The Whys and Hows of Energy Taxes: The 20th-Century Policy Aimed at Developing Domestic Energy Sources No Longer Makes Sense. the 21st Century Demands a Fresh Approach

Article excerpt

Current federal energy tax policy is premised in large part on a desire to achieve energy independence by promoting domestic fossil fuel production. This, we argue, is a mistake. The policy also relies heavily on energy subsidies, most of which are socially wasteful, inefficient, and driven by political rather than energy considerations. Finally, the energy taxes that are in place could be more precisely targeted to specific market failures, and these higher taxes themselves would encourage the production of alternatives more efficiently than do current subsidies.

It is widely held that the United States must reduce its reliance on foreign oil. The concern over U.S. vulnerability to the disruption of supply by the Organization of the Petroleum Exporting Countries (OPEC) is understandable, given the fact that the United States imports over 60% of the oil it consumes each year. Of the oil that the United States imports, 40% comes from OPEC countries and nearly half of that from the Persian Gulf region. Many Americans are also concerned that oil monies help countries such as Iran pursue activities that are contrary to U.S. foreign policy.

As a response to these concerns, current tax policy promotes domestic oil and gas production in a variety of ways. The federal government provides a production tax credit for "nonconventional oil" (essentially a subsidy for coalbed methane), generous depreciation allowances for intangible expenses associated with drilling, and generous percentage depletion allowances for oil and gas. In addition, the Bush administration has consistently lobbied to allow additional drilling on the Alaskan North Slope.

This supply response ignores a fundamental fact: Oil is essentially a generic commodity priced on world markets. Even if the United States were to produce all the oil it consumes, it would still be vulnerable to oil price fluctuations. A supply reduction by any major producer would raise the price of domestic oil just as readily as it raises the price of imported oil. In addition, if the United States reduces its demand for oil from countries such as Iran, it has little effect on Iran, because that country can just sell oil to other countries at the prevailing world price. Indeed, this effect has been made abundantly clear by historical experience. The United States has cut its dependence on Iranian oil to zero, buying no oil directly from that nation since 1991. Despite the U.S. import ban, Iran was the world's fourth-largest net oil exporter in 2005.

A policy of energy independence that depends on boosting domestic oil and gas supplies through subsidies has several defects. First, subsidies reduce production costs and so do nothing to discourage oil consumption. Second, the policy encourages the consumption of high-cost domestic oil in place of low-cost foreign oil. A policy to encourage the United States to use up domestic reserves and thus become increasingly vulnerable in the future to foreign supply dislocations seems especially peculiar to us. Third, it is expensive. The five-year cost simply for the incentives mentioned above totals nearly $10 billion, according to the most recent administration budget submission.

Assuming that reliance on oil is unattractive, a clear sign that policy is headed in the wrong direction is the high and even recently increasing dependence on oil of the U.S. economy. Petroleum accounted for nearly 48% of primary energy consumption in the United States in 1977. Since this peak, it fell to a low of 38% in 1995 before inching up to just over 40% in 2005. Even going back to 1977, the 16% drop in the oil share from its peak to 2005 falls far short of the percentage reduction in oil share of other developed countries. The United Kingdom, for example, has reduced its oil share from a peak of 50% to just under 36%. France has reduced its oil share by 48% and Germany by 22%. In Asia, Japan has reduced its oil share by 39%, and even China has reduced its oil share by more than has the United States, with a 26% reduction. …