Posted by: bmeverett | March 30, 2013

The IMF should speak English


Congressman George W. Julian recalled discussing a confusing political question with President Abraham Lincoln: “[Lincoln] used to liken the case to that of the boy who, when asked how many legs his calf would have if he called its tail a leg, replied, ‘Five’, to which the prompt response was made that calling the tail a leg would not make it a leg.”

Let’s listen to Lincoln on this critical point and speak English. It’s a really nice language with an extensive and precise vocabulary. Unfortunately, our political discourse has degenerated into confusion and babble as people try to redefine terms to support their political agendas. In introducing the Senate budget proposal, Budget Chairman Patty Murray (D-WA) called tax increases “cutting wasteful spending in the tax code.” A tax increase is a precise term. Calling it a spending cut doesn’t change anything.

The International Monetary Fund (IMF) (established to manage a fixed exchange rate system that no longer exists and costing about $1 billion per year to operate) has just weighed in on the issue of energy subsidies with a clarion call for increased energy taxes. The IMF study evaluates two types of subsidies around the world. The first is called “pre-tax” subsidies, defined as government policies designed to keep energy prices below market levels. The IMF analysis here is reasonably balanced, but tells us nothing new. In 2011, governments subsidized energy to the tune of $500 billion per year – a conclusion similar to that reached by the International Energy Agency in its study last year. About half of this amount is attributed to countries in the Middle East and North Africa, particularly oil producing countries like Saudi Arabia who sell gasoline to their citizens at absurdly low prices of $0.50 per gallon or less. The study acknowledges that such subsidies are negligible in the US and other advanced countries.

It’s no big surprise that developing countries lack basic free market institutions and that the largely undemocratic governments in these countries subsidize many basic commodities to try to keep the peace among unhappy and frustrated populations. If the IMF wants to convene a meeting and encourage the Saudis, Iranians, Venezuelans, Nigerians and Russians to allow free market pricing for energy products, they have my blessing. That issue, however, has nothing to do with the United States.

The IMF study then falls off the cliff with its analysis of “post-tax” subsidies, which it claims totaled $1.9 trillion in 2011. I have discussed the fallacies associated with the energy subsidy argument in previous posts (see “The Oil Subsidy Myth” from February 17, 2012). The IMF study falls into all these traps and more. Let’s take a deep breath and go through the IMF’s analysis.

First and foremost, the study conflates three different economic concepts. A subsidy is defined by Webster’s dictionary as “a grant by a government to a private person or company to assist an enterprise deemed advantageous to the public”. This is a perfectly good definition and we should stay with it. Personally, I would take no exception to the inclusion of tax credits in this category, since a tax credit is the grant of government money by excusing a payment normally due from a private person to the government. If we use the word “subsidy”, we should use it in its precise sense.

The IMF, however, expands the definition of subsidies to include a failure to tax. This strange construct is very common in Washington where government is the core institution of society, but it makes little sense to anyone else. The IMF analysis assumes that there is a “correct” level of energy taxation that can be defined as either the prevailing level of VAT (value added tax or national sales tax) or, for countries like the US which have no VAT as “the average VAT rate of countries in the region with a similar level of income”. This definition assumes that there is a proper model of governance and that it’s not the US model. European governments take a significantly larger share of GDP than does the US (at least for now). The difference derives from a 200-year old argument about the proper roles of government and the private sector, the size and scope of the welfare state, the nature of economic planning, the role of civil society and many other critical and highly debatable issues. The IMF study essentially assumes (as do President Obama and the Democrats) that the American government is too small and insufficiently powerful. Americans on the whole have never believed this, and it’s not at all clear that they believe it now.

The IMF study then turns to the question of externalities. In economics, an externality is the cost of a transaction which is (a) imposed on people not party to the transaction and (b) not reflected in the price. Pollution is the classic example of an externality. The concept is valid and worth addressing, but it’s not the same thing as a subsidy. Grouping subsidies and externalities together confuses rather than clarifies.

We deal with some externalities, like dumping toxic waste in the river, by prohibiting the activity. For other externalities, however, like sulfur emissions from power plants, we use a tax or “cap-and-trade” system to ensure that we mitigate the externality without killing off the underlying economic activity. In order to use the latter approach, however, we need to have some idea of the value of the externality. Otherwise, we can’t set sensible limits or taxes. Unsurprisingly, the IMF focuses on climate change as the critical externality of fossil fuel use and offers $25/metric tonne as the “correct” tax level. According to the IMF, anything less than $25 should be considered a subsidy. That’s complete nonsense. As discussed in numerous posts, we understand very little about the influence of carbon dioxide emissions on the climate. We have no idea whether increasing levels of carbon will cause an accelerated temperature rise, how high temperatures might rise, when such rises would occur or what their impact on society would be. How in the world can we establish a price? The IMF uses a typical bureaucratic answer. They simply use the result of the United States Interagency Working Group on Social Cost of Carbon from 2010. Committees can do useful work, particularly in characterizing the state of knowledge on a particular problem. Committees cannot, however, answer every possible question. For example, how many intelligent species are there in the universe? The answer is that we don’t know. If you get the best scientific minds together for six months and ask them to come up with an answer, they might give you a guess, but it would be meaningless. As another example, which team will win the World Series in the year 2100? We know the teams and the players for the 2013 season, and can’t make a meaningful prediction six months out. A Committee on Future World Series Winners might offer an opinion, but it would have no predictive value. Zero.

The US currently emits about five billion tonnes of carbon dioxide annually. A $25/tonne tax would initially cost American consumers $125 billion a year. The IMF wants us to impose such a tax on the basis of a government committee’s analysis of a problem they don’t understand. Seriously? Given the dominance of Chinese carbon emissions, a $25/tonne tax in the US is unlikely to have any impact on global carbon (See my post “The Great Climate Change debate from March 7) but would most certainly have severe impacts on the US economy.

The IMF report also offers higher energy taxes as a way of reducing the externalities of traffic congestion and vehicle accidents. First, these issues don’t really qualify as externalities. It’s a bit of a stretch to argue that other drivers are imposing a cost on me by driving on my road. We treat most roads as public goods, and the real problem is that their use is priced at zero. Economics 101 tells us that free goods tend to be over-consumed. For many years, we lacked any practical road pricing mechanism. I can remember driving on the Garden State Parkway in New Jersey and repeatedly waiting 10-15 minutes to pay a 35¢ toll, much of which just covered the cost of collecting the money. Fortunately, we now have transponder technology, such as the E-ZPass, which allows us to pay tolls without even slowing down. Furthermore, tolls could be set by time of day. Applying pricing to roads is a much better way to manage congestion than increasing gasoline prices. Accidents are fully priced into car costs through insurance premiums and do not require any policy intervention.

The study assigns about $500 billion of energy subsidies – a quarter of the global total – to the US, making us one of the biggest global miscreants. The study doesn’t document, however, how this number is calculated. If the IMF is saying that the US is guilty of not imposing either a national sales tax or a carbon tax, it has strayed way outside of any meaningful definition of “subsidy”.

Having started with a useless definition of the term “energy subsidy”, the IMF report then proceeds to combine all the countries of the world into a single group and to propose a series of recommendations for everyone to follow. The circumstances of countries differ so sharply that global recommendations are (like just about everything else in this study) meaningless. Does the IMF seriously think that Iran and the US need to apply the same economic policies? Should we study global drug violence and develop a set of recommendations equally applicable to Mexico and Luxembourg?

The IMF study implies that all countries, including the US, should implement their universal recommendations. An underlying assumption of the study is that biggest problem governments have is providing for the poor and that insufficient energy tax revenue robs governments of the funds needed to meet that objective. That may be true in Bangladesh or Haiti, but it’s certainly not true in the US. “Poor” American families generally live in quality housing, have one or two cars, a full set of home appliances, 2-3 color televisions, cable TV, home computers and internet service. Most US entitlement programs (which are indeed underfunded) benefit middle class or even upper middle class families.

To make matters even worse, the IMF recommends that governments “de-politicize” energy pricing by making its recommended price increases automatic under the supervision of “an independent body”, presumably one not accountable to the public. It is annoying to bureaucrats when the public objects to massive tax increases based on staff analysis and interagency task force recommendations, but politics is the process by which societies make difficult decisions. Since early colonial times, taxation in the United States has been THE critical political issue. Remember “No taxation without representation”? The IMF’s preferred slogan is “Representation impedes taxation”.

Not to worry, however. The IMF study also recommends “consultation with stakeholders”. Such consultation allows the bureaucrats to ease the concerns of the public without actually allowing the public to make decisions. In other words, democratic institutions are to be replaced by clearer explanations from the government. If the public really understood what the bureaucrats were trying to achieve, people would understand and be supportive. You cannot, however, allow the citizenry (known in government circles as “special interests”) to get in the way of what’s right.

It would be easy to dismiss this study as just another terrible piece of analysis. Unfortunately, it feeds into the common misconception that fossil fuels dominate our energy economy because of heavy subsidies, rather than because of their low cost and high performance. The storyline from the Washington Post, for example, reads “IMF: Governments need to end energy subsidies”. The New York Times says, “I.M.F. Calls for Curbing Fuel Subsidies”. Most people will see these headlines without reading the study and come to exactly the wrong conclusions.

The IMF is an institution that is supposed to help the global economy deal with financial disruptions and crises, making use of its nearly $800 billion in capital. The energy subsidy report, however, reveals a strong preference by the IMF staff and management for autocratic political institutions and central planning. Why in the world would we entrust these people with anything?

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