Saturday, November 22, 2008

How to Save the Auto Industry (Without a Bailout)

Ever since the Big Three auto companies flew in with tin cups and private jets seeking a $25 billion bailout loan from Congress, the media and most pundits have been fixated on three extreme alternatives: bankruptcy, bailout, or government takeover. But there are other alternatives that avoid these extremes, if only folks would ask the right questions.

First, let's think through the problem. Has anyone else noticed the irony that the Treasury Dept. is spending $700 billion to encourage the credit markets to loan more money, but the auto companies, instead of going to the private debt market as they should -- are coming straight to the Congress? Aren't we bailing out the credit markets so that they will make exactly this kind of loan?

The right question to ask here is NOT should we bail them out, take them over, or let them go bankrupt. That is what everyone is asking. The right question, which nobody is asking, is: what can we do to encourage the private sector to finance the Big Three?

What is the problem? Detroit's labor costs are too high, and they are not producing the right kind of cars for the current market -- affordable, extremely fuel efficient vehicles, not the expensive gas-guzzlers they produce -- so their business model is unprofitable.

Logically, then, to encourage private financing, we need to find ways to help Detroit become profitable, either by reducing their costs, or by helping them produce affordable, green-powered vehicles profitably, or both. We also need to look for ways to make loans and other financing more profitable to investors.

Too bad the media, Congress and the punditocracy are all focused on extreme, unpalatable and not-so-helpful solutions: bailout, bankruptcy or government takeover. No one in these opposing camps seems to be asking how we can avoid such extremes: fix the problems, encourage normal loans and investments, and make the auto industry greener and more profitable without all the drama.

Here's one way:

We can spur both new loans and new equity investment if we make it extremely profitable and attractive for the auto industry to move in the right direction, towards producing and selling advanced green energy vehicles. We can do that in short order if we make the entire business of producing such green vehicles 100% tax free. To reduce costs and boost sales, revenue from green vehicles should be free of all state and local sales taxes, and all federal income tax. Further, the cost of all materials and components needed to build such vehicles should be tax free as well, to reduce costs and increase green vehicle profitability even more. Interest on loans or bonds to finance the development, production or purchase of such vehicles should be income tax free, making such loans more profitable. The stock and dividends of companies producing green vehicles should be capital gains tax free, in proportion to the percentage of revenue derived from such vehicles in the previous year, attracting more equity investors and encouraging management to shift green to escape taxes. All the above should hold true for businesses producing the infrastructure needed to support green vehicles, such as electric, hydrogen and natural gas fueling stations, all 100% tax free.

If we take these steps, we will vastly reduce the costs and increase the profitability of producing green vehicles. We will also make loans for producing and purchasing such vehicles more profitable and attractive to lenders, simply by making the interest tax free, but also by making the underlying business more profitable. Overall, we will immediately spur enormous debt and equity investment in a revitalized, highly profitable Big Three dedicated to selling as many green vehicles as possible, in order to maximize profits and minimize taxes for each company and their shareholders. Essentially, we would be creating a green goldmine for investors, one that is good for both America and the Earth.

The benefits of this approach extend well beyond the auto industry. A study by the Pacific Northwest National Laboratory estimates PHEVs have the potential to cut US oil imports by 52%, or 6.5 million barrels per day. Plug-in vehicles can reduce energy costs nationwide by using underutilized, off-peak energy, which is generally cheaper and would otherwise go to waste. Local trips could cost as little as the electric equivalent of $1/gallon of gasoline. These savings and benefits could be even more dramatic if combined with a smart grid and renewable energy sources, such as wind and hydro power, further reducing emissions and allowing the PHEVs to act as an on-demand power storage system, storing cheap off-peak power from an increasingly green grid, for use during expensive peak-load times -- with vehicle owners pocketing a profit. If tax freedom were extended to ALL green energy technology (vehicles, clean/renewable energy sources, smart grid development, etc.) that would supercharge investment in green energy, reducing overall energy costs, while stimulating the economy and creating millions of new jobs.

And of course, one of the nicest aspects of this approach is that it does not require a dime of upfront federal spending. Further, it lets the market (not the government) decide which green auto technology wins.

Is this somehow an unfair subsidy of green over gasoline vehicles? Many economist argue that oil, coal and gas guzzling vehicles are already heavily subsidized in a number of ways, such as the infamous $25,000 Hummer tax credit, but even more fundamentally in that these vehicles contribute heavily to the social costs of global warming, foreign oil dependency and oil-related wars, but get a free ride by forcing the taxpayer to pick up these costs. But raising taxes on carbon fuels and carbon producing technologies, such as automobiles, while correcting the free ride problem, would be disastrous for a struggling economy and a struggling auto industry. Tax freedom for green energy and green vehicles is another way to correct the free ride problem, but one that stimulates the economy, rather than depressing it. Instead of a carbon tax, we can implement a no-carbon tax cut for a much better pro-growth outcome.

Are we going too far with 100% tax freedom for green vehicles? Not at all, because Detroit and the American economy are in dire straits right now. There is no excuse to not pull out all the stops right now. Our economy is dangerously vulnerable to wild spikes in the oil market, which vulnerability can only be reduced by reducing demand for oil. This we must do fast, at full speed, not half-speed, or more oil spikes will greet us if and when our economy begins to recover, possibly choking off any rebound. We have a long, long way to go before 100% of American vehicles are highly fuel efficient, and an even longer way to go before 100% of vehicles use 100% renewable energy. We can always reassess and maybe throttle back later when we have reached a reasonable midpoint goal, when say the auto industry is profitable again and 50% of all vehicles sold are plug-ins and deliver 100 mpg or better. But right now, we need a profitable, green auto industry and less dependence on foreign oil. It is a rule of economics: if you want more of something, tax it less. Ergo, no tax on green autos.

Tax freedom for advanced green energy vehicles is manifestly in the national interest, not just to save the automobile industry and millions of jobs, not just to avoid economic depression, but in order to reduce the ongoing strategic, economic, environmental and security risks posed by foreign oil dependency and global warming. But even disregarding the larger goals, it is nice to know there is a sensible alternative to bailouts, bankruptcy or socialism, and one that lets the markets work as they should.


Given the unattractive options being floated by the punditocracy, one worse than the next, I hope this original proposal can help move the national debate in the right direction. If you agree, please help by forwarding this link on to your friends, elected representatives, the Obama Transition Team, the media, the blogosphere, and anyone you know who might be interested and helpful. And thanks!


Anonymous said...

Using plug-in vehicles to create a distributed electricity storage capablility our the power grid(s) is an intriguing idea, but how this could actually be put into place, and whether economically it makes sense to ensure that enough people have devices installed in their garages to make this possible is a question i have about the idea. However, it seems to work just fine for home solar systems in Long Island (amoung other places), albeit with a subsidy.

Anonymous said...

Proposing gratuitous new tax cuts is easy to put on the table, but there are so many other existing high value non green tax cuts to compete with. You should offset any NEW tax cuts for green energy with the ending of EXISTING tax cuts for dirty energy, thus making your policy budget neutral. There are many bad tax cuts to choose from: The $18,000 SUV write off. The transfer of depreciation write offs for buses and garbage trucks, etc from municipalities to private "lease holders"...I'm sure there are many more. Also, you then would be isolating the issue of supporting green policy from the issue of busting the budget...More importantly it forces you to quantify the economic impact of your proposals.