOP bill, but a related provision is that so-called “pass-through” income, of the type earned via many privately-owned businesses, would be taxed at a maximum rate of 25%. These businesses generate more income than C-corporations. Currently, pass-through income is taxed as ordinary income, so capping the top rate at 25% represents a very large tax cut. As Alex Tabarrok points out at the last link, tax treatment should be neutral with respect to the form of business organization, but under the GOP bill, the effective gap between the top rate for pass-throughs versus corporate income would be even larger than it is now.

Critics of a reduction in corporate taxes should bear in mind that its incidence falls at least partly on labor, perhaps mainly on labor. The U.S. has the highest corporate tax rate in the industrialized world. That undermines U.S. competitiveness, as does the complexity of corporate tax rules. Tax planning and compliance burn up massive resources while drastically reducing the tax “take”, i.e., the revenue actually collected. The corporate income tax is something of a “show” tax that exists to appease populist and leftist elements in the electorate who consistently fail to recognize the unexpectedly nasty consequences of their own advocacy.

 

Trump Budget Facts and Falsehoods

02 Friday Jun 2017

Posted by in Federal Budget, Government, Trump Administration

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The innumerate left is unhappy over cuts in various categories of spending in the budget proposal submitted by the Trump Administration last week. However, they have adopted “talking points” that are incorrect in an effort to rail against the budget. There is no reduction in overall spending in the proposal. Instead, there is a reduction in the growth of total spending. Ryan McMaken calls the mistaken assertions about spending “the media version of ‘cuts’“. The budget plan calls for an increase in total spending of 41% ($1.7 trillion) by 2027, versus 63% ($2.6 trillion) under the baseline (based on current law). Many of the actual cuts and growth reductions are in so-called discretionary spending. However, in one key mandatory component, Medicaid, spending increases by 39% under the plan, or $146 billion, versus 82% under the baseline. That is not a spending cut.

Another issue over which the Trump budget has been attacked is the so-called “math error,” or “double counting” of economic growth, to which former Treasury Secretary Lawrence Summers alluded with apparent delight. The gist of it is that the proposal somehow double-counted the salutary effects of growth in eliminating the projected deficit over the next ten years. In other words, the tax cuts proposed by Trump would be not just revenue-neutral due to stronger growth; they would result in an increase in tax revenue sufficient to eliminate the deficit by 2027.

Thus far, the Trump tax reform plan has been revealed in only a one-page summary released in late April. In static terms, it implied a loss of revenue of $5 trillion over ten years, though the summary left many features unclear. There could be additional provisions to broaden the tax base that might bring the ten-year static revenue loss down to somewhere between $3 and $4 trillion. In dynamic terms, however, the impact of the tax cuts would be smaller. The cuts would stimulate the economy (yes, they would!), but the precise impact on growth is unknown. In the budget, economic growth is assumed to increase from 1.8% to 3.0% annually over most of the ten year period. That has been criticized as unrealistic, but such a boost would likely be enough to make the tax cuts revenue neutral.

Here is a summary of the budget from the Office of Management and Budget (OMB). The tables at the back of the document, on pages 27 and 29, provide enough information on the cumulative ten-year changes to evaluate Summers’ double-counting claim. Keep in mind that his claim applies to changes expressed relative to a baseline. The proposed budget shows a total ten-year deficit projection of $3.2 trillion, compared to baseline of $6.7 trillion. So the deficits are reduced by a total of $3.5 trillion over the full ten years.

Individual and corporate income tax receipts are virtually unchanged over the ten-year period. There’s our revenue neutrality. Other receipts are down by $0.9 trillion, however. Most of that decline is attributed to a $1 trillion “allowance for repeal and replacement of Obamacare”, presumably elimination of taxes on such things as medical devices, Cadillac insurance policies, and fines for failing to comply with insurance mandates. So increased tax revenues do not account for the decline in the budget deficit.

Total cumulative outlays are reduced by $4.6 trillion in the budget proposal relative to the baseline. That more than accounts for the ten-year deficit reduction. Like the policies or not, the decline in spending is sufficient, relative to the baseline, to fully explain the deficit reduction. Yes, the budget assumes that some of the spending reductions are afforded by the faster assumed rate of economic growth, such as welfare payments, but that is not double-counting.

Revenue neutrality of the tax cuts is certainly an assumption worth questioning, especially because the summary of the tax plan gave every impression of abandoning neutrality. Neutrality was probably imposed on the budget plan as a matter of convenience. In a sense, it made the job of presenting the Administration’s spending priorities (like them or not) a cleaner exercise. For another, while budget reconciliation rules do not require the tax plan to be revenue neutral, Senate leaders have stated their strong desire for neutrality. The Trump budget proposal thereby allows Congress’ budget process to get underway while deferring the introduction of a more detailed and potentially controversial tax plan, one that is obviously still in flux and is likely to involve a loss of revenue, even in a dynamic sense.

The assumed change in economic growth is not solely attributable to tax effects, however. It would be reasonable to expect some growth to be driven by deregulation and the “deconstruction of the administrative state“, as Steve Bannon described so eloquently. This intention is embodied in the budget proposal. In that sense, it was unnecessary for OMB to impose revenue neutrality of the tax plan to eliminate the budget deficit over ten years. The economic growth spurred by deregulation would generate some of the extra growth in tax revenue.

I happen to like many of the priorities expressed in the proposed budget, despite the document’s lack of specificity. This includes the deregulatory initiatives, Obamacare repeal and replacement (we’re waiting…), and some of the welfare reform proposals. I am not happy about the scale of the shift toward defense, and I am not happy that government continues to grow in the aggregate. And as for the still-incubating tax reform plan, I like many of the features originally described, though not all.

Many believe that the Administration’s economic growth assumptions are unrealistic, and many dislike the spending priorities. Those cannot be used as excuses for mischaracterizing the proposal, however. Reductions in some spending categories occur only relative to the baseline growth path. They are not real cuts in spending. Likewise, Summers’ double-counting allegation is false. The recovery of tax revenue via economic growth is not double counted, and there is no “math error”. The proposed reductions in spending relative to the baseline more than account for the deficit reduction. I suspect that Summers’ motives were strictly polemic and not grounded in a careful examination of the budget proposal. He is not innumerate. What’s worse, a number of economists swallowed the “double-counting” story hook, line, and sinker.

Private Incentives and Infrastructure

10 Tuesday Jan 2017

Posted by in infrastructure, Markets

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motorway-to-hell

 

 

 

 

 

 

 

Material infrastructure is fixed plant and equipment providing services considered basic to the functioning of society. That definition leaves plenty of room for interpretation, however. For example, it does not limit the meaning of “infrastructure” to facilities necessary for the provision of “public goods”, for which benefits are non-exclusive. And it encompasses facilities used by firms in certain competitive markets, such as some forms of telecommunication. The character of infrastructure tends to change over time, as new technologies lead to changes in our way of life (e.g., the cellular network). That’s even more evident when infrastructure is defined more broadly, as Walter Buhr does in “What Is Infrastructure?” His definition of material infrastructure encompasses all facilities enabling “the activation or mobilization of the economic agents’ potentialities.”

Infrastructure ≠ Government

There is a popular fallacy that infrastructure is the exclusive province of government. Infrastructure often does provide some public, non-exclusive benefits, but the willingness of users to pay is the key test of private benefits. As it happens, most infrastructure needs can be met privately and partly, if not fully, supported by user fees. That follows from the high degree of exclusivity of benefits yielded by the infrastructure. Today, privately-owned infrastructure includes communication networks, power generation and distribution, some water and sewer systems, toll roads, ports, and landfills. The presumed monopolistic nature of some infrastructural services probably encourages the notion that infrastructure must be public, but that view is largely unjustified: the services may be “monopolized” only to the extent that the relevant market is defined narrowly, such as road travel, rather than transportation. Indeed, certain kinds of infrastructure functions in markets that are fairly competitive (e.g., wireless networks).

The great thing about most private infrastructure is that owner-operators have an incentive to put it up and keep it up. So it kind of takes care of itself. I say “kind of” because there is always a degree of public involvement, from land use and environmental approval to construction permits, to licensing, to spectrum auctions, to rate regulation, and many other varieties of oversight. Aside from those considerations, if there is a need for infrastructure that is commercially-viable, the project is likely to be proposed by private interests. The funds necessary to pay for construction can be raised from private investors, rather than taxpayers. It’s not at all strange to say that private infrastructure is highly advantageous from a public finance perspective.

There are risks to private infrastructure developers, but those risks are too often borne publicly. A new facility, be it a water treatment plant or a road, might not prove to be profitable once a new revenue stream or reduction in operating costs is realized. Given those circumstances, private interests might seek additional incentives from public authorities to ensure profitbility. To the extent that the shortfall is due to an error in pricing administered by a public regulatory authority, it might be reasonable to make adjustments in the owner-operator’s favor. However, to the extent that demand falls short of the owner-operator’s expectations, it might be better to let the firm fail. That would allow the assets to be sold at a discount to a new operator who can make the cheaper investment profitable. No bailouts!

Trumpian Infrastructure Incentives

The coming Trump Administration is known to have certain steps in mind for encouraging infrastructure development. While the tax plan that has been discussed has a few questionable features, any policy that reduces corporate tax rates would increase the return to existing and prospective private infrastructure, and the profitability of private operation of public infrastructure. In addition, a proposal mentioned explicitly by Trump is a corporate tax credit for infrastructure development.

Here is where a more precise definition of infrastructure would be helpful. Would traditional categories of infrastructure investment by power, telecommunication, and water treatment companies qualify automatically? Moreover, the long timelines required in the planning and installation of most infrastructure might make it difficult to distinguish between new plans and those already in the works. Will the administration establish a bright line between infrastructure investment and run-of-the-mill corporate spending on new plant and equipment? Perhaps any form of corporate investment will qualify. These are questions that remain unanswered as we await Trump’s inauguration.

There is another public-finance dimension of the Trump infrastructure credit. Public infrastructure projects, such as roads, are frequently difficult for governments to fund because they face limits on the debt they can issue. This is emphasized by Randall O’Toole in a recent piece on the Trump credit. Instead of issuing its own debt, a government can take advantage of a large private road builder’s ability to raise funds in the capital market, agreeing to compensate the contractor over time. Thus, taxpayers will be obligated to pay-off the contractor’s debt. The term “Public-Private Partnership” has been invoked in this connection.

Private Incentives Or Central Planning?

I am never averse to reduced tax rates to the extent that taxation always distorts economic incentives. However, selective targeting of tax benefits at certain industries, specific forms of business organization (like corporations), or specific activities like capital investment is overt central planning. Overriding market incentives in this way is not desirable. (Neither are proposals to subsidize exporters and penalize importers. Tyler Cowen at the Marginal Revolution provides some salient quotes from Lawrence Summers on this point.) At this stage, Trump’s tax plan looks like central planning gone berserk.

Ideally, private investment and private infrastructure should be judged on its real merits, not on the prejudices of a central authority. To that end, I believe the Trump Administration’s intent to roll back regulatory distortions is commendable. A case in point is nuclear power generation. Despite the constant outcry against the burning of fossil fuels, there has been little emphasis on encouraging investment in new nuclear capacity. The lengthy approval process and costly regulatory requirements discourage this zero-carbon form of energy production relative to other forms of energy investment.

Users Are the Cost-Causers

I should note that O’Toole speaks favorably of “targeting” certain kinds of public infrastructure, but I think his point is that private operation of infrastructure, if not ownership, will allow markets to do the targeting more efficiently than government ever could. In particular, he notes that politicians tend to prefer new projects to the maintenance and repair of existing infrastructure, independent of the actual merit. Would relying on private operation and user fees encourage better maintenance?

“Unlike infrastructure paid for out of tax dollars, user-fee-funded projects tend to be well maintained because the agencies that manage them know they have to keep them in good shape to continue earning revenues.“

The cartoon above satirizes the consequences of providing free access to a costly facility. User fees encourage more rational patterns of use. For example, it is folly to think that projects like light rail can be financially viable when free alternatives exist. Specific highway routes under high demand must be priced in order for commuters to make rational decisions about the alternatives available to them, and for providers of transportation facilities, whether public or private, to rationally balance the resources dedicated to supporting various modes of travel.

Lower tax and regulatory burdens under the Trump infrastructure plan offer some encouragement for private development and operation of infrastructure projects. As a by-product, the plan might encourage greater reliance on user fees as a method of defraying the costs of infrastructure and promoting a more efficient allocation of resources toward infrastructure needs. However, there are unanswered questions about the details of the plan, and some of its heavy-handy features should be dispensed with.