Actually Mr. President, There Is A Solution: The Freedom Tax

On January 26, with competing headlines announcing at least 77,000 job cuts in just one day while jobless claims hit a 26-year high, President Obama made his first major policy address on energy. The president described the our energy challenge in very stark, clear terms:

“At a time of such great challenge for America, no single issue is as fundamental to our future as energy. America’s dependence on oil is one of the most serious threats that our nation has faced. It bankrolls dictators, pays for nuclear proliferation and funds both sides of our struggle against terrorism,” Obama said. “It puts the American people at the mercy of shifting gas prices, stifles innovation, and sets back our ability to compete.”

But he did disappoint in one significant way when he said: “I cannot promise a quick fix. No single technology or set of regulations will get the job done.”

Actually Mr. President, there is one major policy solution that would go a very long way to addressing the energy challenge and at the same time stem the staggering loss of jobs that dramatically stole the headlines away from your speech. And this simple policy shift can make major strides in addressing both our energy and economic challenges by encouraging market based solutions without incurring additional government debt.

What we now need Mr. President, is your leadership to not only speak clearly about the energy challenges we face, but to also act boldly in solving them. We need you to lead the effort to promote and pass the Freedom Tax.

The Freedom Tax is a revenue neutral shift in tax policy away from taxing jobs and work and substituting a tax on petroleum. Taxes are very effective in shifting market signals to discourage whatever is being taxed. Currently our high levels of taxes on employment discourages job creation, while our very low level of taxes on petroleum encourages wasteful use of petroleum products and discourages the development of effective alternatives.

With two thirds of our petroleum imported and world wide petroleum discoveries now forty years past their peak, many of our current and potential future national problems can be traced directly to our excessive use of petroleum. Trade deficits, environmental problems, economic challenges and our most significant national security concerns can all be traced directly to our unsustainable levels of petroleum use. While well intentioned people may dispute the details of such impacts, nobody credible suggests that our excessive use of petroleum is either good for the nation or sustainable at current levels.

There is an emerging consensus that the place to start a tax shift to the Freedom Tax is in reducing FICA payroll taxes significantly while substituting a tax on petroleum imports and production. Opinion leaders across the political spectrum all suggest and support such a plan. Today what is needed is a concerted effort to push for its passage through Congress.

Ideally the Freedom Tax will be phased in to reduce immediate disruptions to markets and to the expectations and lifestyles of Americans. The easiest mechanism to do this is through a ratcheted increase in the tax on petroleum. When market forces push the price of petroleum higher, prices would be allowed to rise. When market prices decline, the Freedom Tax would ratchet up to maintain then current pricing. Such a mechanism has the added advantage of discouraging volatility and speculation in petroleum markets and providing a more predictable future for companies developing alternative energy supplies.

For the balancing tax reductions, in the current economic environment, the most rational tax based economic stimulus would be a reduction in FICA taxes, ideally in a 50/50 split of employee and employer contributions. Such changes would reduce the impacts of the least progressive aspect of our current tax system, immediately put more money directly in the pay checks of every worker and reduce the cost to businesses of keeping and creating jobs.

Shifting taxes away from discouraging job creation and instead taxing our nations unsustainable addiction to petroleum is a policy that everyone can support. So, how can we help gain your support, Mr. President?

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4 Comments

Filed under Best Stuff, Climate Policy, Economic Policy, Energy Policy, Fundamental Perspectives

4 responses to “Actually Mr. President, There Is A Solution: The Freedom Tax

  1. fredunger

    February 5th over at Greg Mankiw’s blog (see link) he gave a strong argument for the Freedom Tax below:

    Thursday, February 05, 2009

    My Preferred Fiscal Stimulus

    Regular readers of this blog have a pretty good sense of my policy preferences. But for those occasional readers who might be stopping by, let me reiterate what I would do right now if I were the fiscal king.

    I would institute an immediate and permanent reduction in the payroll tax, financed by a gradual, permanent, and substantial increase in the gasoline tax. I would make the two tax changes equal in present value, so while the package results in a short-run budget deficit, there is no long-term budget impact. Call it the create-jobs, save-the-environment, reduce-traffic-congestion, budget-neutral tax shift.

    I recognize that some state governments are now struggling in light of the macroeconomic crisis. For the next two years, I would let each state governor have the authority to divert a portion of the payroll tax cut in his or her state and take the funds instead as state aid. This provision would essentially be giving governors the temporary authority to impose a payroll tax on his or her citizens, collected via the federal tax system. Those governors who think they have valuable infrastructure projects ready to go would take the money. When designing a fiscal stimulus, there is no compelling reason for one size fits all. Let each governor make a choice and answer to his or her state voters. It is called federalism.

    Any further federal spending projects should be evaluated on the basis of cost-benefit analysis. That analysis would take time, but it would ensure that the projects are not a waste of taxpayer dollars.

    Some traditional Keynesians would object on the grounds that government spending has a larger multiplier than tax cuts. Even though that is the prediction of standard Keynesian models, the evidence is not completely consistent with that conclusion, as I have discussed here in previous posts. In addition, given the lags inherent in large spending projects, and the risks inherent in hasty spending at the federal level, the case for taxes over spending as the fiscal instrument of choice is compelling. To me, at least.

    None of this should be viewed as a substitute for fixing the banking system and trying to come up with a better process for homeowners and banks to work out mortgage loans in default. Housing and finance are the real sources of the macro problem. Any fiscal stimulus, such as the one I propose above, is only an attempt to mitigate the symptoms. Those symptoms are severe, so mitigation is fully appropriate. But fiscal policy is not a panacea for what now ails the economy.

  2. fredunger

    Over at the NESEA Blog http://www.NESEA. org where this post also appeared recently, my buddy Erich Stephens wrote:

    I agree that this is a good policy in concept. But I will quibble with two aspects of Fred’s Tax, er, I mean the Freedom Tax. Fred won’t consider them details, but to me they are not terribly important relative to the general concept. The Fred’s idea would work, but I think the modification below would be even better:

    First, use cap and trade instead of a tax. With a tax, you are not going to get the number right. To low a tax, and the policy is useless to achieve the reductions you want. Too high a tax and the reductions cost more than you need to pay. There will have to be constant jiggering of the tax rate, and the lawyers and lobbyists will be the real winners. Cap and trade enables you to decide what matters from the start: the amount of pollution reduction. Then the market figures out the most cost effective way to achieve those reductions, and therefore what it costs to continue to pollute at the acceptable levels. It’s functionally the same as a tax, but with a market setting the tax rate and not lobbyists.

    A realpolitik note: Let’s not forget we tried a petroleum tax once before, and it went down in flames (but thanks for trying, Bill). And, let’s not forget we’ve been using cap and trade for something like two decades now, and it worked and continues to work wonderfully in reducing two sources of air pollution: NOx and SOx (those older enviros among us remember when acid rain was the bogey man of much discussion). Finally, while the Europeans seem to have fallen on their face with it, that’s not saying much. They can’t even comply with their own treaties regardless, assuming they can even agree to anything meaningful. The US states actually have a much better track record of “gettin’it done” than Europeans, so long as it’s something we care enough about to actually make work. And the two successful RGGI auctions so far give me confidence that we have figured out how to make carbon cap and trade work (at least, step one work…agreed we need to expand RGGI beyond electricity generation). If nothing else, I note that what I am proposing here is more in line with what Obama is already proposing, and so if you are okay with the big picture you might want to help defend the big picture instead of trying to get the picture perfect and risk losing it all together (which is why I consider all this details in the scheme of things)

    Second disagreement with Fred is that payroll taxes is what inhibits job creation. While payroll taxes are a pain for small businesses, they just aren’t a huge expense relative to the Mother of All Payroll Expenses, namely health insurance. While health insurance is obviously not a requirement for employers to pay, it is a de facto expense since the market requires it of any job worth creating. And it is also a very big expense, and a largely uncontrollable expense, and an administrative nightmare (payroll taxes are a breeze in comparison). So I would say use cap/trade revenue to finance a standard health insurance program for everyone. This would immediately free up billions of dollars for employers and make them more indifferent to head count. Us working stiffs wouldn’t get cash in the pocket (like Obama is proposing), but we might get a raise (since employers would be competing more on salary than on benefits). And we would be free to move to a new job, or start our own business, more easily knowing that we don’t need to worry about sticking to a bad job just for the health insurance. And of course, we would be assured of having some insurance at all times- certainly worth something.

    And if you don’t like the idea of using carbon revenue to pay for health insurance, then I agree with Obama on this one: Just give the money directly back to the people who are spending it in the first place -the employees- in the form of a tax credit or check in the mail. If you give it to employers directly (in the form of payroll tax cut), there is no reason to think they will actually create jobs with it. More likely, they’ll just use it to pay for the more expensive jet fuel in their corporate jets.

  3. fredunger

    My response to Erich:

    Erich,

    Economists who have studied the question universally agree that a direct carbon tax will be far more effective at actually reducing carbon emissions and more effective as economic policy than Cap and Trade solutions. Gilbert Metcalf at Tufts has written extensively on the subject and gave a great presentation on exactly this subject at a recent NESEA conference. Greg Mankiw at Harvard has also written fairly extensively about the subject. For a list of some of the diverse base of opinion leaders who have supported this kind of policy in the past check out https://emergingconsensus.wordpress.com/2009/02/01/who-else-supports-tax-shifting. Links to some of Mankiw’s and Metcalf’s work are also available there

    Taxes are the most effective thing government does to discourage whatever is being taxed. Right now, most of our taxes are derived from taxes on working and investing in productive economic activity. For those concerned about job growth and economic prosperity, the results of such short sighted tax policy that we are experiencing today should really be no surprise.

    Like many other supporters of a carbon tax, I favor generally shifting taxes from productive activities like work, investment and job creation onto unproductive things like wasteful consumption and pollution. I am in favor of returning money to taxpayers as you suggest. But unlike some folks here, I am much less inclined to increase taxation and have the government decide how to distribute money. It would be far better economic policy if they simply not take it in the first place.

    That brings us to your question of realpolitik. The fact is that there is actually very broad support among liberals, conservatives, progressives, libertarians, environmentalists and even oil company executives for some form of “carbon tax”, as long as that tax is offset by taxes on productive endeavors. With the exception of politicians, this form of tax shifting is probably more universally accepted and supported than any other policy solution I am aware of. Unfortunately it is politicians who make laws.

    That broad support for effective carbon policy immediately becomes very narrow support of those leaning to the political left if it is decoupled from offsetting tax shifts. Current Cap and Trade policies are actually far more contentious than the almost universally supported tax shifting solutions. The real realpolitik is that Cap and Trade policies are a tax masquerading as a no-cost environmental benefit. The tax is paid through utility bills and the costs of goods manufactured by facilities subject to the caps, so it doesn’t feel like a direct government tax and politicians can raise revenues for government while pretending it isn’t a tax. That’s the kind of game big government politicians on both the left and right side of the spectrum love to play.

    Regarding your suggestion that reducing the cost of hiring people won’t encourage job creation, I wonder what you believe should be done to spur job creation. I would point you to the relative success of our economy here in Rhode Island, where some of the highest business tax and regulatory burdens in the nation have led very directly to our nation leading unemployment rate. Those who think that jobs and economic prosperity are created by government are unfortunately fooling themselves, despite the popularity of that misguided delusion these days.

    Unfortunately, you are probably right that the less universally supported, less economically effective and less environmentally effective solution will likely be chosen because it is more convenient politics for those with power these days. That is really not the kind of change I was hoping for in the new administration. Seems like more of the same old divisive politics to me. I eagerly await a politician who pushes for effective rather than merely expedient solutions. I look forward to a politician who offers real change, hope and responsibility to America by making the effort to push for truly effective broadly supported solutions, by telling the truth to the American people, even when it gets a little complicated to explain.

  4. fredunger

    Over at the dcexaminer.com, Irwin Stelzer offers “Four Big Problems With Cap and Trade” all of which would be appropriately addressed through a carbon tax like the Freedom Tax, in lieu of Cap and Trade. http://www.dcexaminer.com/opinion/columns/IrwinStelzer/Four-big-problems-with-cap-and-trade-40837762.html

    “[Cap-and-trade] has nothing to do with the stimulus package into which this green agenda has been inserted. It takes years to get permits for new windfarms and transmission lines, by which time we hope the recovery will be well underway.

    The second problem is the volatility of the price of permits. The goal is to make it so expensive to emit greenhouse gases that polluters will switch to other, greener means of producing energy. But significant investment in greener technologies can occur only if investors can calculate the costs faced by their CO2 -emitting competitors.

    In Europe, the price of permits has fluctuated between zero and around $40 per ton. Green technologies that were economic, and could attract capital when permits fetched $40, are uneconomic when the price at which permits trade is far less, as it now is (about $10).

    The third problem is that a recession is a bad time to load costs onto businesses and consumers. The Obama team counters that the levies won’t cut in until 2011. But for businessmen planning long-term investments, that is right around the corner, and the uncertainties associated with cap-and-trade will surely discourage investment.

    The fourth problem is that Obama has promised that no family earning less than $250,000 per year will pay one dime in higher taxes. But the companies that have to pay for permits will pass that cost on to consumers in the form of higher prices for electricity and other products. So these families will pay $645 billion, only some of which will be returned in the form of lower income taxes, for a system that is terribly inefficient.

    The solution, of course, would be a straight-forward tax on carbon, the proceeds to be refunded through the payroll tax system. But unlike the hidden tax of cap-and-trade, a carbon tax is out there for the voters to see. And given the choice between a stealthy tax and a visible tax, politicians will pick the former every time.”

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