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03/01/93

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ENERGY TAX COULD HELP ENVIRONMENT AND ECONOMY

STANFORD - President Clinton's proposal to raise taxes on energy represents an important shift in U.S. tax policy, says Stanford University economist Lawrence Goulder.

If adopted by Congress, the president's program could put the world's largest industrial nation on a path toward substituting "corrective" taxes for "distortionary" taxes, he said.

Corrective taxes charge people for activities that have harmful indirect effects, such as using fossil fuels that pollute the environment. In contrast, distortionary taxes charge people for activities that are largely beneficial, such as earning income by working or investing.

"Economists have suggested for decades that it's better for the government to rely on corrective taxes than distortionary taxes in order to raise revenue," Goulder said. "Given the numerous external costs, like pollution, that stem from energy use, it's fair to regard an energy tax as a corrective tax. So the focus on energy taxes in the president's proposals is very consistent with the long-standing suggestion of economists."

Goulder uses computer simulation models to assess the economic impacts of both distortionary and corrective taxes. His research indicates that energy taxes may be less costly ways to raise revenue than ordinary income taxes.

"What's critical in calculating the costs of these different taxes is the extent to which you factor in the potential of energy taxes to reduce pollution and thus bring about health and other benefits," he said. "The usual GNP or national income statistics ignore many environmental effects, so in terms of these indices, energy taxes appear to be more costly than income taxes that raise the same amount of revenue."

On the other hand, he said, "once you include environmental benefits in the calculation, energy taxes may be less costly overall."

"I don't know why the new administration decided to raise revenue through energy taxes, but it seems to me there are good economic reasons for doing it this way."

Much of Goulder's research has focused on a carbon tax - a tax levied on the amount of carbon content in fossil fuels. Clinton's proposed energy consumption tax would tax fossil fuels based on their output of heat, rather than their carbon content (or eventual emissions of carbon dioxide). Under either type of tax, the government would collect the tax from producers of coal, oil and natural gas, who then would pass on the cost in the form of higher prices on everything from plastic toys and tires to gasoline and home heating fuel.

Through higher prices, both taxes would discourage consumers from using goods and services based on fossil fuels. "The main difference is that a carbon tax imposes an especially high tax on coal relative to the other fossil fuels, since coal has especially high carbon content," Goulder said.

"If your main concern is carbon dioxide emissions and the greenhouse effect, a carbon tax may seem preferable. But if you're equally concerned about other external effects from fossil fuel burning - like local air pollution - the energy tax may look better."

Beyond indicating the overall advantages of energy taxes as a revenue source, Goulder's work emphasizes the importance of how the government uses the revenue from them. Earlier energy tax models "assumed the tax revenue would be returned in lump sum fashion to the economy," he said. "I looked at another alternative, which is to use the revenue to pay for reductions in distortionary taxes like income tax. If this is done, I found there's an additional benefit to the tax over and above the environmental benefit; namely, that it reduces the economic cost that other taxes impose on the economy."

President Clinton proposes to use the revenues from his proposed energy tax to reduce the federal deficit, not to pay for income tax cuts; however, deficit reduction amounts to an implicit tax reduction, Goulder said.

"To the extent that energy tax revenues help reduce the deficit, they pay for reductions in future taxes. This is the case because a smaller federal deficit helps lower the government's future interest obligations, which in turn means it will not have to raise as much tax revenue in the future to make its interest payments," he said.

"You can think of higher energy taxes as giving a tax cut to future generations of Americans. The cuts in distortionary taxes are an additional 'dividend' that earlier studies overlooked."

Some policymakers hoped this second dividend would be large enough to offset entirely the GNP costs of carbon or energy taxes. Goulder's work suggests that "you can make the lunch cheaper, but you can't make it free."

"By judiciously returning the revenues through cuts in other taxes, you can cut the overall cost of the tax package by about half, but not by 100 percent," he said. The technical reason underlying this result has to do with the difference in economic breadth of energy taxes and income taxes.

Goulder sees energy taxes as just one of many potential corrective taxes that could effectively be used in the United States and other economies as substitutes for distortionary taxes. Personal and corporate income taxes and payroll taxes distort, or reduce, the efficiency of an economy, he said, because they reduce incentives to work, save or invest.

"People end up working less than the value of their work to society, or they save less than the value of the savings in the form of future wealth and higher output for the society," Goulder said. "Distortionary taxes drive a wedge between the social value of an activity and the private value."

Corrective taxes instead try to close the gap between social costs and private costs of an activity.

"Environmental problems often result from situations in which producers and consumers don't face prices that give them incentives to balance environmental needs with other goals," Goulder said. "One way to strike a better balance is by changing prices through a corrective tax."

Another approach - command-and-control environmental regulations - has been used more often in the United States. Regulations include mandatory limits on emissions and mandated use of cleaner technologies. Interest has grown substantially, however, in taxes or other incentive-based approaches, such as emission permits that can be sold to the highest bidder.

"Market-based approaches ultimately offer more promise than command-and-control regulations, because they allow firms and households to strike the right balance on their own with less government meddling. They generate incentives for industries to keep finding cleaner ways to produce," he said.

Goulder believes that green taxes should be applied only to environmental problems that are clearly significant. "It's best to focus on the important cases, and to situations where the environmentally damaging activity is relatively easily monitored," he said. "Important cases are auto congestion in urban centers, local and regional air pollution, and global climate change stemming from emissions of carbon dioxide and other greenhouse gases."

There is much more uncertainty associated with global climate change than with the other environmental issues in his list, Goulder said, but this uncertainty does not justify postponing measures to discourage emissions of greenhouse gases.

"It's important to realize that there are potentially huge costs associated with waiting for perfect or even better information. The longer we wait to take action, the more costly it will be to deal with global climate change if it should turn out that action is necessary," he said.

"You can think of higher energy taxes today as paying an insurance premium. We pay the premium so that, if it turns out that significant reductions in energy use are indeed necessary to avert calamitous global climate change, it is much less costly to deal with the problem later on," he said.

"We may find out in the future that we never needed the insurance. But that doesn't make it irrational to purchase it now."

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