Thursday, November 02, 2006

Prop 87 Flunks Econ 101

Proposition 87 claims to reduce our dependence on foreign oil by developing alternative energy technologies, and proposes to fund this research with a tax on in-state oil drillers that is forbidden to be passed on to consumers. This proposal defies basic economics. First, we have this ridiculous statute that forbids any attempt "to gouge consumers by using the assessment as a pretext to materially raise the price of oil, gasoline, or diesel fuel." (Yes, it really says that. See Sec. 18, 42004(c)). Basic laws of economics dictate that there is a relationship between costs of production (including raw materials, labor, etc), revenues (i.e. prices for goods sold), and profits. Regulating one aspect of the equation is like squeezing a balloon - compensatory effects will be distributed elsewhere. Putting a tax on one component of production costs will have effects in terms of upward pressure on prices as well as downward pressure on other component costs of production (e.g., labor). Thinking that it will simply come out of profit is naïve. Profit is the air in the balloon. If you reduce that, incentive to undertake the enterprise risk is reduced, the whole balloon deflates. Legislating that costs have no effect on prices is not unlike legislating that water must flow uphill.

Then there's the brilliant bit about reducing our dependence on foreign oil by levying a tax that applies only to domestic oil. Given that oil extracted in California competes in a global market with oil extracted outside of California, the expected effect of putting a tax only on California oil would be to discourage domestic production and increase the demand for foreign oil. Kind of like a protectionist tariff, but totally backwards. Neat. If that works, maybe we can try reducing pollution by taxing low-emission vehicles.

I'm all for reducing our dependence on oil, and encouraging alternative energy sources. There's a simple though painful way to do so, and that's to put a significant tax on gas at the pump. Pain-free "solutions" like Prop 87 that seem too good to be true are. (And shame on Bill Clinton, who ought to know better, for selling this economic snake oil.)

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