Topic: Tax and Budget Policy

Rethinking Ethanol: A Lesson Only Half Learnt by the NY Times

Sunday’s NY Times acknowledges that:

It is time to end an outdated tax break for corn ethanol and to call a timeout in the fivefold increase in ethanol production mandated in the 2007 energy bill.

But then it goes on to state:

This does not mean that Congress should give up on biofuels as an important part of the effort to reduce the country’s dependency on imported oil and reduce greenhouse gas emissions. What it does mean is that some biofuels are (or are likely to be) better than others, and that Congress should realign its tax and subsidy programs to encourage the good ones. Unlike corn ethanol, those biofuels will not compete for the world’s food supply and will deliver significant reductions in greenhouse gases…

Congress’s guiding principle should be to tie federal help to environmental performance. The goal is not just to stop the headlong rush to corn ethanol but to use the system to bring to commercial scale promising second-generation biofuels — cellulosic ethanol derived from crop wastes, wood wastes, perennial grasses. These could provide environmental benefits and reduce dependence on oil without displacing food production.

But as noted on this blog previously, this is wishful thinking. Tilting the field to help cellulosic ethanol, whether directly through subsidies or indirectly through mandates, will inevitably make it more attractive for farmers to divert land and water to grow fuel rather than food. As a result some portion – perhaps even a large portion – of the resources that would otherwise be used for food production would go toward fuel production.

It is, therefore, naïve to claim that fuel production will not compete with food production. But the NY Times seems naïve about mandates, apparently assuming that mandates don’t entail costs, especially if they are in pursuit of goals it deems laudable.

One can get an inkling of the potentially disastrous effects of tilting the field toward biofuels (such as ethanol) from the Burmese experience regarding jatropha, a bush that can provide feedstock for biodiesel. The Wall Street Journal’s James Hookway reported last week that:

United Nations World Food Program officials say the storm wiped out much of Myanmar’s midyear rice harvest and add that grain stockpiles are dwindling because of the military’s jatropha drive. That makes it likely Myanmar’s plans to export rice this year to other needy nations such as Bangladesh will be scrapped…

The most notorious example of errant policy making reflects the fascination of 75-year-old junta leader Senior-Gen. Than Shwe with biodiesel as a way to break the country’s dependence on expensive imported oil.

In December 2005, the battle-hardened commander kicked off a nationwide campaign to grow jatropha, a squat, hardy bush that yields golf-ball-sized fruit containing a sticky, yellow liquid that can be made into fuel. His drive was similar to initiatives in other parts of the world, including the U.S., which encouraged farmers to grow corn, palm oil or other crops for biofuel and which are now facing criticism for driving up the price of food. [Emphasis added]

India, China and other countries grow jatropha on scrubby land where food crops can’t survive. But researchers say that in Myanmar, some of the country’s most fertile land has been converted to cultivating the shrub…

It isn’t clear how much of Myanmar’s arable land has been converted to jatropha cultivation. Organizations such as the U.N.’s Food and Agriculture Organization warned the government about the risks of farming jatropha on land that could be used to grow food. But Gen. Than Shwe’s goal was to set aside an area the size of Belgium to grow jatropha – a huge commitment for Myanmar, which is roughly the size of France.

In 2006, the chief research officer at state-run Myanmar Oil and Gas Enterprise said Myanmar hoped to completely replace the country’s oil imports of 40,000 barrels a day with home-brewed, jatropha-derived biofuel. Other government officials declared Myanmar would soon start exporting jatropha oil.

Despite the military’s efforts, the jatropha campaign apparently has largely flopped in its goal of making Myanmar self-sufficient in fuel.

While this is an extreme example of poorly conceived policy, it should be kept in mind that the Burmese regime was pursuing what many consider to be a laudable goal – energy independence (with – who knows – possibly the hope of obtaining carbon credits). And what a totalitarian regime can effect with fiat (and sticks), other governments can accomplish with a combination of seemingly more benign policies, specifically subsidies and mandates (i.e., carrots and sticks), in pursuit of the same laudable goals.

The lesson from all this, which the NY Times doesn’t quite get (reiterating from the earlier post) isn’t that biomass – and farmers — shouldn’t play a role in helping meet our energy needs, but that “If farmers can profitably grow fuel rather than food through their own efforts, so be it. But we shouldn’t favor growing one over the other either through subsidies or indirectly through government mandates for so-called renewable fuels. And if anything should be subsidized or mandated, it shouldn’t be growing fuels. That would inevitably compete with food.”

Ag Committee Chair Demands Higher Food Prices

Not content with a protected near monopoly of the domestic market, American sugar producers are demanding that Congress make their pot of subsidies and protection even sweeter.

Chairman of the House Agriculture Committee, Rep. Colin Peterson (D-Minn.), is pushing language in the latest proposed farm bill that would raise domestic price supports for sugar and mandate that sugar imports be used for ethanol production.

His proposals would virtually lock in an 85 percent share of the U.S. market for domestic sugar beet and cane growers, even though a number of foreign countries can grow sugar more cheaply than most American growers. And by the way, did I mention that Rep. Peterson’s district is among the nation’s top producers of sugar beets?

The Bush administration, to its credit, opposes Peterson’s changes in the farm bill. The sugar industry, of course, loves the idea. A spokesman for the pro-protection American Sugar Alliance told this morning’s Wall Street Journal, “We have an administration that seems more interested in supporting foreign producers, than producers right here in America.”

Notice the sugar industry doesn’t mention American consumers. U.S. agricultural policies should not be about favoring “our” producers over “theirs,” but about advancing such national interests as freedom, prosperity, and a more peaceful world. As we’ve explained in detail at the Center for Trade Policy Studies, the U.S. sugar program favors American sugar producers primarily at the expense of the rest of America. American families pay higher prices at the store, while U.S. producers that use sugar as an input — bakeries, food processors, restaurants, candy makers, etc. — incur higher costs because of our sugar program.

As we read daily in the newspaper about soaring food prices, this Congress is the verge of passing a farm bill designed explicitly to raise domestic food prices.

Real Budget Reform

Senator John McCain and other budget reformers are right to rail against the institutionized corruption of federal “earmarking.” Earmarks are, however, just a small part of the massive bloat in the federal budget. Earmark reform is needed, but presidential candidate McCain needs to propose more fundamental budget reforms in the coming months.

Representatives John Campbell (R-CA) and Jeb Hensarling (R-TX) have just introduced an idea that McCain could champion: A constitutional cap on the overall federal budget. You can read the proposed amendment here, but essentially these House budget experts propose that annual federal spending growth should not exceed the long-run average growth in the U.S. economy, except with a two-thirds vote or a declared war.

I’ve proposed a similar budget cap that would be statutory, not constitutional, and thus easier to implement. See here and here.

Either way, the point for Mr. McCain (or Mr. Obama, if he is so inclined) is to promote some sort of overall cap on the budget to drive home that the government’s budget should not grow any faster than the average family’s budget. 

Re: Wall Street Journal Editorials — The Fed Caused the Rise in Food and Oil Prices?

In numerous unsigned editorials, The Wall Street Journal has argued that cutting the federal funds rate to 2% from 5 1/4% last September has been the main reason prices of crude oil and food commodities have soared in recent months. Such commodities are priced in dollars and the dollar was generally falling through February, though not in the past two months (even though the funds rate was reduced by one percentage point).

An April 28 editorial, “The Fed’s Bender,” notes that “since 2003 the dollar price of oil has climbed far more rapidly than the euro price — 273% in dollars, compared to 146% in euros.” It is not likely that the whole 2003-2008 picture reflects “the European Central Bank’s sounder monetary management,” as the editorial implies. The euro had dropped to below parity with dollar until late 2002. And the fed funds rate was repeatedly increased from 1% in 2003 to 5 ¼% in mid-2006 (well above the ECB’s equivalent 4% rate). The euro rose partly because it had first fallen, but also for reasons other than central bank interest rates (economists have no reliable model for forecasting floating exchange rates).

The editorial boldly concludes that “had the dollar merely retained the same purchasing power as the euro, today’s price of oil would be below $70 a barrel.” That is a counterfactual exercise that makes little sense.

Even if we accept the half-true premise that the dollar-euro exchange rate is sensitive to relative short-term interest rates, the dollar might have “retained the same purchasing power as the euro” by having the ECB lower interest rates to 3% and the Fed to keep ours at 3%. Or the Fed might have kept the funds rate at 5% and the ECB at 4%. Although either option might have stabilized that particular exchange rate, they would not have had the same effect on global economic growth and therefore on the world demand for oil.

If oil had been priced in dollars and the euro had not appreciated against the dollar, then the euro area would not have been as insulated as it was against the rising cost of oil. Because demand is responsive to price (particularly business demand), Europe would have bought less oil than it did. Or, to use the editorial version, if the U.S. still faced $70 oil then we would try to buy more. Either way, the price in dollars would not have remained the same.

The Economist index covers the prices of 25 commodities, excluding oil and gold, with food accounting for 56% of the index. By April 22 it was up 31% for the year and 3.7% for the month, when measured in dollars.

That was mostly because of food. Industrial commodities were up only 1.6% for the year.

If we are going to blame the rising price of oil and food commodities on the dollar, do we need a different theory to explain why industrial commodities have barely risen?

Here’s another anomaly: Measured in British pounds, the commodity index was up about the same as it was in dollars—31.6% for the year and 4% for the month. That can’t be because Britain has a weak currency—the pound buys 8.9% more dollars than it did a year ago. It can’t be because the Bank of England cut interest rates too much, since 3-month interest rates are 5.86% in Britain, compared with 1.97% in the U.S.

I happen to agree that the Fed (and ECB) have paid too little attention to the impact of exchange rates on prices of internationally traded commodities. And I suspect the Fed has already gone too far with rate cuts and will have to put rates back up shortly after the election. But to single-out a few sensitive commodity prices that have risen the most (in dollars or pounds) and blame just those prices on the Fed is going too far.

Doublespeak in Health Policy Reporting

By all accounts, U.S. spending on health care has been growing much more rapidly than national output. Health statistics–health spending as a share of national output or per person, compared across developed nations–routinely ranks the United States at the top of the list, and statistics on effective health care delivered per dollar spent routinely ranks the United States near the bottom. So news reporters could not miss the clear implication that Americans need to cut health care spending growth and make their health care sector more efficient. If we could reduce spending on unnecessary and low-value health care services, it would go a long way in achieving both objectives.

Now for the doublespeak: Many proponents of Health Savings Accounts (HSA) that can only be accessed under a high-deductible health plan tout the increased role of health care consumers. With larger out-of-pocket spending initially, consumers have greater incentives to eliminate unneeded and costly health services. But success on this count is routinely dismissed in the media as having undesirable side effects–as in today’s Wall Street Journal (HSA Users Find Hassles Amid Savings, May 1, 2008, Personal Journal, page D1):

…average health-insurance costs rose 3.6% in the past two years for employers who offered high-deductible plans, compared with a rise of 7% for employers without such plans.

That’s followed by

Some analysts say much of those employer savings come because many HSA participants tend to forgo care.

Excuse me, but isn’t this exactly how it’s supposed to work?! The language in all such instances usually hints (as does this WSJ report) that the forgone care is valuable and people with HSAs are therefore suffering unduly. Such implied criticism is unjustified unless accompanied with the qualification that the rejected health care services may not be valuable or cost effective.

Indeed, the article later cites a patient with an HSA “fighting” with a doctor about routine physicals and cardiac exams. The doctor wants these exams to be taken regularly, whereas the patient does not because the high-deductible HSA implies larger out-of-pocket payments. In my personal experience, both types of health checkups are most often a waste of time–all they do is separate the patients from their money, which goes to the doctors.

But if many more consumers were to obtain HSAs and economize their health care spending, it would clearly be a problem for the medical profession. And news reporters usually accept, without further questioning, analysts’ comments about unneeded patient suffering because of forgone care. Clearly, wider use of HSAs and better management of consumers’ health care dollars face tremendous hurdles–the medical profession’s self-interest being the biggest one of all. (And I hope my doctor doesn’t read this.)

Uncle Sam Wants You

USA Today ran an article about the ever-expanding band of bureaucrats on all levels of government. Citing Bureau of Labor Statistics data, the author points to a new 76,800 bureaucrats added to payroll from January-March this year;

That’s the biggest jump in first-quarter hiring since a boom in 2002 that followed the 9/11 terrorist attacks. By contrast, private companies collectively shed 286,000 workers in the first three months of 2008.

For the most part, when a public employee is hired the full cost of their labor – including generous government pensions and health care coverage – is not accounted for upfront.  With the baby boomers starting to retire, the costs of maintaining the army of bureaucrats will only rise.  Tack on the large unfunded liabilities in government-provided defined benefit plans and retiree health plans, and you easily have a trillion-dollar problem

Most governors in “fiscal crisis” states will call for temporary hiring freezes that fail to address the core issue of reckless government expansion.  But watch for some states, like Tennessee, to take steps to cut costs by culling a small number of their taxpayer-funded workers.