Topic: Energy and Environment

IRS Can’t Manipulate Tax Code to Generate More Revenue for Itself

This blogpost was co-authored by Cato legal associate Matt Gilliam.

An American energy company called PPL bought one of many state-owned British utilities privatized in the 1980s. In 1997, PPL thus became subject to the UK’s new “windfall tax,” which was based in part on “profit-making value”—the utility’s average annual profit multiplied by an imputed price-to-earnings ratio.

Various American energy companies subject to this tax filed claims with the IRS for a “foreign income tax” credit, which the IRS denied in 2007, asserting that the British tax was not a creditable one under the “foreign income tax” provision of the Internal Revenue Code (Section 901). The IRS claimed that the windfall tax did not satisfy the “predominant character” standard (was not predominantly an income tax) because the British statute used the term “profit-making value” instead of “net income” and “gross receipts,” and the tax rate was defined “as a percentage of an imputed value … rather than directly as a percentage of net income.”

After the federal tax court held that PPL was entitled to the foreign tax credit, the U.S. Court of Appeals for the Third Circuit reversed. Explaining that a tax exemption is a privilege extended by legislative grace, the appellate court held the tax not to be creditable because it reached beyond realized profit and did not tax actual gross revenue. In a different case last year, however, the U.S. Court of Appeals for the Fifth Circuit held that the British windfall tax was indeed creditable because (1) it reached realized income and (2) gross revenue was an inherent part of the calculation. The Fifth Circuit explained that the form and label of the foreign tax are not determinative and that the predominant character standard requires the IRS to analyze the history and intent of a tax to assess whether it tries to reach some net gain.

Cato now joins Southeastern Legal Foundation and Goldwater Institute on an amicus brief in urging the Supreme Court to take PPL’s case because it implicates fundamental issues of property rights, free markets, and the arbitrary exercise of government power—and the circuit split creates uncertainty for American businesses overseas. We argue that taxpayers have the right to be free from double taxation and that here the IRS and Third Circuit improperly disregarded the substance of the windfall tax and applied an overly rigid construction of its terms.

Ultimately, a foreign tax’s form or label cannot mask its substantive character and intent for legal purposes. American businesses operating overseas should be able to rely on a stable, substantive application of U.S. tax law instead of arbitrary interpretations and constructions manipulated to generate payments to the IRS.

The Supreme Court will decide this fall whether to hear PPL Corp. v. Commissioner of Internal Revenue.

The Lacey Act: Protectionism through Criminalization

This week Gibson Guitars reached a settlement agreement with the Department of Justice to end a highly publicized criminal case involving wood imported in violation of the law of Madagascar.  Gibson was accused of violating the Lacey Act, an old federal law that since 2008 has made importation, sale, or possession of certain forest products a criminal offense.  The case gained notoriety after FBI agents conducted fully-armed surprise raids of Gibson’s Tennessee facilities and confiscated up to a million dollars worth of wood and guitars.  The move was condemned by politicians and activists concerned about over-criminalization and heavy handed enforcement by the federal government, and efforts have begun to reform the law’s most draconian provisions.

You can often learn a lot about a law by identifying its key supporters.  It’s worth noting, therefore, that proponents of the current restrictions in the Lacey Act include not just the predictable cadre of environmental organizations but also the American lumber industry and labor unions.  Why this peculiar alliance among traditional enemies?  As it turns out, the cost of compliance with reporting requirements and the risk of being slammed with huge fines and a criminal indictment for paperwork errors produce strong incentives to avoid buying foreign lumber altogether.  American consumers of lumber, which include productive, job-creating businesses like Gibson Guitars, cannot reasonably control whether a foreign supplier got all the right licenses and followed all local laws.  Ultimately, the Lacey Act enables domestic suppliers to avoid price-squeezing import competition in a way that harms law-abiding foreign suppliers, American consumers, and all sectors of the U.S. economy that make or use wood products.

The willingness to use government to achieve one’s ends can certainly produce strange bedfellows.  Protectionists these days like to paint their foreign competitors as devious cheaters whose unscrupulous ways give them an “unfair” advantage that the U.S. government should fix with trade barriers.  The effectiveness of this strategy prompted the tree-killing industry to team up with tree-hugging environmentalists to label their foreign competitors (and their own potential customers) as perpetrators or supporters of illegal logging and deforestation.  Environmentalists should remember, however, how that same finger-pointing rhetoric was used to justify the imposition of punitive duties on Chinese solar cell and wind tower manufacturers, and that free trade is the best path to advancing affordable clean energy in the United States and the world.

Perhaps one day environmentalists will embrace free-market solutions to both clean energy and forest maintenance, and all businesses will respond to import competition by improving quality and efficiency.  Until then, free traders will need to be eternally vigilant and willing to challenge protectionism in all its forms.  Reforming the Lacey Act is a good way to start.

Denver Fools the Wall Street Journal

“Denver rethinks the modern commuter,” heralds the Wall Street Journal. The article goes on to say that, instead of building parking lots at its rail stations, Denver is encouraging developers to build high-density, mixed-use developments. Somehow, this is supposed to be news.

Let’s think this through. First of all, no one is “rethinking the modern commuter.” The Census Bureau reports that transit carried less than 5 percent of Denver-area commuters in 2010, while more than 85 percent drove. Instead, what RTD, Denver’s transit agency, is rethinking is the role of public transit.

The old-style public transit system used cheap, flexible buses whose routes could be altered overnight to take people from where they were to where they wanted to go. When Denver first built rail, it substituted expensive but glamorous trains for inexpensive buses, but still allowed people to go from where they were–provided they were willing to drive to a park-and-ride station–to where they wanted to go–provided they wanted to go downtown.

Under RTD’s latest “rethink,” transit will no longer take people from where they are to where they want to go. Instead, planners will try to coerce and entice people to live in places served by rail transit and go where those rail lines go. On one hand, this is far more intrusive on people’s lifestyles; on the other hand, it is a far more limited view of the purpose of transit. Instead of “mobility for those who can’t or don’t want to drive,” the new purpose is “mobility for those who are willing to completely rebuild their lifestyles around transit.”

This has been tried before, of course, most notably in Portland. How well did it work there? In 1980, under the old bus-transit model, transit carried 9.8 percent of Portland-area commuters to work. By 2010, with seven different rail lines and scores of transit-oriented developments, transit carried just 7.1 percent of the region’s commuters to work.

The sad part is that the Wall Street Journal not only thinks this is newsworthy, but that it is laudable. In fact, it is government at it worst: inefficient, coercive, and unable to learn from past mistakes.

Transit should serve people and not the other way around. It is time to rethink the rethink.

Yes, Land-Use Regulation Does Increase Income Inequality

Harvard economists have proven one of the major theses of American Nightmare, which is that land-use regulation is a major cause of growing income inequality in the United States. By restricting labor mobility, the economists say, such regulation has played a “central role” in income disparities.

When measured on a state-by-state basis, American income inequality declined at a steady rate of 1.8 percent per year from 1880 to 1980. The slowing and reversal of this long-term trend after 1980 is startling. Not by coincidence, the states with the strongest land-use regulations–those on the Pacific Coast and in New England–began such regulation in the 1970s and 1980s.

Forty to 75 percent of the decline in inequality before 1880, the Harvard economists say, was due to migration of workers from low-income states to high-income states. The freedom to easily move faded after 1980 as many of the highest-income states used land-use regulation to make housing unaffordable to low-income workers. Average incomes in those states grew, leading them to congratulate themselves for attracting high-paid workers when what they were really doing is driving out low- and (in California, at least) middle-income workers.

As Virginia Postrel puts it, “the best-educated, most-affluent, most politically influential Americans like th[e] result” of economic segregation, because it “keeps out fat people with bad taste.” Postrel refers to these well-educated people as “elites,” but I simply call them “middle class.”

Middle class doesn’t mean middle income; it means people with managerial, creative, or other jobs that require thinking, not repetitive or physical labor. As a proxy, I use college education: less than 30 percent of working-age Americans have a bachelor’s degree or better. Though some people with college degrees flip burgers just as some without such degrees gained enough knowledge on the job to be promoted into management, it seems likely that about 30 percent of the population are middle- or upper-class while 70 percent are working- or lower-class.

Census data show that, in the late 1970s, the average worker with a high school diploma but no college education earned more than 64 percent as much as the average worker with a bachelor’s degree. By 2010, it was less than 53 percent.

As I’ve pointed out elsewhere, the barrier between the 1 percent and the 99 percent is far more porous than the one between middle class and working class. The rising cost of higher education and the high cost of moving into regions with land-use regulation prevent less-educated people from bettering themselves. Increased regulation of commercial operations limit people’s ability to start small businesses. Increased traffic congestion (favored by “progressive” anti-auto cities) also hits working-class people harder than middle-class workers as the former are less likely to be able to take advantage of flex-time, telecommuting, and other ways of avoiding congestion.

Britain, which has regulated land use since 1947, is suffering many of the same problems. As the Telegraph reports, this regulation has divided “the nation between old and young, haves and have-nots.”

Of course, many urban planners still refuse to believe that land-use regulation makes housing expensive. Never mind the fact that economists at Harvard, Whartons, and a wide range of other universities agree that it does. Let’s just ignore the fact that such regulation is destroying our economy and oppressing low-income families. All that is important is that the middle-class elites who benefit are happy.

The Miracle that Is the iPhone (or How Capitalism Can Be Good for the Environment)

Last week I asked a friend of mine if he could recommend a good white noise machine. “Why don’t you,” he responded, “download an iPhone app instead?” I did and the app works just fine. That got me thinking: what other gadgets do I no longer have or could do without thanks to my iPhone? I put together a short list and asked Lauren Kessler from Cato’s art department to create the lovely graphic below. Of course, “dematerialization,” or using less material and energy to produce more goods, is not new. As Ron Bailey writes in Reason,

Jesse Ausubel, director of the Program for the Human Environment at Rockefeller University and Paul Waggoner at the Connecticut Agricultural Experiment Station, show that the world economy is increasingly using less to produce more. They call this process “dematerialization.” By dematerialization, they mean declining consumption of energy or goods per unit of GDP. In a 2008 article in the Proceedings of the National Academy of Sciences, Ausubel and Waggoner, using data from 1980 to 2005, show that the world is on a dematerialization binge, wringing ever more value from less material.

No, I am not claiming that because of the iPhone all the gadgets that I have listed below will totally “disappear.” People will still prefer to have their weddings shot by a professional photographer using sophisticated camera equipment. Many people, however, will never need to buy a camera or video camera (especially as the iPhone and similar products become better at taking pictures and videos) and that will save resources.

Dematerialization, in other words, should be welcome news for those who worry about the ostensible conflict between the growing world population on the one hand and availability of natural resources on the other hand. While opinions regarding scarcity of resources in the future differ, dematerialization will better enable our species to go on enjoying material comforts and be good stewards of our planet at the same time. That is particularly important with regard to the people in developing countries, who ought to have a chance to experience material plenty in an age of rising environmental concerns.

Maybe I am too much of an optimist, but dematerialization could also lead to a greater appreciation of capitalism. Namely, the “profit motive” can be good for the environment. No, I am not talking about dumping toxic chemicals into our rivers, which is illegal and should be prosecuted. Rather, I am talking about the natural propensity of firms to minimize inputs and maximize outputs. Take the humble soda can. According to the Aluminum Association, “In 1972… a pound of aluminum yielded 21.75 cans. Today, as a result of can-makers’ use of less metal per unit, one pound of aluminum can produce 33 cans.”

PS: If there are other gadgets that you no longer find essential thanks to your iPhone, let me know and we will expand our graphic accordingly: mtupy [at]

Stopping the EPA: the Long Game

Yesterday’s DC Court of Appeals ruling throwing out an omnibus petition against EPA’s first tranche of carbon dioxide restrictions rested largely on the Court’s decision that EPA’s “Endangerment Finding” from related global warming stands as is. In particular, it noted that the petitioners’ argument that “uncertainty” about climate change was not sufficient grounds to void the Finding.

Indeed, “uncertainty” is thin ice if EPA is in the business of saving us from almost-certain doom. A better argument would have been a direct assault on the Finding’s science, or rather, selective science.

But this is beyond the capabilities of most litigators, who simply aren’t trained to wade through the enormous technical literature on global warming and its effects. That’s about to change.

The next battle with EPA is likely to come over their proposed regulation that would essentially outlaw coal-fired electrical generation. Here at Cato, we are preparing the definitive answer to its Endangerment Finding.

With regard to climate change impacts in the U.S., the Finding relies primarily on one document, Global Climate Change Impacts in the United States. It was produced by the U.S. Global Change Research Program (USGCRP), a mélange of agencies all dependent upon climate change dollars. This document is about as inclusive as one would expect it to be—i.e. it avoids a massive amount of inconvenient science. You can find it here.

Since April, 2011, along with several colleagues around the country, I have been working on the scientific counter to the USGCRP document. It looks like it, section by section. It flows exactly like it. It has more references and notes—almost twice as many—as the USGCRP document. As in the adage, “you can take it to court.”

While it’s not yet in final copy, the latest draft is sufficient to give you the idea: this is the document to take down the Endangerment Finding. You can download it here.

We expect this document is going to figure heavily in the next round in the fight to prevent EPA from imposing scientifically senseless but economically disastrous restrictions on energy use.

Eat Local, Degrade the Environment

The new book The Locavore’s Dilemma, which will be presented at Cato on Wednesday, got a good review in Saturday’s Wall Street Journal:

Pierre Desrochers and Hiroko Shimizu seem to have had the most fun among this group of authors. “The Locavore’s Dilemma” argues that the benefits of eating local have been vastly overstated by food activists and its serious detriments swept under the rug. The tone is distinctly upbeat, no doubt because being a gleeful debunker is fun but also because the two authors are resolutely cheerful about the world’s food situation.

Mr. Desrochers and Ms. Shimizu, a married couple who are both professional economists, present a counterintuitive but well-supported case that local self-sufficiency is the worst thing you can do for the environment, since it requires many crops to be grown in the wrong places, with damaging ecological consequences. American farmers, they observe, used to grow wheat locally in the Shenandoah Valley, tilling steep and rocky slopes—and unleashing a torrent of soil erosion. With the shift of grain farming to the far more productive and erosion-resistant soils of the Midwest, “more grain is now being produced on fewer acres and, overall, more habitat is available for wildlife.” Their study of the history of American agriculture is one of the strongest points of this book.

Famines were common in the past precisely because food security rested on the vagaries of local conditions rather than the resiliency of trade, they observe: “Subsistence farmers periodically starve while commercial agricultural producers who rely on monocultures for their livelihood don’t.”

Sign up for Wednesday’s Book Forum here.