Category Archives: Budget

Gas Taxes and Oil Subsidies: Time for Reform

World oil prices have been highly volatile during the last decade.   Over the past year they have fallen more than 50%.

Should we root for prices to go up, down, or stay the same?   The economic effects of falling oil prices are negative overall for oil-exporting countries, of course, and positive for oil-importing countries.  The US is now surprisingly close to energy self-sufficiency, so that the macroeconomic effects roughly net out to zero.  But what about effects that are not directly economic?   If we care about environmental and other externalities, should we want oil prices to go up or down?  Up, because that will discourage oil consumption?  Or down because that will discourage oil production?

The answer is that countries should seek to do both: lower the price paid to oil producers and raise the price paid by oil consumers.  How?   By cutting subsidies to oil and refined products or raising taxes on them.   Many emerging market countries have taken advantage of the last year of falling oil prices to implement such reforms.  The US should do it too.

Congress continues to shamefully evade its responsibility to fund the Federal Highway Trust Fund.  On July 30 it punted with a 3-month stop-gap measure, the 35th time since 2009 that it has kicked the gas-can down the road!  There is little disagreement that the nation’s roads and bridges are crumbling and that the national transportation infrastructure requires a renewal of spending on investment and maintenance.  The reason for the repeated failure to put the highway fund on a sound basis for the longer term is the question of how to pay for it.  The obvious answer is, in part, an increase in America’s gasoline taxes, as economists have long urged.  The federal gas tax has been stuck at 18.4 cents a gallon since 1993, the lowest among advanced countries.  Ideally the tax rate would be put on a gradually rising future path.

Fuel pricing is a striking exception to the general rule that if the government has only one policy instrument it can achieve only one policy objective.   A reduction in subsidies or increase in taxes in the oil sector could help accomplish objectives in at least six areas at the same time:

  1. The budget. It isestimated that energy subsidy reform globally (including coal and natural gas along with oil) would offer a fiscal dividend of $3 trillion per year. The money that is saved can either be used to reduce budget deficits or recycled to fund desirable spending, such as US highway construction and maintenance, or cuts in distortionary taxes, e.g., on wages of lower-income workers.
  2. Pollution and its adverse health effects.   Outdoor air-pollution causes anestimated annual 3.2 million premature deaths worldwide.  A gas tax is a more efficient way to address the environmental impact of the automobile than alternatives such as CAFÉ standards which mandate fuel economy for classes of cars.
  3. Greenhouse gas emissions, which lead to global climate change.
  4. Traffic congestion and traffic accidents.
  5. National security.   If the retail price of fuel is low, domestic consumption will be high.  High oil consumption leaves a country vulnerable to oil market disruptions arising, for example, from instability in the Middle East.  If gas taxes are high and consumption low, as in Europe, then fluctuations in the world price of oil have a smaller effect domestically.   It is ironic that U.S. subsidies to oil production have often been sold onnationalsecurity grounds; in fact a policy to “drain Americafirst” reduces self-sufficiency in the longer run.
  6. Income distribution.  Fuel subsidies are often misleadingly sold in the name of improving income distribution.  The reality is more nearly the opposite.  Worldwide, fossil-fuel subsidies are regressive: far less than 20% of them benefit the poorest 20% of the population.  Poor people aren’t the ones who do most of the driving; rather they tend to take public transportation (or walk).   As to producer subsidies, owners of US oil companies don’t need the money as much as construction workers do.

The conventional wisdom in American politics is that it is impossible to increase the gas tax or even to discuss the proposal.   But other countries have political constraints too.  Indeed some governments in developing countries in the past faced civil unrest or even overthrow unless they kept prices of fuel and food artificially low.  Yet some of them have managed to overcome these political obstacles over the last year.  The list of those that have recently reduced or ended fuel subsidies includes Egypt, Ghana, India, Indonesia, Malaysia, Mexico, Morocco, and the United Arab Emirates which abolished subsidies to transportation fuel subsidies effective August 1.

Besides raising taxes on fuel consumption, the US should also stop some of its subsidies to oil production.  Oil companies can “expense” (immediately deduct from their tax liability) a high percentage of their drilling costs, which other industries cannot do with their investments.  Most politicians know that sound economics would call for this benefit to be eliminated.  But they haven’t been ab le to summon the political will.  Among the other benefits given to the oil industry, it has often been able to drill on federal land and offshore without paying the full market rate for the leases.

Those politicians who complain the loudest about the evils of government handouts are often the biggest supporters of handouts in the oil sector. Political contributions and lobbying from the industry must be part of the explanation.  Even so, it is surprising that self-described fiscal conservatives see more political mileage in closing the Export-Import Bank – which earns a profit for the US Treasury while it supports exports – than in ending oil subsidies, which cost the Treasury a great deal.   ‘

A recent study from the IMF estimated that global energy subsidies at either the producer or consumer end are running more than $5 trillion per year.  (Petroleum subsidies account for about $1 ½ trillion of that. A lot also goes to coal, which does even more environmental damage than oil.)  US fossil fuel subsidies have been conservatively estimated at $37 billion per year, not including the cost of environmental externalities.

Leaders in emerging market countries have now recognized something that American politicians have apparently missed, that this is the best time to implement such reforms.  Oil prices

he summer of 2014. So governments that act now can reduce energy subsidies or increase taxes without consumers seeing an increase in the retail price from one year to the next.

For the US and other advanced countries it is also a good time for fuel price reform from the standpoint of macroeconomic policy.  In the past, countries had to worry that a rising fuel tax could become built into uncomfortably high inflation rates.  Currently, however, central bankers are not worried about inflation except in the sense that they are trying to get it to be a little higher.

Congress will have to come back to highway funding in September. If other countries have found that the “politically impossible” has suddenly turned out to be possible, why not the United States?

New and Improved Trade Agreements?

WASHINGTON, DC – Trade is high on the agenda in the United States, Europe, and much of Asia this year. In the US, where concern has been heightened by weak recent trade numbers, President Barack Obama is pushing for Congress to give him Trade Promotion Authority (TPA), previously known as fast-track authority, to conclude the mega-regional Trans-Pacific Partnership (TPP) with 11 Asian and Latin American countries. Without TPA, trading partners refrain from offering their best concessions, correctly fearing that Congress would seek to take “another bite of the apple” when asked to ratify any deal.

In marketing the TPP, Obama tends to emphasize some of the features that distinguish it from earlier pacts such as the North American Free Trade Agreement (NAFTA). These include commitments by Pacific countries on the environment and the expansion of enforceable labor rights, as well as the geopolitical argument for America’s much-discussed strategic “rebalancing” toward Asia.
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Give Obama Trade Promotion Authority

Trade is now high on the agenda in Washington. President Obama is pushing hard for Congress to give him Trade Promotion Authority (TPA), once known as fast-track authority.  He intends to use it to complete negotiations with 11 trading partners under the Trans Pacific Partnership.  A majority of trade-skeptical Democrats in Congress have lined up on the wrong side on this one, along with some Tea Party Republicans who automatically oppose anything that Obama is in favor of.

Without TPA, trading partners hold back from offering their best concessions to the president’s trade representative in negotiations, fearing correctly that Congress would seek to take “another bite of the apple” when the White House brought the agreement to them for ratification.  Other countries wised up to this trick 40 years ago.  That is why the Congress has given every president since Richard Nixon fast-track authority, which allows only up-or-down approval of the final agreement.  If they don’t give TPA to Obama, it will not only mean no TPP.  It will also be another step in the ongoing self-inflicted American abdication of global leadership.

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Asia Games: Not Zero-Sum

Two hostesses are rivals in a popularity contest throughout the social season.  When they hold soirees on the same night invitees must choose which one to go to.  The hostesses guard their social ranking jealously, and may even punish a guest who goes to the rival’s party by withholding an invitation next time.

To read about the roles of China and the US over the last month, one would think that Asia/Pacific relations are a zero-sum game like that of these two hostesses in some fictional time and place.   Are countries signing up for China’s Asian Infrastructure Investment Bank?  Or for America’s Trans Pacific Partnership?  Will China’s currency be admitted to the SDR club, or will it be kept humiliatingly waiting at the entrance?  Is the United States still number one globally in economic size, or did China pass it in 2014?

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Devaluations are Often Associated with Changes in Government

The possibility of devaluation is apparently an issue in the upcoming Argentine elections.  (The forward rate for next year is about 13 pesos per dollar, which is close to the informal rate and suggests a big  devaluation relative to the current official exchange rate of 8.)   In this connection, an Argentine newspaper has asked me about “Contractionary Currency Crashes,” a paper that I presented as the 5th Mundell-Fleming Lecture of the  IMF’s Annual Research Conference. 

1) Do you think the conclusions about the connections between devaluation and elections are still valid in 2015 even though your article was published in 2005?

My most relevant finding was that political leaders had historically been twice as likely to lose office in the six months following a big devaluation as otherwise.  It is true that some things have changed over the last ten years.  Medium-sized emerging market countries used to have pegs or targets as their exchange rate policies, with occasional forced devaluation.   Since the turn of the century, the typical medium-sized emerging market country has switched to a managed float.   Thus changes in the exchange rate are more commonplace.   Nevertheless, I think most of the conclusions are still relevant in 2015.

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Does the Dollar Need Another Plaza?

We are at the 30th anniversary of the 1985 Plaza Accord.  It was the most dramatic intervention in the foreign exchange market since Nixon originally floated the US currency.   At the end of February 1985 the dollar reached dizzying heights, which remain a record to this day.  Then it began a long depreciation, encouraged by a shift in policy under the new Treasury Secretary, James Baker, and pushed down by G-5 foreign exchange intervention.  People remember only the September 1985 meeting at the Plaza Hotel in New York City that ratified the policy shift; so celebrations of the 30th anniversary will wait until this coming fall.

The dollar has appreciated sharply over the last year, surpassing its ten-year high.   Some are suggesting it may be time for a new Plaza, to bring the dollar down.   In its on-line “Room for Debate,” the New York Times asked, Will a strong dollar hurt the economy and should the Fed take action?”   Here is my response:

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Will Fed Tightening Choke Emerging Markets?

CAMBRIDGE – As the Federal Reserve moves closer to initiating one of the most long-awaited and widely predicted periods of rising short-term interest rates in the United States, many are asking how emerging markets will be affected. Indeed, the question has been asked at least since May 2013, when then-Fed Chairman Ben Bernanke famously announced that quantitative easing would be “tapered” later that year, causing long-term US interest rates to rise and prompting a reversal of capital flows to emerging markets.

The fear, as IMF Managing Director Christine Lagarde has reminded us, is of a repeat of previous episodes, notably in 1982 and 1994, when the Fed’s policy tightening helped precipitate financial crises in developing countries. If the Fed decides to raise interest rates this year, which emerging markets are most vulnerable to a capital-flow reversal?

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The Non-Problem of Chinese Currency Manipulation

CAMBRIDGE – America’s two political parties rarely agree, but one thing that unites them is their anger about “currency manipulation,” especially by China. Perhaps spurred by the recent appreciation of the dollar and the first signs that it is eroding net exports, congressional Democrats and Republicans are once again considering legislation to counter what they view as unfair currency undervaluation. The proposed measures include countervailing duties against imports from offending countries, even though this would conflict with international trade rules.

This is the wrong approach. Even if one accepts that it is possible to identify currency manipulation, China no longer qualifies. Under recent conditions, if China allowed the renminbi to float freely, without intervention, it would be more likely to depreciate than rise against the dollar, making it harder for US producers to compete in international markets.

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The End of Republican Obstruction

CAMBRIDGE – What a difference two months make. When the Republican Party scored strong gains in last November’s US congressional elections, the universally accepted explanation was that voters were expressing their frustration with disappointing economic performance. Indeed, when Americans went to the polls, a substantial share thought that economic conditions were deteriorating; many held President Barack Obama responsible and voted against his Democratic Party.

Now, suddenly, everyone has discovered that the US economy is doing well – so well that Senate Majority Leader Mitch McConnell has switched from blaming Obama for a bad economy to demanding credit for a good one. Recent favorable economic data were, he claimed, the result of “the expectation of a Republican Congress.”

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The US Economy in 2015

Following the first installment of a year-end interview on the global outlook, I turn in the second installment to the domestic economy.

Part 2. The US Economy

Q – As economic adviser to President Clinton, you oversaw one of the most prosperous periods in recent U.S. history. How do you assess the economic strategy of the Obama administration? What would you have done differently were you an adviser?

A – In my view President Clinton’s policies did contribute substantially to the outstanding performance of the American economy in the late 1990s.  People did not give him enough credit at the time.  (I myself had nothing to do with it, I assure you.)

The situation that President Obama inherited from the second President Bush was quite different from the situation that Bill Clinton had inherited from the father in January 1993.  As of the day Obama took office in January 2009, the worst financial crisis since the 1930s was still underway, US GDP and employment were in free fall (the numbers turn out to have been much worse, even, than we knew at the time), and the budget deficit was skyrocketing.  People like to say that a favorable judgment regarding Obama’s reaction rests solely on the unprovable proposition that the US would otherwise have experienced a Great Depression.  But in fact a turnaround in the economic statistics is visible to the naked eye. GDP and the rate of job loss stabilized almost immediately after Inauguration Day and the recession ended in June 2009. In my view the three main reasons that things began to turn around so quickly were the Obama fiscal stimulus, the new improved TARP program, and continued innovative monetary expansion by the Fed.

A majority of Americans still don’t yet see it that way.  Among other things, they haven’t seen the data on the 2009 turnaround and they don’t know that the US Treasury was paid back for the “bailouts” with a substantial overall profit.

So I think Obama’s policies did a lot of good during the first two years of his presidency.  This is especially true if one includes two big longer-term reforms: the Affordable Care Act (“Obamacare”) and financial reform (the Dodd-Frank bill).  But it is more difficult to attribute the path of the economy during 2011-2014 to the President, because the Republican Congress blocked almost every bit of legislation that he wanted during this period.

Q – What is the outlook for the US economy?

A – We should be able to grow at 3 per cent in 2015.   In 2001, 2012, and 2013, economic growth was impaired by dysfunctional fiscal politics in Congress – fiscal cliffs, debt ceiling stand-offs, government shutdown, and sequesters.  In my view that knocked at least one percentage point off of the growth rate in each of those years.   This is a more obvious explanation for the slow pace of the recovery in those years than the secular stagnation hypothesis.   In 2014 the Congress managed to refrain from actively impeding the economy in this way.  I believe that is a major reason why economic growth in the second and third quarters of this past  year was so much stronger than in the preceding three years.  On top of that, we have had the frackingboom and lower oil prices.   I see no reason why the good performance should not continue in 2015 – unless Congress screws it up again.

Q – If the Federal Reserve raises interest rates as expected in June 2015, might that choke off the recovery?

A – The Fed might in the end wait slightly longer.   (There is no more sign of inflation now than there has been since the period of near-zero interest rates began.)  But when the Fed does raise interest rates, it will be because the US economic recovery is very well-established.   So that would be good news, not bad news.

Q – Name a threat to the global economy.

A – Many countries are hampered by their own politicians’ habit of following pro-cyclical fiscal policy.  That is, they raise government spending and cut taxes in boom times, which exaggerates the upswing, and then cut spending and raise taxes in recessions, worsening the downturn.  Exactly backwards.

Q – Upon release of Capital in the 21st Century by Thomas Piketty, capitalism again became a hotly debated topic around the world. Do you think the current global economic system is sustainable? What aspects could be improved?

A – No doubt one of the reasons that most Americans are skeptical of the economic recovery is that they don’t feel it because virtually all the gains have gone to the rich.  Real median family income is still more than 8 per cent below where it was in 2000.

I disapprove of the recent increase in inequality in the US and other countries.  But I do not see the inequality either as an inevitable aspect of capitalism nor as unsustainably containing the seeds of destruction of the system.  Piketty’s book treats the big decline of inequality in the years 1913-1973 as a temporary reversal in a long-term trend toward unequal wealth that began in Jane Austen’s time, the early 19th century.  To do so is to treat the rise of democracy as a temporary blip, which it is not.  There is no reason why a democratic system cannot choose policies that give a good combination of growth in the overall size of the pie together with a somewhat more equal distribution of the pie.  Scandinavian countries have done this in their own way.   In the US case, I support such policies as universal pre-school education, universal health care insurance, expansion of the Earned Income Tax Credit, and a more progressive structure to the payroll tax, among others.