Tax Code Choice and Conservation

Energy waste is significantly based in the tax code. Tax deductions for travel, vehicle purchase, industrial and commercial use can increase waste, just as deductions for medical insurance often overstimulate 3rd party financing of health care. The loss of revenues from these and other tax preferences also result in higher business and personal tax rates.

Two discussed reforms- a “flat” single rate tax on income (Hall, Rabushka of Hoover) or a national sales tax (Fair Tax) would be improvements, but it’s highly unlikely either will have the required 218 House and 60 Senate votes any time in the near future. Steven Moore of the Wall Street Journal proposed leaving the current system in place to avoid the defensive lobbying and complexity of unraveling each section one by one by letting people/businesses file under an optional flat tax. It would minimize personal side deductions, but retain many on the business side.

The single rate has little or no chance of passing even as an optional code because the current code is progressive (CBO). Even with a larger personal exemption, it’ll be difficult to match the effect of the main code. An optional code with slightly progressive rates of 5-25% or 7-27% can maintain the current “distributional burden”. Paul Ryan proposed the first such code. It’s for individuals and smaller companies and the rate is 10% up to $65k of income and 25% over that, with the first $15k exempt.. but some business “expensing” remains. Former senator Brownback then proposed an optional code that would minimize most if not all of the business-side preferences, replacing them with rates of 10% up to $102k and 25% over that. These latter types of approaches could help us avoid the endless, droning, diversionary class debate so we can deal with the bigger problem of the preferences.

The worst feature of the current code is not the 6 rate brackets, but the allowance of most business and some personal expenses to be subtracted/deducted from gross income prior to applying the tax rate. They create $230 billion of compliance costs annually (Tax Foundation), $500 billion of other external costs plus market discounted energy prices. The GAO’s Summary of Estimates of Costs of the Federal Tax System cited studies that put these costs other than compliance at 2-5% of GDP. 3.5% of $18 trillion would be over $630 billion. Robert Carroll, formerly of Treasury’s Tax Analysis division, testified on April 15, 2008 at the Finance committee that the code could cost an overall “$1.3 trillion in economic output” annually.

In December of 2006 at the American Enterprise Institute, the House tax-writing (Ways and Means) committee former chairman Bill Thomas said “most of the business preferences can also be replaced with lower rates”. By allowing less deductions, credits and exemptions, a greater amount of income is taxed. The rates could then be lowered for revenue neutrality, but more revenue can be generated from increased growth. Assuming all expenses must be deductible to avoid “double taxation” creates a consumption encouragement system. The preferences ultimately misallocate resources.

For example, a single filer being able to deduct $100k of purchased insurance from $413k of business income prevents the $100k from being taxed at a 40% rate (sole proprietor, over $313k bracket), so the purchase winds up getting discounted by $40k. This incentive to pre-pay into a 3rd party pool of funds reduces price sensitivity causing inflation which reduces access for others. Other problems include disproportionate tax benefits to upper-income earners and iatrogenic illness.

Most energy costs are also deductible and businesses use at least half of all the oil- around 10 million barrels per day out of 19 MBD total: 5 MBD for industrial (4 for utilities, 1 for raw materials), 1/2 MBD for commercial (stores, offices) and about 5 MBD for travel. 1/3 of airline travel is business use and all 1.5 MBD of the fuel purchase is deductible. (EIA, FHWA, BTS). Shipping fuel is a small, but growing category.

A vehicle owner paying $3 per gallon, traveling on business, can deduct that from income before it gets taxed at, for example, a 25% rate (sole proprietor, $37k-90k bracket). Every $3 reduction of taxable income saves 75 cents. The market price is, or at least seen as discounted, thereby tending to discourage conservation. Even worse, the standard mileage rate option, currently at 50 cents per mile, multiplied by 20 miles traveled, allows a $10 deduction, which saves $2.50. At these savings, vehicle MPG is less important, used less efficiently and of course often used for personal reasons, but claimed as a business expense.

Purchasing a vehicle over 6k lbs. allows a first year deduction of $25k (IRS section 179), about $10k of regular depreciation and some “bonus” depreciation. For 6k lbs. and under, it’s only the $10k. The over 6k lb. allowance was raised to $100k in 2004 and lasted for 18 months before the media temporarily woke up, which woke up Congress, lowering the total back to about $35k- still a strong incentive to buy a heavier vehicle. With either category, a buyer can justify the extra gas cost with the tax savings.

With utilities deductions there’s the added problem of many office and some factory and store leases having utilities included in the rental price since the owner of the property can subtract these costs as operating expenses. The tenant is not paying for the heat, A/C, etc. directly and so is even less likely to conserve.

Former Department of Energy policy advisor Karen Harbert stated on May 16, 2006 at the House Government Reform Committee “Countries that provide reduced priced product.. encourage an unhealthy reliance on non-market priced oil, which is not sustainable.” Her statement probably referred to nations such as China, which used to heavily subsidize oil use, but can also apply to the U.S.

A 1999 study by the International Energy Agency ‘Looking at Energy Subsidies: Getting The Price Right’, found in the 6 countries studied (not U.S.), eliminating the existing 20% government price discounts could reduce demand 13%.

We still use almost twice as much oil as China and therefore have the largest effect on the international price.

The National Association of Manufacturers believes lowering tax rates is a higher priority for international competitiveness than labor costs. Frank Vargo on 2/15/07 at the Ways and Means subcommittee on Trade said production labor averages just 11% of costs. For the corporate rate, the Treasury Department suggested a list of preferences to replace, in its Background Paper on Business Taxation and Global Competitiveness, that alone could bring the highest rate down to 27%, revenue neutral. Replacing more could reduce the lower brackets further so more small businesses could get off the ground.

Making more things here would not only lessen our funding of China’s military. It would slow their own increasing oil appetite, including Beijing to L.A. container ships that could use 200k gallons one way. Their factory growth also contributes to up to hundreds of thousands of Chinese dying annually from air and water pollution (World Bank).

The non-energy tax preferences and other government related waste also uses energy. How much oil is used within the $700 billion of tax system inefficiencies? the $600 billion of excessive legal costs? the $400 billion of needless regulations? the $900 billion of spending waste? How much is wasted just within the 30% or $900 billion of government and private “ineffective medical costs” (IOM, Dartmouth/Atlas) out of $3.2 trillion (CMS)? How about all those commuter miles for government workers and contractors?

Price is the most efficient rationing mechanism with the fewest negative secondary effects. The mid 2008 demand drop from 20.7 MBD to 19.5 MBD was mostly due to the $4 price and many businesses weren’t even effectively paying that. We could get to 18 from 19 today without hurting the economy. Any additional desired conservation could come from an above market, revenue neutral tax restoring the $4 price. Increasing domestic production by opening more federal land might be more politically achievable if a real conservation plan were offered.

Allowing individuals and companies the option of lower rates in exchange for paying market prices can decrease oil use now, as opposed to a promise for 5 or 10 years from now. It can also reduce pollution, inflation, including international food prices and dependency on other imports. Increased disposable incomes would expand the ability to pay for the basics like housing, food, health care and education.