Thursday, January 15, 2009

Apostle to Cato III: Epilogue (and Prologue)

Jerry Taylor has withdrawn from this debate. For now, at least.

You may each judge for yourselves†, but it seems to me, and apparently to some of my readers, that Jerry left standing my three central points: that cutting taxes on green energy, vehicles, infrastructure and efficiency appears to be 1) much like the broad tax cuts proposed by Cato's supply-siders, and hence, better for the economy than doing nothing; 2) far better than the tax and spend energy initiatives currently on the table (carbon tax-or-trade, subsidy, mandates) which were initially preferred by Jerry over tax cuts; and 3) similar to Cato's tuition tax credit and tax free health saving account proposals, as tax cutting strategies designed to strategically avert a big-gov disaster.

If I am right about these points, then Cato – and many other think tanks on the right as well – should adopt the green energy tax cut proposal because it is philosophically consistent, economically beneficial, can help avert a big-gov disaster, and can help convince progressives (whose identity is evolving) to appreciate the benefits of tax cuts, and draw them away from pitfalls of tax and spend policies.

So I issue an invitation, and a challenge – to Cato, AEI, Heritage, Americans for Tax Reform, Manhattan Institute, Atlas and many others. Let's build this proposal together. Let's use our time in the wilderness to save the wilderness, and capitalism too.

But if you think I am wrong, then let's debate. If you think you can make a better case, then make it. But the truth is, as we have seen here in this debate, that just as cutting taxes beats doing nothing (or tax hikes) on the macro level, it does so on the sector level as well. If you disagree, bring it on.

If you have courage in your convictions, that is.

Now, excuse me, but I need to go talk to some progressives. Let me leave the final word on this debate (for now, at least) to one of my readers, Rachel from Seattle:
"Both you and Jerry Taylor make many wonderful points. I think Taylor is right that doing nothing is better than tax credits, subsidy, carbon tax. But it seems to me that he has misread your proposal, and much of this debate is a misunderstanding. He is reading it as a tax credit proposal, but it is not. Your point is a persuasive insight that I have not heard before, that tax cuts are entirely different from tax credits (or subsidy) in that government is simply getting out of the way vs throwing money at failure. Subsidy probably isn't even the right word for what you are describing. More an unburdening. And you probably are right that it could benefit the whole economy.

Jerry is also right that more debt should be avoided, so if your proposal is to work, it will be critical how it is designed, so that it is at least revenue neutral.

Nice to read a really good debate like this between libertarians."
†Readers may find part I of the debate here, and part II here.

Friday, January 9, 2009

Apostle to Cato II

So continues my debate with Jerry Taylor of the Cato Institute, and with it, my apostolic ministry of reason, to rededicate the hearts and minds of the Cato community to the cause of reduced taxes and government – for the sake of the general prosperity – wherever and whenever we can do this; specifically, through green energy tax cuts, here and now.

I note that now, while Obama spends the weekend pondering the need to replace portions of his stimulus package with tax cuts, we have an opportune moment to start. There is much unproductive green energy stimulus being considered that would be well to replace with a productive green energy tax cut.

Round one of this debate can be found here. The comments on round one include a fine exchange with Cato's Randal O'Toole that gets to the heart of the carbon tax. Without further ado, here is...

The Second Reply of Cato Senior Fellow Jerry Taylor:

I am in favor of the smallest government possible consistent with the job that government is charged with (protecting my right to life, liberty, and the pursuit of happiness). The size of government is defined by how much it spends and how much it regulates. Not by how much it taxes.

I suspect that you don't agree. If not, ask yourself this - if we zeroed-out taxes for 2009 and found a way to borrow all the money necessary to meet current federal spending plans, would we have reduced the size of government to zero? No. Would we have reduced the size of government at all? No again. To argue to the contrary is to argue that putting your grocery bill on your credit card reduces your effective grocery bill to zero. The reality, of course, is that you simply decided to pay for today's groceries tomorrow ... but with interest. If you pay interest on your credit card, the size of your total bill went up, not down, by putting those groceries on the credit card.

Why exactly do some libertarians believe that paying for your groceries with a credit card is somehow more "freedom enhancing" than paying with cash? Beats me. A stronger argument would be to pay with cash. At least you avoid paying the interest on the borrowed money.

The inescapable reality is that - unless interest rates on Treasury Bills are zero - borrowing to pay for current spending increases the size of government relative to levying taxes to pay for current spending. Because my fundamental aim is to reduce the size of government, I prefer the latter to the former.

Now, you are certainly correct that taxes harm economic growth. But borrowing to pay for spending programs simply transfers the economic harm of the taxes avoided from the present to the future. Hence, tax cuts are in a very real sense "borrowing" economic growth from the future. We are temporarily wealthier for it but we will later be poorer for it ... or future generations will be poorer for it if we die before the bills come due.

Again, the only way to reduce the economic harm caused by taxation is to reduce spending. Borrowing will not do the trick.

As far as economic stimulus is concerned, I don't think the best stimulus is a tax cut for the simple reason that a tax cut may not be used to purchase goods or services ... it might instead be saved. Now, that's fine with me (I'm not sold on the Keynesian stimulus argument anyway), but if government-induced stimulus is the objective, I don't think tax cuts will do the job as well as spending might. Again, however, I am not in favor of government-induced stimulus, so that's neither here nor there.

So let's focus specifically on your green tax credit idea.

First, since the tax cut you propose takes place in an era of deficit spending, you are by definition increasing the size of government with your tax cut.

Second, your claim that tax credits do not entail deadweight losses is risible. The federal ethanol program is largely (but not entirely) founded upon the 51¢ blenders' tax credit and economists Harry de Gorter and David Just at Cornell find that the deadweight losses from that tax credit will total $28-49 billion by 2022. Deadweight losses likewise follow from the existing tax credits afforded the renewable energy industry, but how large they might be is unclear.

Third, many of the energy sources you hope to favor with these tax cuts will not actually be helped because, as Tufts economist Gilbert Metcalf points out, their net tax burden at present is actually negative!

Fourth, by using the tax code to favor some energy investments over others, you are again, by definition, expanding the size of government (hastening back to Friedman's definition that the size of government is defined by how much it spends AND how much it regulates). You are of course welcome to argue for market rigging exercises, but please, don't lecture me for being ideologically impure in the course of doing so.

Fifth and finally, you may be right that your green energy tax cut idea is better than the Obama alternatives, but it is not Cato's job to figure out how best to maneuver on the existing political terrain and to use that insight to inform our arguments for second-best policy change. Our job is to argue for what policy OUGHT to be and let the political chips fall where they may. There are plenty of people in Washington who engage in this "argue for the best deal (or least bad deal) that we can get this year" approach. And there's nothing wrong with that. But there likewise needs to be someone or some institution out there arguing for best practice.

Finally, a few points of clarification. I do not "extol the virtues" of a carbon tax. I am against a carbon tax. I do not extol the virtues of taxes in general. I prefer them to borrowing if the question is how to pay for our governmental bills (save for spending that will largely benefit future generations, in which case borrowing to some extent is defensible), but I more strongly prefer cutting spending and, correspondingly, cutting taxes as we go.

Jerry Taylor, Senior Fellow, The Cato Institute

My Second Reply:
Feeling Quite Ignored

One of the strangest features of debating you, Jerry, is the nagging feeling that you are really debating someone else. Honestly, I am feeling quite ignored. For your most devastating arguments bury nameless foes whose feckless views seem quite different from my own.

Who are these people? Please name some names, cite some articles! Who are these "libertarians" who champion debt financing? 'Cause it sure as subsidized sugar ain't me, Jerry.

Now, they may exist, but I don't know any libertarians currently arguing for debt financing. So unless I am mistaken, the real target of that remark is -- besides myself -- anyone arguing for tax cuts, including Chris Edwards, Richard Rahn, Daniel Mitchell and most of the tax policy team at Cato. Is that right? Because from what you say here, it is clear that you disagree with these gentlemen's most fundamental recommendations to cut taxes -- and not just when it comes to energy policy, as I supposed earlier.

In order to make the argument that I, or any tax cut advocate, favor debt financing, you assume that any tax cut will lead to a tax revenue decline and hence more debt. In order to make that assumption, you must ignore supply-side economics and the Laffer curve -- you never even mention either, but simply disregard these arguments as if I never raised them. But I do, often. I also specifically cite and rely on Chris Edwards' recent arguments that cutting present US corporate tax rates would boost the economy and raise overall tax revenues, in order to illustrate how a corporate green tax cut would enhance overall prosperity and could either increase overall tax revenue or be tax neutral, depending on how it is crafted.

But you never bother to refute those key arguments, so they stand. Similarly you ignore but never refute my arguments that avoiding the big-gov disaster along with the spending cuts which are integral to my proposal, would, on top of revenue neutrality, shrink the size of government. Therefore, your claim that a green tax cut would "by definition increas[e] the size of government" (by forcing debt financing, I suppose you mean) simply fails because it does not refute the contrary arguments on the table.

Jerry, if you ignore powerful, key arguments -- like supply-side theory, the Laffer curve, or your colleagues' recent tax research -- then I win the point and the debate. You must refute these arguments to prove my proposal leads to anything other than prosperity and less government. State clearly why the Laffer curve is a bunch of hooey, if that is what you think. Tell us why Chris is wrong, if you believe he is leading us to ruin. But as things stand – ignored but unrefuted – (a) your tax-cuts-lead-to-debt critique is fatally flawed in that it ignores that tax rates, if too high, may be cut while increasing tax revenue; (b) you therefore have not diminished my case that a green energy tax cut leads to general prosperity and less government.

Debatable Points

That big picture is echoed in flaws in your specific points:

1) Government size is defined by extent of spending and regulation, not taxation. Nonsense. First, taxes are regulations, often called IRS or Treasury regulations. Second, if taking our property under threat of violence is not the quintessential and second most potentially objectionable act of government, I don't know what is. You even define your libertarianism by quoting the Declaration of Independence, which ironically is the world's most famous complaint against tyrannical taxation. So I'll stand with Jefferson and the Continental Congress on this one, thank you. Taxes are government encroaching, and tax cuts removes that government encroachment -- possibly even permanently, without transferring it, depending on the shape of the applicable Laffer curve. I suspect many if not most libertarians would agree with this traditional American view.

Your illustrative zero taxation thought experiment is fun but flawed. Just turn it on its head to see why: imagine a world with no (non-tax) regulations, with spending set at zero, but also with taxation at 100% of not only income, but any and all assets you own. According to you, government has then vanished. But destitute and homeless, I doubt you would feel government had shrunk much or developed a lighter touch. Taxation is just as much a measure of the burden of government as spending, regulation, debt or collective force.

The application of this idea to the green tax cut debate is that carbon taxes, subsidies, mandates all increase government. A green tax cut is fundamentally different from these interferences, in that it actually reduces government and removes it from a particular endeavor, and so has fundamentally different economic characteristics (reduction of dead-weight loss, etc.).

Revisiting your related claim that I am "by definition, expanding the size of government," I further reply that I am rather removing and shrinking government both by cutting taxes, and by displacing much more onerous big-gov tax and spend programs like carbon taxes, subsidies, and mandates. However, I am somewhat put out by the thought that you will probably just ignore this argument as you have the others.

2) "[T]he only way to reduce the economic harm caused by taxation is to reduce spending." Again, you are denying the Laffer curve here, which says that the harm caused by excessive taxation may be reduced by reducing rates, without reducing revenues. You are right that only spending cuts solve excessive spending -- we agree there -- but the reason is that no matter how much you tax, there is a maximum revenue that can be raised, period. Since we can't tax our way out of debt, we must ween the progressives away from spending policies, which is precisely what my proposal accomplishes. In other words, my proposal is a path to the spending reductions you yourself say are essential.

3) A tax cut is not the best stimulus because "a tax cut may not be used to purchase goods or services ... it might instead be saved." That possibility is really only true of personal income and property taxes and personal savings. The business tax cuts that are part of a green energy tax cut (sales, corporate income and capital gains tax cuts) are not subject to this objection and are well documented to encourage consumption, investment and general prosperity.

4) "[L]et's focus specifically on your green tax credit idea" ... "your claim that tax credits do not entail dead-weight losses is risible." Please, Jerry, read the title of my blog. It says tax cuts, not tax credits. Again you are ignoring what I actually say in order to set up a strawman. As I argued in my original remarks, these are NOT the same thing, and it makes a big difference.† Tax credits are a form of direct subsidy, a federal expenditure that allows a buyer to pay more for something than it is worth. This allows an unprofitable business to seem profitable. It allows the subsidization of failure. This is what YOU said is better than tax cuts: direct subsidy. I said politically directed subsidies, including tax credits, entail higher dead-weight loss. You are not attacking my argument here: you are attacking yours!! You are confirming that my argument is correct!

No actual tax cut will allow this subsidization of failure. If you cut a sales tax or a corporate income tax, any products sold must still turn a profit on their own merit for the business to be viable. Tax cuts come into play only after a sale is made and a profit logged. In my proposal, there is no cash payment offered up front (i.e., tax credit/subsidy) that boosts the product above its true price. Only the green energy businesses that are profitable on their own merits will survive under my proposal, and the most profitable business models will receive the most in total tax cuts. Tax cuts promote success, while all other forms of subsidy, including tax credits, often subsidize failure.

I fully expect corn ethanol will NOT survive in the Green Energy Tax Cut environment – including the elimination of existing subsidy tax credits – because the basic business model is unprofitable without subsidy, and the fuel requires more energy to produce than it yields. But that is a good thing, because the green technologies that thrive will be viable and productive.

A related point is that the negative net tax burden that Prof. Metcalf reports is another way of describing the subsidization of failure through tax credit subsidies. Zero or low tax burden indicates a successful approach, but prolonged negative tax burden indicates an approach mired in failure. Which is in fact the direct subsidy approach you say is superior to green energy tax cuts.

5) As to your remark that I favor market rigging, my reply is I do not, that rather I favor lowering taxes where both possible and most likely to pass along the benefit to the whole economy. I favor eliminating tax-spend-regulate approaches, if externalities need to be taken into account, and replacing these with the most economically beneficial alternative: tax cuts. That is actually an effort to minimize market rigging. Since the public has clearly decided that such externalities exist and warrant support for alternative energy, it is arguably a form of market rigging on your part to insist there be no price adjustment. I believe in the face of a clear public decision such as the above, it is Cato's responsibility to promote the most economically beneficial option that meets the public's goals.

This speaks to your point that Cato should promote best practice. A green energy tax cut is better practice than doing nothing, because it is more conducive to prosperity, because it shrinks government and better avoids the big-gov disaster, because it sets up an environment conducive to future broad tax and spending cuts. It is just as much best practice as tuition tax credits or tax-free health savings accounts, as tax cutting proposals designed to reduce overall government interference. Contrary to your tax cut critique, Cato's supply-siders are also pushing best practice, and there is no reason to think their recommendations would not work best for the green energy sector as well. If you think Cato is wrong to push these proposals, that Cato should limit itself to calling for the end to public schooling, for example, you should say so boldly. But I think Cato is on the right track in promoting strategic tax cuts as the best policy to promote prosperity and reduce harmful government interference in these areas. Cato needs to merely get on an intellectually consistent track with respect to energy policy in order to hit the best practice sweet spot.

Lastly, if you say that Cato has no business arguing for second-best policy, why oh why then are your articles freighted with an elaborate hierarchy of second, third and fourth best policy choices – all far worse than tax cuts? In my view, your hierarchy not only is wrong, but gives aid and comfort to tax and spend advocates, for whose policies you should have not a single kind word. Looking at Patrick J. Michaels bang-on evisceration of the carbon tax (video on Cato home page today) I can't fathom why any Cato scholar would say that it is an effective price adjustment tool, when empirically it simply does not work and causes great harm.

Points Ignored and Lost

In addition to the unchallenged arguments noted above, you seem to have wisely conceded the point – and all underlying arguments – that green energy tax cuts are superior to a carbon tax, cap-and-trade or subsidy. Perhaps your argument about the dead-weight loss of tax credit subsidies for ethanol was an attempt to refute my arguments, but I trust you can see now how it rather refutes yours.

Further, beyond your flawed tax cuts = debt critique, your response does not directly challenged my central arguments that green energy tax cuts, like all tax cuts, would tend to enhance prosperity more than doing nothing;†† would help reduce spending by avoiding a big-gov disaster (i.e., the tax-and-spend approach you preferred and have apparently abandoned); and would create conditions conducive to future spending and tax cuts, as we ween progressives away from the big-gov trough. Nor do you challenge the idea that strategic tax cuts in the energy sector would act like a broad tax cut for the whole economy, as the benefit of the cut is passed on in reduced energy prices.

I very much appreciate the exchange of ideas with thoughtful individuals like yourself and Randal. I don't mind sharp, challenging arguments, I enjoy a tough debate, and hope you feel the same. I sincerely hope you are able to respond, and fill in the gaps in your argument – or even better, are ready to concede a few points, and make some changes for the better in Cato's energy policy. I am also very curious to hear from the Cato scholars whose views you directly contradict: the supply-siders, Edwards, Rahn, Mitchell, et al., and the health and education reform advocates. Do they see the contradictions? Do they agree with your tax-cuts-lead-to-debt critique? Do they agree with me that tax cuts remove government, and so are economically different and superior to any of the tax-and-spend interventions you initially preferred? Do they think that the approaching big-gov energy disaster is somehow different from the education and health care disasters, and so requires a different logic and response?

I'm all ears.

R. Randolph Richardson, Green Energy Tax Cuts Beta Blog

†As I said in my original remarks: "Most subsidies, even tax credits, can allow unprofitable companies to seem profitable. Tax cuts, however, cannot make the unprofitable profitable, so only real solutions will survive. [I]f broadly applied, tax [cuts] will allow the market, not the government, to pick the specific winners among clean technologies."
†† You at least partially admit green energy tax cuts would promote prosperity when you agree that taxes harm prosperity.

Thursday, January 1, 2009

Apostle to Cato

What follows is an utterly bizarre philosophical tango between myself and Jerry Taylor, Senior Fellow at the Cato Institute. Bizarre, because it features a reportedly libertarian Cato scholar arguing that tax hikes and government spending make for better policy than tax cuts, at least when it comes to alternative energy. This is strange, because when it comes to anything else, Cato scholars invariably – and rightly – prefer tax cuts to tax hikes, spending, or just about any other big government approach one might name. But here is Jerry, openly flirting with at least elements of the Big Government Disaster.†

Jerry goes on at some length about what he sees as the failings of the "libertarian faith" concerning tax cuts. So be it. As an apostle of reason, then, and not faith, I reach out to Jerry and all the Cato brethren to say: Re-examine your reason; be wary of contradictions lest ye stumble into disaster and miss the way forward out of the wilderness.

Some Cato scholars will, I am sure, instantly see as much and more. May they strive to spread the grace of reason. For Jerry's approach – inconsistent with the best reasoning to be found at Cato concerning taxes, spending, tuition tax credits, tax free health savings accounts, and much else – will undoubtedly leave us defenseless to the approaching Big Government Disaster that will hit the energy sector (and economy with it) within months. Just as it damaged our health care system and destroyed American education decades ago. Cato can only play valiant catch-up in these areas with innovative tax cut proposals. But now, before the storm hits, if Cato heeds the apostolic call, armed with the sound reason of a new innovative green tax cut proposal, there is a chance to avert a new and similar disaster completely, before it ravages our energy sector and economy.

So forget the distracting controversies of global warming and oil dependency. Let us rather keep the following firmly in mind. If, as many Cato scholars argue, cutting taxes is the best thing to do right now to stimulate the economy, then cutting some taxes is the next best thing. If avoiding mandates, tax hikes and federal investment schemes is also good, then let's do even better by substituting tax cuts instead. You do what is possible. Right now, the progressive agenda gives us the opening, because we can show progressives how to accomplish their most cherished green goals better than they can themselves – and in doing so, we can lift the economy and demonstrate the power of smart tax cuts to help America prosper and shift green. Who knows? Tree huggers and progressives may even come to love tax cuts.

All this continues a fascinating Google Knol debate which asks whether alternative energy deserves government support. Jerry, and Peter Van Doren of Cato, argue no; Joseph Romm, editor of the blog at the Center for American Progress, says yes. And I, in comment, offer up a compromise for libertarians and progressives alike: broad supply-and-demand-side tax cuts on green energy, vehicles, infrastructure and efficiency, in order to supercharge green energy investment, entrepreneurship and employment, reduce energy prices, and boost the overall economy (and, as a bonus, save the auto industry without a bailout).

In his reply, I note that Jerry never once disputes the benefits resulting from a green tax cut, contenting himself with some theoretical objections, and surprising un-Cato-like preferences for taxes and subsidies. So those benefits stand as yet unchallenged. Well and good. Let's talk about Jerry's concerns, and he can respond as he likes. I welcome comments from all my readers, and on this post, especially from anyone at Cato or the Center for American Progress. Maybe we'll hear from Joe. Readers can find here below, slightly redacted, my knol comment first, Jerry's reply next, and my current response below that.

Thank you, Jerry, for your thoughtful reply to my comment. As an apostle of reason, I offer new wine for the new year to you and the brethren of Cato. Perhaps if we libertarians use our time in the wilderness wisely, we can save ourselves, the wilderness and capitalism too.
†We should note up front that I am in no way calling for a litmus test for Cato scholars. I am saying that internal contradictions could be a sign of a flawed argument, and so deserve to be carefully noted and considered. I am also saying that Cato should consider and adopt new ideas consistent with and building on existing Cato models.

My Knol Comment:
Why not tax cut our way to a greener future?

Jerry/Peter and Joe may seem poles apart, but perhaps they have simply failed to realize that not all incentives are equal. There is at least one undiscovered option that should work far better than anything Joe has proposed, and should appeal to any serious follower of Milton Friedman.

Try this on for size: total tax freedom for all green energy sources, infrastructure and vehicles. Zero sales or income tax (or capital gains tax on stocks and dividends) in proportion to the percentage of a company's revenue that comes from green energy sources.

Now, I'm not going to make all possible arguments about this here and now. But I will say this. Tax freedom is utterly unlike any subsidy or incentive that has been discussed in this debate so far, in several critical respects. Most subsidies, even tax credits, can allow unprofitable companies to seem profitable. Tax cuts, however, cannot make the unprofitable profitable, so only real solutions will survive. And, if broadly applied, tax freedom will allow the market, not the government, to pick the specific winners among clean technologies.

There can be no doubt that tax freedom or even sharp tax cuts for green energy will supercharge investment in this vital area of entrepreneurship well beyond anything Joe or the President-elect has proposed, creating millions of new jobs. Obama's proposed $150 billion direct investment over ten years simply cannot compete with what the private sector can do if unleashed and properly motivated with low-or-no taxes. ExxonMobil itself would shift green in order to become tax free. And, by the way, this proposal would swiftly bring massive new debt and equity investment to a green-shifting auto industry, obviating the need for bailout, bankruptcy or socialist takeover.

Why Joe should love this is obvious. It is massively more effective than the incentives he has proposed, and does not cost a dime of federal spending upfront.

Why Jerry and Peter should love this goes to the heart of what Cato is about. Milton Friedman once said "I am in favor of cutting taxes under any circumstances and for any excuse, for any reason, whenever it's possible." There are plenty of other arguments I could make about putting downward pressure on energy prices, etc. But this one is the clincher: it is a TAX CUT. As such, the net benefit to the economy from cutting taxes will be positive. Forget global warming, forget foreign oil dependency. If, as many Cato scholars argue, cutting taxes is the best thing to do right now to stimulate the economy, then cutting some taxes is the next best thing. You do what you can.

Tax cuts are fundamentally different from most tax-funded subsidies: federal spending or "investment," mandates, bold new initiatives to pick this or that particular winner, even tax credits. All of those create economic drag and have other negative blow-back, none have the pro-growth benefits of a broad tax cut.

One last thing. As a Cato donor for decades, I can't begin to express my dismay that a Cato Fellow would extol the virtues of a carbon tax (or any tax hike). Or the unenforceable boondoggle that is cap-and-trade, a carbon tax by another name. Our economy is reeling from the 500% oil price rise over the last five years -- which may likely return if the economy attempts recovery -- and you want to make oil cost more? Do you want to bring on a depression?

But at least I am glad that you like the principle behind the carbon tax, which is that the best thing to do, if anything, is to adjust any price discrepancy between fossil fuels and clean energy. Because a green energy tax cut really amounts to the double negative of a carbon tax: it is a no-carbon tax cut. Same price adjustment, superior result. Why? Tax cut, not tax hike.

Think tanks like Cato need to wrap their head around the notion that green energy incentives are coming, like it or not. Many of those incentives could do major damage. Cato and it friends should champion the one incentive that won't do that kind of harm and that will actually do a great deal of good: a green energy tax cut.

R. Randolph Richardson
The Green Energy Tax Cuts Beta Blog

Reply of Jerry Taylor, Senior Fellow, Cato Institute:

There is no universal consensus on the matter of tax cuts here at the
Cato Institute, so the opinion I am about to express should not be taken
as a reflection of the opinions you might find elsewhere in this
building. My take, however, is that the tax code should not be used to
encourage this or discourage that because I do not believe in having the
government direct capital flows in the economy and favor some
investments relative to others. Tax cuts are simply an indirect way of
doing this and are in one sense worse than more direct interventions
because tax preferences are less visible to third parties. Tax
preferences increase the cost of tax collection, decrease otherwise
desirable economic activity, create dead-weight losses, and produce less
economic efficiency as a consequence.

Nor do I buy the argument that tax cuts are always a good idea. Why is
it a matter of libertarian faith that it's better to pay for government
spending with a metaphorical credit card than with cash? The former
must be paid for in cash eventually ... with interest. That is, it will
cost society MORE to pay for government via debt than via taxes. All
that changes is the time in which the taxes are collected. Deficits
simply borrow tax receipts from the future ... which, in a sense, is the
same as borrowing economic growth from the future. It is not obvious to
me that a political system that forces people in some distant future to
pay for my government services today is somehow more libertarian than
one that forces recipients of government help to pay the bills to some
extent for that help.

Moreover, to the extent that taxes are reflections of the marginal cost
of government to the average voter, cutting taxes while increasing
spending reduces the marginal cost of government. It's no wonder, then,
that public appetite for government spending goes up whenever taxes are
cut. Do you doubt, for instance, that the $700 billion bail-out of Wall
Street or the likely $125 billion bail-out of Detroit would never get
off the ground if those programs had to actually be paid for by
taxpayers in the here-and-now?

The usual defense, however, is that tax cuts starve government of
revenues and thus, eventually, will starve-out government spending.
Unfortunately, there seems to be no functional limit on the federal
credit card and, thus, no empirical evidence that tax cuts = less
spending. In fact, in-house regression analyses that we've performed on
the matter show no clear relationship between the two ... an observation
that we shared with Milton Friedman before he passed away and a finding
that convinced him (in correspondence with us) that his "starve the
beast" hypothesis was likely wrong.

Regardless, there are less economically disruptive ways of promoting
renewable energy. Direct subsidy from the Treasury is preferable
because it avoids the inefficiency associated with a distorted tax code.
Cap and trade or a carbon tax would be even better. But do not confuse
that with a support for either policy. I do not favor a carbon tax or
cap and trade programs in the energy sector because I am convinced (for
the time being anyway) that focused adaptation is a less costly and more
effective means of dealing with climate change than emissions

Jerry Taylor, Cato

My Response:
The Remarkable Tango Keynesio

Jerry, I am very relieved to hear that your opinion on tax cuts is not universally shared at Cato. For when you suddenly shift from strict libertarian non-interventionism to argue that tax hikes (!) and direct federal spending are better policies than tax cuts to boost the green energy sector, the auto industry and the economy, you do-si-do right off the honest libertarian ranch only to fling yourself in the foul embrace of the old Tango Keynesio. Perhaps urbane types like Mr. Romm would not notice or care. But no, as a longtime Cato supporter and friend, I can't let you be led astray by this duplicitous gancho two-stepper.

So shaken was I by your fall into Keynesian ways that, after grabbing my smelling salts, I had to rush to check, and yes, your position is shockingly at odds with most of your Cato colleagues. For instance, just last month in the Washington Times, Cato senior fellow Richard W. Rahn demolished the notion that direct federal investment or subsidy (which you prefer to tax cuts) has any net beneficial effects, and proposed a broad array of, yes, tax cuts instead. Cato's Chris Edwards, in a essay called "Not Keen on Keynes," said much the same, and in contradiction to your argument that tax cuts increase government deficits, offers global evidence that various tax cuts do in fact boost tax revenues by strengthening the economy.

But it is not just the Keynesian bits, the tax-and-spend footwork, that is out of sync. It is the whole remarkable tango. Stepping back, we see your seemingly strong laissez-faire entrance is really a sort of unrealistic utopian libertarianism that is also out of step with Cato's usual realism. You take the position that "the tax code should not be used to encourage this or discourage that because I do not believe in having the government direct capital flows in the economy and favor some investments relative to others." But your position is at odds with some of the best real world campaigns in progress at Cato. Posted dead-center on Cato's home page in December we find Adam B. Schaeffer's excellent article, "School Tax Credit Can Help Kids and the State," arguing that the tax code should be used to encourage private schooling. Elsewhere, we find Michael F. Cannon proposing tax-free health savings accounts, which again use the tax code to encourage saving for medical expenditure, at the expense everything else from dry-cleaning to ExxonMobil.

Keeping it Real

Cato's real world libertarianism regarding strategic tax cuts seems to be nuanced as follows: Let's not use the tax code to favor this or that... unless the alternative is socialism or some other disastrous government boondoggle. Then in that case, a well-crafted tax cut to favor a popular social goal is absolutely the preferred way to go, because tax cuts foster growth, entrepreneurship and competition, and avoid the pitfalls of big government. If, as it seems, that is the larger Cato view, then, Hallelujah, praise the board! But your position ignores the looming big government disaster, spurning realistic tax cut alternatives in favor of unrealistic, no-win do-nothingism.

Fortunately, the Cato board apparently disagrees with the no-win do-nothing approach in education and health care. Sadly, Cato was not in the game back when public education and health programs were first created. Otherwise, we might now enjoy education tax credits, vouchers or tax-free health savings accounts, instead of playing catch up with a host of big-gov disasters in place, all very difficult to reform or remove.

Clearly, the same situation is now at hand with green energy. As with education and health care, the public has determined overwhelmingly that it wants some kind of government support for renewable, cleaner, more efficient energy technology. That is not just evident in the polls: it is here, now, a clear fact that the new administration will certainly enact extensive new forms of public support for alternative energy and energy efficiency in mere months. Many of these (cap and trade, Federal "investment" subsidy) could be damaging to the economy and impossible to remove... unless good people, like you folks at Cato, get in the game NOW, stop with the do-nothing rhetoric that earns only scorn, and champion tax-cutting, pro-growth, market oriented strategies like green energy tax cuts. Otherwise, you are going to be playing catch up in 5, 10, 20 years, facing entrenched big-gov programs, proposing exactly these kinds of alternatives then, and wishing you had acted earlier.

Not only is your utopian do-nothingism out of step with the above ongoing campaigns at Cato, that you ignore negative externalities makes it out of sync with basic economics. Sure, in a perfect world, government should not intervene in the markets to favor one group or another. But it is also well accepted among economists of all stripes that if one industry (say fossil fuels) is creating a mess for which everyone else must pay ("negative externalities"), then price adjustments through taxes or other means may be warranted. This is ultimately decided not by economists, but subjectively by an annoyed public, for – never mind the complex climate and security controversies – how do we really price the bulldozing of our purple mountain majesties, or oil slicks on either shining sea? You are ignoring the 800 pound gorilla: the public has determined that big negative externalities exists, whether we agree, or not.

The Only Question That Matters

Since massive government intervention is on its way, like it or not, doing nothing is a lost argument, hence nearly irrelevant. The only real question becomes, what would be the least damaging, most beneficial intervention?

(I am setting aside "focused adaptation" because it does not address the various negative externalities beyond climate change; the policy is also extremely unlikely to be adopted in the near future; and the policy serves simply as a subsidiary argument supporting your basic proposal that we do nothing right now – which, again, is not going to happen.)

So let's focus on the policy alternatives that will likely become legislation very soon: various tax hikes on carbon, fossil fuels or oil company profits; pay-to-play cap-and-trade; various clean energy mandates; massive Federal "investment" (i.e., subsidy). Because of their likelihood, these are the only alternatives that really matter when evaluating green energy tax cuts. Half of the benefit of the Green Energy Tax Cut proposal lies in avoiding exactly this disaster. And here you are preferring it. I tell you, Jerry, I feel like Alice in Wonderland when I have to defend tax cuts to a Cato scholar who prefers big government programs.

It should not surprise us that when you start down the path of favoring tax and spend policies over tax cuts, not only do you contradict your fellows at Cato, you contradict yourself. For instance, you say:

"Direct subsidy from the Treasury is preferable because it avoids the inefficiency associated with a distorted tax code. Cap and trade or a carbon tax would be even better."
You say you don't like "a distorted tax code," then say you prefer a carbon tax. Hello Jerry. This makes no sense. A carbon tax is itself a tax code distortion, actually a far worse one than a green tax cut, as you yourself explain and we shall see. But first, let's notice that you also contradict yourself in the first part of your statement: "subsidy... avoids the inefficiency associated with a distorted tax code." Not so, as you explain at length to Joseph Romm. To pull out just one of your many anti-subsidy remarks from the debate, you said:

"Subsidies... re-direct investment flows from more profitable to less profitable activities and thus will impoverish the economy."
That sounds like a pretty bad distortion, Jerry. In fact subsidies can create a worse economic distortions than broad based tax cuts, especially if these take the form of the Federal "venture capital" investments promised by the Obama campaign. These will only train green entrepreneurs to shower donations on politicians in hopes of preferment. If history is our guide, subsidies and "investments" will often be handed out for political reasons, and the resulting inefficiency and corruption of American entrepreneurship will be enormous.

But you already know all about this kind of distortion, because (in another example of the same self-contradiction) you yourself brilliantly list for Joe the long history of failed and politically motivated bad government "investments" in the alternative energy industry. By contrast, an across the board green energy tax cut does not favor one particular green company over another, but lets the market pick the winners -- without any of the massive distortions from politically determined subsidies that you describe.

To Tax, Or Not To Tax?

Now, going back to carbon taxes, how do we know that distortion from a carbon tax hike would be economically worse than from a green energy tax cut? You point the way when you argue that: "Tax preferences... create dead-weight losses, and produce less economic efficiency as a consequence..." Both options are tax preferences, so equal on that score. The difference is, tax hike versus tax cut. We know that a carbon tax would entail more dead-weight loss because economics 101 says that tax hikes create dead-weight losses, but tax cuts eliminate them. For anyone who is wondering what a dead-weight loss is, here is a nice little description that sums it up. Any tax prices out some consumers who can't afford it, creating losses for both those consumers and the producers, who sell less. Eliminate the tax, and you eliminate the loss.

This dead-weight loss analysis is a technical way of saying that tax hikes depress economic activity and tax cuts boost economic activity. So if you need to adjust a price in the market, the better way to do it is with a tax cut, not a tax hike.

And by the way, lest anyone be misled by jargon, the distortion caused by the politically determined subsidies Jerry favors is ALSO a dead-weight loss, and as noted, far more damaging than a broad tax cut. Contrary to what Jerry implies, subsidies do not have any dead-weight loss advantage over tax cuts, rather the reverse.

Thus far, your arguments for favoring subsidy and carbon tax hikes are self-contradictory. You have not advanced any logical, non-contradictory arguments to support these preferences. This is the predictable result of doing the Keynesian Tango. Those sly sacada steps will trip you up every time.

Paths of Error

The rest of your arguments may or may not be self-contradictory (I have not read everything you have written). They are, however, wrong:

1) "Tax cuts are... worse than more direct interventions because [they] are less visible to third parties." Not so. As I am sure all your Cato fellows are keenly aware, no third party can see any of the $2 trillion dollars of entirely invisible direct investment that the Fed has recently doled out to God knows which banks, because they aren't telling. By contrast, tax cuts are extremely visible to market participants, featuring prominently in any sales or investment pitch when relevant. Tax cuts in fact must be visible if they are to work as planned. It is the back room deals to subsidize in this or that particular company, the approach you prefer, that are truly invisible and pernicious to boot.

2) "Tax preferences increase the cost of tax collection." T'ain't necessarily so. Tax cuts, as your Cato colleagues will tell you, increase tax compliance, so decrease the cost of tax enforcement. Besides, a carbon tax would have the same objection (oh, hey, there's a self-contradiction!) only the enforcement costs would be even greater, because compliance would be worse. Cap-and-trade would require the cost of a huge bureaucracy to give the illusion that the program is enforceable and not running off the rails. All "direct interventions" you favor would have similarly huge administrative costs. Indeed it is safe to say that the administrative costs for each of these tax and spend options would be far larger than for green energy tax cuts, which could possibly lower tax collection costs through better compliance.

3) "Tax preferences... decrease otherwise desirable economic activity." OK, well, this is part of the same self-contradiction again. For the above merely tweaks the dead-weight loss argument a bit, so the same objection applies to both carbon tax and subsidies, only more so. But the formulation is noteworthy.

Let's be clear, the economic activity that is principally decreased here -- oil and coal consumption -- is not really all that desirable in the eyes of the American public. All the policies we are discussing are supposed to do just that. The key difference is that tax and spend policies drag the entire economy down in the process, while green tax cuts, like any tax cut, will help boost not only the entire economy, but can also help the oil and coal companies profitably diversify in clean green ways, becoming increasingly tax free the greener they get. So everybody benefits.

In fact, strategic tax cuts or hikes, focussed on the energy sector, will have a 2X effect, positive or negative, for a cumulative 4X difference in outcome. Energy is such a key input in the economy, like taxes or interest rates, that energy price changes can have a big impact on economic health. A tax cut in the energy sector will have all the benefits of a normal tax cut (benefits for the energy sector, etc.) plus the added benefit of lower energy prices stimulating the entire economy. A carbon tax, would have a double negative effect: all the dead-weight harm to the industry from a fossil fuel tax hike, plus the harm of higher energy prices for all.

That is why the energy sector is the best possible area to target for a strategic tax cut, because the benefit of that tax cut is immediately passed on to the rest of the economy through reduced energy prices. That is also why a gas or carbon tax would be an economic disaster at this time, because that tax hike is also passed on. So it is clear that a carbon tax would "decrease otherwise desirable economic activity" to a huge degree, while a green energy tax cut would actually benefit the whole economy, net of net.

Indeed, the net economic benefit is even greater than that, for if we include tax cuts on energy efficiency, we get an additional multiplier effect by factoring in those gains. If our cars and refrigerators use less energy, not only do we consume and pay less, but that reduced demand puts even more downward pressure on energy prices. Those combined saving are also passed on to the entire economy, like a broad tax cut.

Like a broad tax cut? Actually, it really is a broad tax cut, because the benefits of a strategic green energy tax cut flow through so easily via energy prices, because the double multiplier effect magnifies the benefit to all. Since Cato stands no hope of getting a broad across-the-board tax cut passed in the next several years, this is certainly the next best thing.

What is in it for Oil and Coal?

Now, you may argue, why should the oil or coal industries suffer? I would agree. They should not. But they would definitely suffer a great deal under the punitive anti-fossil-fuel tax-and-spend policies you and the Democrats currently prefer. By contrast, under the green energy tax cut proposal, those industries are offered a massive opportunity to simultaneously diversify and reduce all corporate taxes (sales, income, interest income, even shareholder's capital gains taxes) by shifting green. Think of it. Companies like ExxonMobil are currently sitting on mountains of cash that the Democrats would like to take away from them. Now we all know they will have to diversify someday. Why not now? How about instead of the punishing policies you prefer and the Democrats will likely enact, we let them keep all that cash and even reduce their taxes by diversifying into the most promising green energy investment available? How would ExxonMobil feel about becoming the leader in not just oil, but in every clean, green energy source... which they could certainly do with their piles of cash. How would they feel about becoming increasingly tax free? And then, when fuel competition has increased to the public's satisfaction through strategic tax cuts, we will have an object lesson in the power of tax cuts, and an excellent case for across the board tax cuts to decrease dead-weight loss, boost the economy and raise revenue.

But Wait: Jerry Hates Tax Cuts!

Oh right. To me, this is the most puzzling part of your footwork, the pro-tax anti-deficit interlude. For in this passage, you may not be contradicting yourself, but you are not exactly contradicting me either. I am not sure who it is you are debating with here, or who you think believes in the "libertarian faith." Not me. I like my libertarianism grounded in reality and reason. I don't know who put the jam in your jelly with the "starve the beast" hypothesis. Wasn't me. I don't know who is calling for debt financing. Not me.

For the record, the Green Energy Tax Cut proposal pays for itself as follows: the elimination of all direct subsidies for energy ($16.6 billion for oil, coal, nuclear, renewables, biofuels, etc.), agriculture ($20 billion), and vehicles; elimination of all proposed and existing federal programs to invest directly in alternative energy including nuclear ($30 billion); elimination of mandate programs; elimination of all proposed cap and trade programs; legalization and taxation of hemp. Total saving: about $66 billion per year, minimum.

In addition, if your colleague Chris Edwards is right that reducing US corporate taxes by 14% would maximize tax revenues, then if the revenue curve is bell shaped, reducing them by 28% would most likely be revenue neutral. (These numbers serve only to illustrate; other economist might offer other figures.) That means green energy corporate taxes can likely be cut by up to these amounts and pay for themselves with no offsets. (Very likely green energy corporate taxes can be cut by more than these amounts because tax cuts in the energy sector flow through easily, with multiplier effects, to the rest of the economy, producing more economy wide growth and tax revenue than your average corporate tax cut.) A well designed Green Energy Tax Cut plan could produce both a textbook Laffer curve revenue increase, and a spending reduction by replacing wasteful programs.

The only pro-tax argument you make that addresses my proposal is your notion that tax cuts should be avoided because they encourage over spending by reducing its marginal cost to the tax payer. But deliberately raising taxes in hopes that spending will decline strikes me as a rather backwards policy, not supported by evidence. Cato's in house regression analysis found "no clear relationship" between tax cuts and spending. That implies that while tax cuts do not "starve the beast," you actually have no evidence that tax hikes reduce spending either. Tax rates seem not to affect spending, apparently. So better to tackle the spending directly, and impose balanced budget requirements or debt limits, as many states do. The pro-growth, Laffer curve benefits of tax cuts should not be lost because doing so will not reduce spending, according to your evidence.

The Bottom Line

Analysis of your principle arguments reveals the following. Relative to green energy tax cuts, carbon taxes and politically distributed subsidies would have higher administrative costs, decrease desirable economic activity to a far greater degree, create more dead-weight loss, and produce less economic efficiency as a consequence. Political subsidies and carbon trades would also be less visible to third parties, so more liable to misbehavior. Green energy tax cuts would improve compliance, pass on tax cut benefits to the entire economy, and eliminate dead-weight loss. As such strategic green energy tax cuts are preferable because they avoid the greater economic inefficiency of the other alternatives, and actually confer a net benefit, acting in effect like a broad tax cut for the whole economy.

Indeed, a successful green energy tax cut today becomes an excellent argument for an actual economy-wide tax cut tomorrow. If we can point to a revived and greener auto industry, a strong stable US economy, US world leadership in the burgeoning green energy sector, the majority of global green energy investment passing through US capital markets, massive advances in energy efficiency and emissions reduction, increased energy competition and supply, lower, more stable energy prices, millions more jobs, increased tax revenues, cleaner, more diversified energy companies, and finally, the Big Government Energy Disaster averted, this can all become a teachable moment. Cato would look like a champion, with a great new argument for eliminating tax and spend social policies and slashing taxes across the board.