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

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