Sunday, May 29, 2011

Democrats use oil profits as a campaign device

Published in The Tennessean, Sunday, May 29, 2011

by Richard J. Grant

History is easier to understand when we remember that the interests of individual politicians regularly differ from those of their constituents. This helps explain the recent grandstanding by Senate Democrats when they summoned oil-company executives to act as political punching bags to help distract attention from the Obama administration's abysmal record on energy supply.

This show trial was the centerpiece for hearings in support of the Democrats' “Close Big Oil Tax Loopholes Act,” which purports to eliminate oil-industry subsidies. The show-trial format fit well with the political exploitation of public distress over rising gasoline and oil prices. The Senators made wild and misleading insinuations in the form of marketable soundbites while the oil executives had to respond in the longer paragraphs that are usually needed to explain reality.

Passive listeners were led to believe that oil companies were making rapacious profits at the expense of consumers and not paying their fair share of taxes. In truth, the profitability rates of the major oil companies are unexceptional and the industry is taxed quite heavily.

Perhaps the Senators who sponsored the bill believe, as the president does, that profits are a cost and impose a burden on customers. They seem to believe that profits should be redistributed to the people through the U.S. Treasury.

Whatever revenue the proposed bill might initially deliver to the Treasury would decrease over time as the industry adjusted. Ironically, the higher tax burden would lead to higher pre-tax rates of profitability in the oil industry as capital allocations shrink and adjust to reflect the new tax structure and to preserve after-tax profitability rates comparable to those in other industries.

If the Senators were successful in passing this bill, the result would be the same as most of their previous interventions. It would drain capital away from domestic energy production, reduce total oil supplies, and increase the demand for imported oil. That means that oil prices will be higher than they would have been otherwise. The Senators will once again hurt their constituents.

Those who do not understand the nature of capital and profits are likely to believe that profits are just a surplus that can be harmlessly redistributed. The presidential candidate, Barack Obama, supported a “windfall-profits tax” on oil companies for just this purpose. Such taxes are a perennial campaign device.

In 1980, Congress enacted a so-called windfall-profits tax, that was really an excise tax, to capture for the Treasury a portion of oil-company profits that rose with high imported-oil prices. The 1970s were years of high inflation and domestic-oil price ceilings that forced U.S. oil producers to sell their product at below-market prices. It is no wonder that these were also the years of energy crises.

The windfall-profits tax reduced the competitiveness of the American oil industry relative to the OPEC producers. American producers had less revenue, a significant portion of which was diverted to the U.S. Treasury leaving less capital for reinvestment in domestic oil production. The relative lack of internally generated funds needed for reinvestment and expansion caused many firms to turn to outside funding sources and increase their debt. Heavier debt loads made more companies vulnerable to bankruptcy when oil prices later dropped.

In the wake of the recent financial crisis and the recent volatility in oil prices, these unhappy consequences of government intervention should sound very familiar.


Richard J. Grant is a professor of finance and economics at Lipscomb University and a senior fellow at the Tennessee Center for Policy Research. His column appears on Sundays. E-mail: rjg@richardjgrant.com

Copyright © Richard J Grant 2011

Sunday, May 22, 2011

Inflation subsidizes hot air

Published in The Tennessean, Sunday, May 22, 2011

by Richard J. Grant

The Federal Reserve Board has been trying to raise prices, particularly house prices. On average, it has more than succeeded: Consumer Price Index figures for April show an annual increase of 3.2 percent in consumer-goods prices. In the past, the Fed has expressed a belief that 2 percent price inflation would be about right to promote growth.

In contrast to the rising CPI, home prices seem not yet to have bottomed out nationally. The Fed has purchased huge blocks of mortgage-backed securities, and has been creating money to buy Treasury securities in unprecedentedly large quantities. This has kept interest rates artificially low and has undoubtedly slowed the adjustment of prices in the property market.

Expansions in the money supply cause prices generally to be higher than they would have been, but prices are not all affected equally. Some prices rise faster than the average while others rise more slowly or, like portions of the real estate market, fall.

From an economic perspective, prices simply reflect the relative supplies and demands for particular goods and services. Prices will adjust as people trade and move resources from lower-valued uses to higher-valued uses. Relative scarcity causes prices to rise while higher productivity tends to keep prices lower. There is nothing special about any particular price.

But from a political perspective, not all prices are treated equally. It has long been politically desirable to stimulate home buying and, more recently, to prevent home prices from falling. But for other prices, such as those for oil and gasoline, the opposite has been desired.

During the past year, gasoline and fuel-oil prices have increased by more than 30 percent. Commodity prices in general have been rising rapidly, and the U.S. dollar has been falling in value relative to other major currencies.

This run-up in oil and gasoline prices has created political heat. But rather than reduce government restrictions on domestic drilling and energy production, the Democratic-controlled Senate attempted to redirect blame toward oil companies. They threatened to eliminate special “subsidies” in the tax code.

The trouble with the Democrats’ argument is that the effective tax treatment of the oil industry is little different from that of other domestic manufacturing industries. Further, their main retail product, gasoline, is subject to a federal sales tax.

To the extent that there are tax differences, Democrats would likely find it relatively easy to gain Republican support for repeal. The more obvious subsidies are not in the tax code at all but are administered by the Department of Energy. Why should taxpayers fund research and development when it can be done better privately?

David Kreutzer, a senior policy analyst at the Heritage Foundation, has noted the unequal subsidy treatment within the energy industry. Wind-energy producers attract huge subsidies, such as the option to take a 30 percent investment tax credit or to receive a significant 2.2 cents per kilowatt-hour production tax credit.

Unlike the wind-energy industry, the oil industry can survive without subsidies. But if an oil company could get the same 30 percent investment tax credit as wind producers, it would receive several million dollars in subsidies for each new oil well completed. If the oil company could get a production tax credit, then a proportionate treatment at current prices would generate a subsidy of about $40 per barrel.

Perhaps the Senate should direct its hot air against wind subsidies.


Richard J. Grant is a professor of finance and economics at Lipscomb University and a senior fellow at the Tennessee Center for Policy Research. His column appears on Sundays. E-mail: rjg@richardjgrant.com

Copyright © Richard J Grant 2011

Sunday, May 15, 2011

Deficits imply an increased future tax burden

Published in The Tennessean, Sunday, May 15, 2011

by Richard J. Grant

Over the years from 1792 to 1930, the federal government ran surpluses twice as often as it ran deficits. But in the 80 years since 1930, the federal government has run annual deficits seven times more often than it has run surpluses. It has been 10 years since the last surplus.

During the first hundred years of the Republic, it was not at all unusual to see significant reductions in the national debt. Debt was always recognized as a useful tool in the pursuit of national interests, but that recognition was balanced by a strong ethical imperative to avoid deficits and to pay down the national debt whenever possible.

The Great Depression marked a turning point in this ethical attitude. In 1932, when government revenue fell to half its 1930 levels and spending rose by more than 40 percent, President Herbert Hoover stumbled through an election-year with a deficit that was almost 58 percent of the budget. His opponent, Franklin Roosevelt, demanded a return to fiscal rectitude. Roosevelt still believed, as did most citizens, that public debt was little different from household debt.

As president, Roosevelt’s attitude changed. He never did balance the budget, but ran pre-war deficits, most of which were higher than in Hoover's worst year. The initial deficits swelled in political response to the pain of the stock market crash and the recession that followed. Only later was the stigma associated with debt accumulation weakened by an effective philosophical assault.

The idea of British economist John Maynard Keynes, that it was prudent deliberately to increase budget deficits during times of recession and then balance them with surpluses after the recovery, provided a new justification and political cover for deficit spending. Just as it has always been easier to water down ethical rules and cultural virtues than to restore them, it was easier to get politicians to create deficits than it was to produce the corresponding surpluses. Political expediency took it from there.

Although the stigma of debt never fully disappeared, it was overwhelmed by optimism and the expectation that we would always outgrow the debt-service burden. The dollar amount of the national debt has grown accordingly. Increases to the legislated debt limit became routine and perfunctory.

The government is now borrowing 40 percent of the dollars it spends. The national debt is growing 3 to 5 times faster than economic output and is approaching 100 percent of GDP. Taxpayers are increasingly aware that current deficits imply an increased future tax burden and that most government spending, especially “stimulus” spending, is counterproductive. The next increase of the debt ceiling will not be perfunctory.

House Speaker John Boehner, R-Ohio, has insisted that any increase in the debt ceiling must be matched by real spending cuts of at least equal size. If Senate Democrats and the president can't agree to this, then the government will run out of legal borrowing capacity by August. Either way, budget cuts are required.

The need for cuts would be mitigated only if increased economic growth were to yield higher government revenues. But this is made less likely by the heavy fiscal and regulatory burdens imposed by the administration and the previous Congress.

We are learning that hope is not currency and that there are real economic and social consequences when we use government to evade old ethical rules.


Richard J. Grant is a professor of finance and economics at Lipscomb University and a senior fellow at the Tennessee Center for Policy Research. His column appears on Sundays. E-mail: rjg@richardjgrant.com

Copyright © Richard J Grant 2011

Sunday, May 08, 2011

Canada's Conservative leaders outdo U.S. economically

A shortened version was published in The Tennessean, Sunday, May 8, 2011

by Richard J. Grant

Canada's forty-year flirtation with socialized medicine has created the impression in the minds of many Americans that Canada is an example of a socialist country. But one sector does not a country make. By recent measures of economic freedom, Canada ranks as high as or higher than the United States.

The “Economic Freedom of the World” report, published in 2010 by the Fraser Institute and the Cato Institute, gave the US and Canada virtually equal overall rankings. The more recent 2011 “Index of Economic Freedom,” published by The Wall Street Journal and the Heritage Foundation, ranks Canada three places higher than the US.

If Canada is less free than the US in its health-care sector, then it more than makes up for it with greater freedom in other areas. But even in the health-care sector, the Canadian government does not interfere with everything and the US government does not interfere with nothing. For several decades, more than half of US medical expenditures have been paid through government. Medical-related services and insurance are among the most heavily regulated activities in both countries.

During the 1960s and 1970s, both countries embraced new welfare programs. Such programs are often described as “popular” and always will be to those who believe that they are getting something for nothing. Canadians love the fact that they can walk into a doctor's office and present a little plastic card. Most have no idea what it costs them or that it costs them anything at all. But the smart ones make the connection between this and the long waiting lists for specialist consultations and procedures, and sometimes long journeys for diagnostic tests. There is also a serious shortage of family physicians.

We can afford certain indulgences as long as we remain prudent and productive in other aspects of our lives. Canadians reached the peak of indulgence more than a decade ago and have made a reluctant peace with the need for fiscal restraint. Like it or not, privatization has been a necessary and successful solution to the inefficiencies and shortages created by government programs. This applies also to segments of the medical sector.

During the past five years, Canadian Prime Minister Stephen Harper has led a minority Conservative government. Despite the need to pull parliamentary votes from liberals and socialists to pass legislation, Harper and his Minister of Finance, Jim Flaherty, cut the national sales-tax rate to 5 percent from 7 percent. They also cut the federal corporate income-tax rate to 16.5 percent and will reduce it to 15 percent next year. This is less than half the US federal rate, which is 35 percent.

I have met Mr. Harper on several occasions and have had lunch with both him and Mr. Flaherty. Both men exhibit a high level of economic understanding and executive competence that is, unfortunately, not matched by their current American counterparts. Last week, their Conservative Party won a majority of the seats in Parliament. Canadians should not be surprised to see reductions in their personal income-tax rates, strengthened national defense, and a greater reliance on private enterprise.

Prime Minister Harper has promised to balance the federal budget by 2015 without raising tax rates. By that time, Canada's national debt will have fallen below 30 percent of GDP, less than half the rate of the US public debt.

This sounds like good medicine.


Richard J. Grant is a professor of finance and economics at Lipscomb University and a senior fellow at the Tennessee Center for Policy Research. His column appears on Sundays. E-mail: rjg@richardjgrant.com

Copyright © Richard J Grant 2011

Sunday, May 01, 2011

Seniors would benefit from Ryan's budget proposal

Published in The Tennessean, Sunday, May 1, 2011

by Richard J. Grant

The “CAP Act of 2011,” as championed by Sen. Bob Corker, R-Tenn., would place a cap on total federal government spending and gradually reduce the maximum level to 20 percent of GDP over 10 years. Placing a legislated cap on spending does not bind future congresses, but it would give them guidance and would provide a benchmark that future taxpayers could easily monitor.

The purpose of a cap is to create an upper limit. It is a ceiling, not a floor. It also leaves open the question of what will be the composition of the spending that does occur. We still need to make specific choices about specific spending programs and specific cuts. That is the purpose of the budget.

President Barack Obama has presented two budgets already this year, neither of which would comply with Corker's spending cap. Obama's first budget would actually have kept spending close to present levels and the second would not even bring spending down to 22 percent of GDP. Both budgets would require tax revenues to increase significantly above historic levels as a percentage of GDP.

The second Obama budget appeared to be a reaction to the budget presented by Rep. Paul Ryan, R-Wis., who chairs the House Budget Committee. The president was outflanked by the Ryan plan, which not only brings spending down to at least 2007 levels, but also offers entitlement reform and tax-rate reduction. Ryan would bring spending down to about 20 percent of GDP within five years. That makes the Ryan plan perfectly compatible with the Corker plan.

Ryan's plan has been attacked from two directions: from those who feel the cuts should come more quickly and from those who fear that it might adversely affect Medicare. The first group has a reasonable case from a straight economic perspective. This might best be illustrated by a bill proposed early in the new Congress by Sen. Rand Paul, R-Ky., that would have been called the “Cut Federal Spending Act of 2011.” A much more timid budget plan for 2011 has already been passed, but Sen. Paul would have cut $500 billion from the budget in the first year. That would reduce federal spending by about 15 percent and would reduce this year's deficit by a third.

In a clearly written 12-page bill, Sen. Paul suggests numerous significant and clean cuts that would be justifiable on economic and constitutional grounds. It does not touch Social Security or Medicare, but those could be reformed separately.

Attacks on Rep. Ryan's budget from the left insinuate that his plan would jeopardize Medicare. Ryan's plan would actually spend at least as much as that promised in the Affordable Care Act (better known as ObamaCare), but with greater choice and flexibility. Seniors would get a better and more secure deal.

In a growing economy, spending as a percentage of GDP can be reduced without necessarily cutting the dollar amount of spending. Long-term economic growth tends to be higher in those countries where government spending and taxation are kept lower. It is significant that the Ryan plan would also simplify the tax structure and reduce the top individual and corporate rates to 25 percent. This would increase the growth potential of our economy.

The determination to cap and reduce government spending as a share of the economy will ensure for us a larger and better-developed economy.


Richard J. Grant is a professor of finance and economics at Lipscomb University and a scholar at the Tennessee Center for Policy Research. His column appears on Sundays. E-mail: rjg@richardjgrant.com

Copyright © Richard J Grant 2011