Obviously the income tax is a tax on people’s income-generating activities. What this means is that it penalizes these activities relative to activities that do not generate income. In a market setting, income-generating activities are those that lead to the production of goods and services. So the income tax penalizes work relative to leisure, and saving and investment relative to consumption. It is the latter that tends to be least understood and therefore will be the focus of this essay.

Consume or Invest?

The broad choice facing an individual in choosing to allocate his or her income is to either spend it or save and invest it. This consumption/saving choice is distorted by the income tax in favor of consumption.

Using the traditional terminology, the income tax double-taxes saving relative to consumption. It should be noted that this terminology is somewhat misleading. As will be demonstrated, the tax does not explicitly double-tax saving but reduces the returns to saving twice, while reducing the returns to consumption just once.

This can be shown with a simple example. Start with an individual who has $100 of pretax income. In the absence of taxation this person has $100 for either consumption — the purchase of goods and services — or saving. If the interest rate is a simple 10 percent per year, then the person can decide whether he prefers to spend $100 or save the $100 and have $110 available for spending a year from now. The decision will be based on his preference for satisfaction now relative to satisfaction in the future. This is what economists call time preference.

Now assume that the individual faces a 10 percent income tax. His $100 is reduced to $90, cutting the amount available for consumption by that rate. Likewise, the tax implicitly reduces his returns to saving by 10 percent. In other words, by taxing the principal the government is simultaneously reducing the entire stream of returns from the investment. So if he saves the $90, because of the tax his interest income is reduced from $10 to $9.

The Returns to Waiting

In the absence of further taxation the individual’s choice is between spending $90 now or waiting a year and having the opportunity to spend $99. Returns to consumption spending and returns to saving have both been reduced equally by the tax. But under a standard income tax, the returns to saving are reduced yet again. The $9 in interest also is taxed 10 percent, leaving $8.10.

So the tax reduces the returns to savings twice: first from $10 to $9 when the initial $100 is taxed, and second from $9 to $8.10 when the interest is taxed.

Note that the return from consumption is only reduced once, from the level of satisfaction that could be obtained with $100 to the level that could be obtained with $90. The tax on interest or other returns to investment, including dividends and capital gains, biases decisions against saving, investment, entrepreneurship, and business expansion, and in favor of consumption spending.

In addition the government, at both the federal and state levels, further punishes investors with a separate corporate income tax. The corporate tax, which at the federal level is 35 percent, adds a third layer of tax on both dividends and capital gains.

Exempt Returns from Saving

The most straightforward way to remove the bias is to exempt from taxation all returns from saving. This is the approach that has been taken by those who advocate the flat tax, for example, Steve Forbes. From this perspective, saving and consumption are treated symmetrically.

An alternative way of remove this bias is by eliminating all saved income in the current time period from the tax base, taxing it only when it is withdrawn for consumption purposes. A tax that deals with the bias against saving in this way is called a “consumed income tax.” The idea would be to treat all savings and investment in the same way that IRA and 401k retirement investment plans are treated, except that there would be no penalties for withdrawing funds before any legally specified age.

In reference to our example, if the person decided to spend his $100 in pretax income, he would be subject to the 10 percent tax immediately and would have $90 available for consumption. If instead he decided to save or invest the $100 for a year, he would not be taxed on it until it was taken out of savings and used for consumption. At the end of a year, if he chose to withdraw the money from savings or to cash in his investment, the original $100 and the return of $10 would be taxed 10 percent. This would leave him with $99 for consumption, or the equivalent of a full 10 percent return on $90. The point here is that only income that is used for consumption is taxed, hence the name “consumed-income tax.” It should also be noted that this gives the same result as the flat tax, which would exempt the interest income from the tax base. The individual would save $90 ($100 minus the 10 percent tax) and earn $9 in interest.

Full Exemption of Expenses

The consumed-income tax suggests that all expenses incurred to generate future income, which is the definition of investment, should be eliminated from the tax base. This implies that all work-related expenses, including commuting expenses, educational expenses incurred to enhance future income, and day-care expenses, should be excluded from the tax base. These expenses are analytically equivalent to saved income. They represent forgone current consumption in an attempt to generate future income. This approach also implies that all business expenses (labor, plant, and equipment) should also be deducted in the year they are incurred rather than depreciated over time. This insures that the full cost of the investment, rather than a time-discounted cost, is realized in the tax deduction.

A word of warning is in order. It needs to be made clear that there is no such thing as a tax that does not damage productivity and economic growth. To invoke a term often used by economists, a “neutral tax” does not exist. At the very least, all taxation transfers the control of productive resources from the free market to government control, that is, from an institutional setting that will generate a more efficient use of resources to one that will generate a less efficient use of resources. What this means is that overall the economy, and therefore human welfare, always suffers as a result of taxation.

But, alas, Freeman readers are not the relevant decision-makers. Tax increases are driving much of the discussion, and no option is discussed more than a value-added tax, or VAT. Indeed there is much speculation that President Obama’s Bipartisan Commission on Fiscal Responsibility and Reform will include a VAT as the major source of new revenues in any set of recommendations.

The VAT is a pernicious and insidious tax that promises to fuel dramatic growth in government. But this cannot be understood without first examining the mechanics of the tax. The devil is indeed in the details.

Theory

Theoretically a VAT is levied on the “value added” at every stage of production to goods and services ultimately purchased by consumers. The consumer, however, pays the final tab.

The table below shows four stages of production leading to the final sale. (This example is from Michael Schuyler’s “Consumption Taxes: Promises and Problems,” Fiscal Issue 4, Institute for Research on the Economics of Taxation, 1984.) As each stage is completed, a partially finished product has value added before it is sold to the next stage. In this example, value added is taxed at 10 percent. To simplify, a starting point is picked with “prior producers” having added the first $10 of value. At the point of sale a 10 percent tax, $1, is collected. Thus the cost to the manufacturer is $11.

After adding further refinements the manufacturer sells his partially finished product for $30 to the wholesaler and charges a 10 percent VAT, receiving $33. To figure the tax, the manufacturer subtracts the tax from the previous stage to avoid double taxation. Before sending the tax to the government, he deducts the $1 paid to the original producer. With value added at $20, he sends $2 to the government.

The wholesaler adds $50 in value to the product and sells it to the retailer for $80 plus the 10 percent, for a total of $88. But before he sends the $8 to the government, he deducts the $3 in VAT paid to the manufacturer. The net tax collected is $5. Ultimately the retailer sells the finished product to the consumer for $100 plus the 10 percent VAT, or $110. Again, the retailer deducts the $8 that he had previously paid and sends $2 to the government, or 10 percent of the $20 in value added at this final stage. (If at any stage a producer sells his goods for less than the cost of his materials, he would pay tax only on the actual selling price.)

In principle there is no difference, in terms of the total tax collected, between a VAT and a retail sales tax. But the compliance costs of a VAT would be much higher because the tax is collected at every stage of production.

Practice: The Invoice-Credit Method

Most governments have adopted the “invoice-credit method” for collecting a VAT. The United States would likely do the same. This method makes tax collection automatic. In the example, which doesn’t use that method, companies deduct the amount of tax already paid at each stage of production before sending in the tax on value they added. But with the invoice-credit method, the taxpayer at each stage is responsible for the entire amount of the tax on his sale and can only obtain a credit for taxes paid previously if he provides an invoice from his suppliers. For example, the retailer that purchases the product from the wholesaler for $88, VAT included, must pay the full $10 tax on his sale to the final customer and then submit an invoice provided to him by the wholesaler showing that he paid $8 in tax. Only then can he get credit for it.

Michael Schuyler, economist at the Institute for Research on the Economics of Taxation, points out that the invoice-credit method ensures that the tax is “self-policing.” Focusing on the transaction between the manufacturer and wholesaler in the example, Schuyler writes, “Suppose . . . that the manufacturer wants to understate the sale price of its output . . . so that it can reduce its tax. . . . Would the wholesaler allow the phony amount to be listed on its purchase invoice? The wholesaler would object because the [amount gained by] the manufacturer would be lost to the wholesaler.”

Thus there is a strong incentive for businesses to police the reporting of their suppliers.

A Central Planner’s Dream Tax

From the perspective of the State, this is a near-perfect tax. It touches every stage in every production process, from new homes to hair cuts, and allows the government, because of the required invoices at every point, to keep track of every business’s buying and selling. For a State bent on managing the details of business, possibly to implement CO2 controls or to make sure that politically favored firms (say, unionized ones) are patronized, the information can establish a useful database.

But beyond this, the VAT would be a revenue-generating machine, unmatched by any other form of taxation. First, it guarantees that a percentage of the total value of all goods and services sold in the economy goes to the State. Nothing escapes the tax. Also, because it is levied on such a broad base, very small increases in the rate would bring in large amounts of revenue. While this is also theoretically true of a retail sales tax, the multilayered enforcement mechanism of a VAT makes it almost impossible to avoid. Note that the tax on the full value added up through any stage of production is the responsibility of the company operating at that stage, until the company provides the needed invoices from his suppliers that allow him to receive the credit. As a product passes through different stages of production, the incentive is always to collect the tax from those you are selling to and to collect the invoices from those you are buying from. Every business becomes a revenue agent. With very little enforcement effort, the government watches the money roll in.

Adding insult to injury for the taxpayer and icing on the cake for the State, the tax is usually hidden from the final consumer. Unlike a retail sales tax, the VAT is usually included in the sticker price of the product. Consumers are not directly confronted with the fact that they are paying it. This both makes the tax easy to increase and masks the true cost of government. If we are ultimately going to reduce the size of the State, individuals need to feel the pain it inflicts. This starts with making people keenly aware of the taxes they pay. There is no tax more hidden from the people who pay it than a VAT.

The VAT is not just another tax. It poses a fundamental threat to liberty and a free society. And since a tax with such massive revenue-generating capabilities would be nearly impossible to repeal, it is likely that there would be no turning back the advancement of Leviathan.

None of those statements should come as news to the readers of The Freeman. Such precepts underpin most of what is written in these pages. What is remarkable is that they come in a book on global warming by a well-known climatologist with no training in economics.

Dr. Roy Spencer is the principal research scientist at the University of Alabama at Huntsville. He has a Ph.D. in meteorology and was a senior climate scientist at NASA. Along with his colleague Dr. John Christy, he developed the original method for precise monitoring of global temperatures from earth-orbiting satellites. But unlike many scientists whose work impinges on public-policy debates, Spencer understands the importance of economic analysis in answering the fundamental question: “What should be done?” He recognizes that just because science may indicate a causal connection between human activity and some negative consequence—either for the environment or for other human beings—it doesn’t follow that policies should be implemented to curtail those activities. That is, the answer to the “should” question cannot come from the sciences.

That is why, in the middle of his book about global warming, Spencer includes a cogent and well-schooled chapter on both basic economics and the relationship between freedom and prosperity. The title, “It’s the Economics, Stupid,” conveys the importance he places on economic analysis not only for formulating policies toward global warming but also in determining whether there should be any such policies at all.

Some might interpret Spencer’s excursion into economics as a form of disciplinary imperialism—pontificating in an area where he has no expertise. That would be wrong. In fact, it is an act of disciplinary humility.

In writing this book on climate policy, Spencer realized that his own disciplines—meteorology and climatology—could not provide the answers to the policy questions. He understood that he needed to learn some economics. He did his homework well.

Ultimately though, the book is mostly about science and scientists. Indeed, it’s as much about the latter as the former. Chapters 3 and 4 are especially important. In the former, “How Weather Works,” Spencer addresses basic issues concerning weather, the climate, how the two are different, and how the former determines the latter. This is the background typically ignored in discussions about anthropogenic global warming. In Chapter 4 Spencer’s skeptical stance on global warming is conveyed in the title, “How Global Warming (Allegedly) Works.” Those chapters give the reader a solid, plain-language discussion of the science that almost anyone can understand.

As noted, much of the book is about scientists—their attitudes and the incentives they face. Spencer sets the tone with a cartoon showing three scientists standing in front of a battery of telescopes. The scientist in the middle is introducing a younger colleague to an older, more experienced researcher. The caption reads, “This is Doctor Bagshaw, discoverer of the infinitely expanding research grant.” Spencer spends many pages dragging scientists down off their pedestals. He shows that what they research and what they conclude, particularly in an area like global warming, is as much a function of financial incentives, ideological and religious beliefs, and peer pressure as it is a function of the scientific method.

The past decade has produced a battery of books written on global warming from a skeptical perspective. I have read many of them. What makes Spencer’s book stand out, in addition to its integration of sound economics with sound science, is its readability and sense of humor. It simplifies complex issues in climatology to a point where any reasonably intelligent person can understand them and keeps the reader continuously engaged.

Policies currently being enacted and proposed in the name of fighting global warming represent the biggest challenge to liberty of the last half-century. Those of us who cherish liberty need to come to grips with this issue and be able to discuss its ramifications intelligently. Spencer’s book is a great place to start.

Neither the government nor anyone else can spend future dollars. In reality all current spending must come from current revenues and can use only existing resources. Every dollar the government spends, even if borrowed, has to come out of some existing person’s pocket and therefore preempts the use of that dollar somewhere else in the economy—not in the future, but here and now.

The government can obtain its borrowed money by selling Treasury bonds to either American citizens or foreigners. If it borrows from domestic sources, it is getting money that Americans would have either invested somewhere in the economy or spent on goods and services. Government borrowing simply diverts the cash from other uses, just as if its spending were financed by taxation. Economists call this the “crowding out effect.” 

A typical response is that most of the government borrowing will be from foreigners and that the Obama deficit won’t crowd out economic activity in the United States. Thus we are said to be mortgaging our children’s future to people in other countries. The first thing to notice is that we can’t know who the bondholders will be in the future when the loans come due. Treasuries are sold and resold many times over. This is also true of debt originally issued to Americans. 

The real problem has nothing to do with who holds the note at the time of repayment. A good economist asks what else these foreigners would be doing with their dollars. Because they are lending dollars, as opposed to euros or yen, this money would ultimately be either spent on American goods, thereby increasing exports, or invested in the U.S. economy. We reach the same conclusion regardless of who lends the government the money. The real costs of government spending, no matter how it is financed, are experienced here and now.

Government Spending Always Competes with Private Spending

Also, regardless of where the money comes from—taxation, borrowing, or printing press—government spending always preempts other spending in the economy. Those who get the borrowed money have purchasing power transferred to them that will increase the demand for the resources they use. That will increase the cost of those resources to other buyers. Government spending thus always competes with private-sector spending for scarce resources and preempts growth.

This is not to argue that deficit spending is the same as tax-financed spending. It is not. Deficit spending creates the occasion for coercive wealth transfers from future taxpayers to future government bondholders. When the bills come due, most of our children and grandchildren will have part of their incomes coercively transferred through higher taxes to those who hold the Treasury notes. Government debt makes our children less free.

Furthermore, deficit spending obfuscates the true cost of government, not only in lost liberty but also in lost productivity and wealth. Deficit spending is dishonest because it leads people to believe they are getting something for nothing while in reality their wealth is diminished just as if the spending were covered by taxation. But that cost is not seen in the tax bill. This is why politicians find deficit spending so appealing. It is a tool for pulling the wool over citizens’ eyes while rewarding special-interest groups and expanding the state’s control over the private sector.

Ultimately, the real choice is not between deficit-financed and tax-financed spending. The moral question is whether we should have more spending and bigger government with less liberty or less spending with a smaller government and more liberty. The hand-wringing on the left and right about passing the cost of “stimulating” our economy onto future generations is misplaced. No matter how it’s financed, Obama’s new spending has the potential to stimulate only one thing: the size, scope, and power of government.

It’s been said that when the only tool you have is a hammer, every problem looks like a nail. For politicians, bureaucrats, and many activists, when the only tool they have is coercion, the cause of every problem looks like too much freedom.

Make no mistake: if you are committed to accomplishing your social goals by using government power, then by definition your only tool is the hammer of coercion. An observation often attributed to George Washington has it that “Government is not reason; it is not eloquence; it is force.” And when people choose to use government to accomplish their goals, they are choosing to use force, not reason and certainly not eloquence.

True to form, governments at all levels have affirmed Washington’s reputed observation. But I think state and local governments are the biggest culprits. Issues like eminent domain and gun control, where constitutional issues arise, tend to get widespread publicity and public scrutiny, but routine tyranny occurs with respect to day-to-day issues that are often considered legitimate local-government functions.

If a local grocery store’s produce department runs out of oranges or its deli has a shortage of roast beef, it doesn’t blame its customers for having too much freedom to purchase fruit and meat. It simply finds a way to accommodate that freedom and meet the demand. That’s not how governments respond.

The People Are Nails

Typical is Raleigh, North Carolina’s approach to solving its drought and water-shortage problems. The city for much of the past year has been running short of water, one of only a handful of goods it is charged with supplying. Its response has been to blame people for having too much freedom, including the freedoms to water their lawns, wash their cars, power-wash their homes, and most recently, to enjoy the conveniences of a garbage disposal. In the name of solving its water shortage, Raleigh has passed an ordinance banning the installation or replacement of all garbage disposals. Instead of city politicians’ asking themselves, “How can we accommodate our citizens’ free choices?,” as the grocery store would, they immediately blame the problem on those freedoms. This is their nail, and their solution is the hammer of force.

Here’s another example. For years, city and regional transportation planners have faced traffic congestion in larger cities and medium-size communities around the country. Traffic congestion is much like a water shortage—it is a shortage of road space. Governments have massively failed to adequately accommodate people’s free choices regarding their transportation needs. And as with the water shortage, politicians think the traffic problem is caused by too much freedom, specifically, too much freedom in the use of cars.

Many states, instead of better managing the supply of roads, have adopted an approach euphemistically known as transportation-demand management (TDM). As the Nevada Department of Transportation describes it, TDM “is a general term for actions that encourage a decrease in the demand for the existing transportation system.” And as noted by the North Carolina Department of Transportation, “[M]ost TDM strategies deal with the modification of travel behaviors.”

Ultimately, TDM is a collection of policies meant to force people out of their cars, either directly or through artificial incentives, and onto public transportation. But this is only feasible when people live in high-density communities. So not only does their freedom to make transportation decisions need to be “modified,” but so does their freedom to choose living arrangements. Along with transportation-demand management comes “housing demand management” and “land-use demand management.” To accommodate public-transportation systems and to discourage driving, TDM typically includes new zoning laws intended to cram people into areas with dozens of housing units per acre. Transportation planners have taken it on themselves to substitute congested living arrangements for congestion on the roads.

According to transportation planners in North Carolina the “vision [of TDM] extends far beyond public transportation. It embraces notions of how we want to live in the 21st Century and what we want our neighborhoods and communities to become.”

It is quite clear that the “we” being referred to is not individual citizens and families. It is instead the paternalistic “we” of bureaucrats and government planners.

Environmental Regulation Is the New Hammer

Probably the most pernicious example of government-as-force-not-reason is the approach now being taken by many state governments ostensibly to fight global warming. While the federal government is looking at broad-brush policies such as carbon taxes or cap-and-trade programs, state-level policies are much more aggressive in using global warming as an excuse to micromanage people’s choices. More than 25 states have hired an advocacy group, the Center for Climate Strategies (CCS), that poses as an objective consultant to help devise policies that would force people to modify their behavior in order to reduce carbon-dioxide emissions. CCS can charge bargain-basement consulting fees to the states because it is subsidized by a host of statist left foundations, including the Rockefeller Brothers Fund, Heinz Endowments, Turner Foundation, and Z. Smith Reynolds Foundation. (See the critical website www.climatestrategieswatch.com.)

While there are competing theories regarding the causes of global warming (for example, see research by Duke physicists Nicola Scafetta and Bruce West on the influence of the sun on climate change at http://tinyurl.com/rs2hp), in hiring CCS, the states agree not to discuss these alternative theories when formulating policy. In fact, they must agree that the science is settled with regard to human-generated greenhouse gases.

This is ominous to those concerned about freedom because other theories, such as those related to natural climate variation, would not imply the need for coercive restrictions on people’s lifestyle choices. In other words, the only theory of global warming that these states are considering is the one that has freedom as the culprit. It is important to note that everything humans do, including breathing, emits carbon dioxide. The implication then is that all production and consumption activities are up for scrutiny and possible coercive control. The proposals CCS suggests to every state are generally the same. They include restrictions on the kinds of cars people can drive, fuels they can use to heat and light their homes, and auto insurance and appliances they are allowed to buy. The size of the lots they can build houses on and the size of those houses are also subject to the proposed restrictions.

The actual goals of such proposals are questionable. Indisputably, these restrictions will not reduce global temperatures, even if the whole world adopted them—and state officials and their CCS consultants know it. This implies that these proposals are not really about global warming, but are instead exercises in what could be called “lifestyle imperialism.” Like laws against homosexuality or gambling, they are in fact an attempt to legislate morality.

Given the principles behind the founding of the United States, policymakers need to view individual freedom as a moral imperative. They should realize that it is not the role of government to solve all conceivable problems but to protect liberty. To the extent that government takes on a problem-solving role, the question decision-makers should continually ask themselves is: “How can we achieve our objective without limiting people’s freedom to live as they see fit?” Unfortunately, many, if not most, bureaucrats and policymakers seem more interested in asking which freedoms they can get away with limiting.

It amazes me how so many newspaper columnists have no qualms about voicing opinions on topics they clearly know nothing about. This is the case with Anne Applebaum, politics and foreign-policy writer for the Washington Post. In her February 6 column, “Global Warming’s Simple Remedy,” she announced her discovery of a “solution” to global warming that is “grippingly unoriginal [no argument there], requires no special knowledge of economics [if this were true Applebaum would be a well-positioned advocate], and is easy for any country to implement.” What is this magic bullet? (Drum roll, please.)

A carbon tax.

Applebaum arrives at this insight by first laying the scientific foundation. She cites no fewer than two newspaper articles reporting on the February 2 release of the Summary for Policy Makers of the United Nation’s report on global warming. The report, by the way, had not been fully written yet and was not scheduled for release until this month. So as not to mislead her readers into thinking that she is an “Annie come lately” to global-warming alarmism, she quickly assures them: “[D]on’t get me wrong: I was convinced by the reigning consensus on global warming a long time ago.” Apparently Applebaum read some newspaper stories after the release of the 2002 UN Summary for Policy Makers.

Applebaum’s second step takes her away from the science and into the world of practical policy analysis. She turns to the Kyoto Protocol, the 1997 United Nations treaty signed by Bill Clinton but rejected in a 95–0 “sense of the Senate vote.” Applebaum argues that Kyoto should be abandoned because “it creates a complicated and unenforceable system of international targets for carbon emissions reduction.” (In my view, this is one of the few things going for it—just a different perspective, I guess.) It is this observation that brings her to the carbon tax.

Her main policy criteria are simplicity and ease of compliance. And, of course, the tax should be broad based. Heck, she almost sounds like Steve Forbes talking about a flat tax. Applebaum’s approach is to tax everything that exhales CO2, save human and animal respiration, although she doesn’t say why this is left out. Maybe it’s like the home mortgage-interest deduction in many flat-tax proposals—too popular to make elimination politically feasible. According to Applebaum, the tax should “be applied across the board to every industry that uses fossil fuels, every home or building with a heating system, motorist, and every public transportation system.” And this could happen “without a U.N. committee, or a complicated international effort of any kind. . . .”

Here’s the rub. While the title of the article claims that a carbon tax would be a “simple remedy” for global warming, there is no mention of how or even if a carbon tax would have any noticeable impact on the climate. In fact, neither short-term nor long-term climate change is even noted as one of the benefits of the tax. The only social “benefits” that she asserts will occur (evidence is not necessary when righteousness is on your side) relate to technological change, energy conservation, and fiscal responsibility.

First she asserts that the tax would “immediately . . . produce a wealth of innovations to save fuel, as well as new incentives to conserve.” Of course the idea that the tax would induce people, to some degree, to cut back on the consumption of fossil fuels is trivial. If you want people to do less of some activity, you tax it. What is completely unsupported is the claim that it would be “immediate” and would “produce a wealth of innovation.” To know this she would need to have a great deal of the “specialized economic knowledge” that just one line earlier Applebaum claims would not be necessary. She would need to know the amount of the tax, something she doesn’t even discuss in the article; the demand for different kinds of energy; the elasticity of demand for electricity, gasoline, heating oil, and so on; and a long list of other variables. But even if her assertions were true, the presumed goal is not energy conservation per se but the reduction in future average global temperatures. On this point Applebaum is silent. By the way, so are nearly all other advocates of climate-change policies.

Then Applebaum gets to what she sees as the real benefit of the tax—more money. “More to the point, [the carbon tax] would produce a big chunk of money that could be used for other things.” (Apparently she means things other than what those who have earned it want to use it for.) She goes on to suggest balancing the budget or “fixing” Social Security. As an aside, she also claims that there is “a foreign policy benefit.” Countries that use the tax “would suddenly find themselves less dependent on Persian Gulf oil . . . ,” proving my initial point that most columnists have no problem writing on topics they know nothing about. It is very likely that such a tax would increase dependence on Middle East oil because oil refiners would reduce their use of the most expensive oil first. Middle East oil happens to be the least expensive.

No Impact on Climate

Ultimately though, Applebaum makes no claims regarding the impact of her tax on climate change. This is typical. The dirty little secret behind nearly all the alarmists’ policy proposals is that they will not have any noticeable impact on the climate. For example, assume that the Applebaum tax produces the same level of CO2 emission reduction as the Kyoto Protocol, a result that she would apparently be happy with. Her complaint was that Kyoto was complicated and difficult to enforce, not that emission reductions were too small. The widely acknowledged best estimate of the impact of Kyoto on climate, assuming full compliance by all the countries that were originally intended to participate, is that global temperatures in 100 years would be 0.26 degrees F less than they would be if nothing were done. The Energy Information Agency says the cost to the United States of this unnoticeable change would be about 4 percent of GDP and millions of jobs.

But let’s get real. According to well-known climate alarmist Dr. Jerry Mahlman of the National Center for Atmospheric Research, to stabilize CO2 levels in the atmosphere at current levels, which he claims would still lead to a 1 degree increase in temperatures over the next 100 years, a 75 percent reduction in CO2 emissions per capita would be required. A recent John Locke Foundation study calculated that this would take us back to about 1895 levels of per capita CO2 emissions. Here is where I think Applebaum’s assertions about immediate incentives to conserve would be correct. If she obtained a high enough tax—and the reader can speculate how high that would have to be because I sure don’t know—undoubtedly it would have a powerful incentive effect.

On the other hand, there would also probably be a massive increase in worldwide poverty and even starvation and disease. Mahlman himself argued that the consequences of this radical a reduction would be “horrific.” But it probably would reduce our dependence on Persian Gulf oil.

Unfortunately, in an October 4, 2005, column titled “The Solve-Everything Tax” Tierney buys into a laundry list of economic and scientific fallacies as justification for a new 50-cent-per-gallon gasoline tax.

He opens by saying,“I have a modest proposal to fight global warming, save energy, cut air pollution, ease traffic congestion, reduce highway fatalities and, while we’re at it, reform Social Security.” But in fact, Tierney’s “Solve Everything Tax” would solve nothing and would causes problems of its own. Let’s take his claims one at a time.

Fight global warming. In a 1998 Geographical Research Letter article Thomas Wigley, a scientist who accepts the alarmist vision of global warming, concluded that if the Kyoto Protocol were implemented with 100 percent compliance the result would be global average temperatures in 50 years that are an undetectable 0.126 degrees Fahrenheit cooler than they otherwise would be. This result has gone unchallenged. Even if one accepts the alarmist position that global warming is primarily human induced and that its effects will be dramatic, extensive, and harmful, a 50-cent-per-gallon gasoline tax will do nothing to alleviate the problem.

Save Energy. It is not the role of government to tell people which productive inputs they should economize on and which they should use more of. Market prices reflect relative scarcities, and people will make tradeoffs in their lives and productive activities accordingly. For Tierney to suggest that he or policymakers know better what resources should be conserved invokes what Hayek called a “pretense of knowledge”and substitutes the decisions of central planners for freely choosing individuals.

Cut air pollution. Assuming that Tierney is referring to ground-level ozone (smog), the primary pollution “problem” still attributed to cars, then this tax is likely to accomplish little. Nationwide, ground-level ozone has been in steady decline for many years and this is likely to continue. Older, more-polluting cars are being replaced by newer, cleaner cars, and in the next few years more stringent federal regulations are coming on line. Leaving aside arguments that both the federal ozone standard and these new rules are overkill, if nothing more is done, most if not all of the country will be in compliance with this standard within the next several years. Tierney doesn’t explain why a permanent tax increase on gasoline is necessary to attack what is at most a short-run problem.

Ease traffic congestion. Congestion is experienced primarily during morning and evening rush hours. Commuting to work is probably the most important use that people make of their cars. Economic analysis suggests that the higher prices brought about by a new 50-cent tax—which will translate into less than a 50-cent price increase at the pump—will get people to economize on the least, not the most, important uses of their car. In other words, people are most likely to decide to go to restaurants or movie theaters that are closer to their homes, or take vacations that do not involve quite as long a drive. None of this will have an effect on traffic congestion during rush hour.

Reduce highway fatalities. To the extent that this tax encourages the purchase of lighter, more fuel-efficient cars it will actually increase highway fatalities. This has been the well-documented result of federal Corporate Average Fuel Economy (CAFE) standards.

Reform Social Security. For Tierney this is the clincher. It is what ensures that his gas tax is indeed the “solve everything tax.” The idea is that the revenue from the gas tax would fund private accounts for Social Security so, as Tierney puts it, “at least they’ll get their money back,” referring to purchasers of gasoline. The idea that people who pay the gas tax will “get their money back” in the form of a private retirement account is based on several false assumptions. First it assumes that these accounts will somehow be set up in proportion to the amount of gas tax that people pay. If this is not the case, then the whole program would be nothing but a coercive wealth transfer from those who pay relatively more in taxes to those who receive relatively more in “retirement account money.” But even if Americans were given retirement accounts that exactly equaled the amount paid in gas taxes, they would still be made worse off. This is because without the tax, the money can be used at any time for any purpose—to pay the rent, buy new clothes, and make car payments, and so on. But money received as a retirement account would be restricted to retirement use. Hence from the perspective of economics that money is less valuable to the taxpayer than the money paid in taxes. This takes into account that the money in the account would accumulate interest. If the gasoline taxpayer preferred to put this money away in an IRA or other retirement account and have it accumulate interest, he would have that option without the “help” (coercion) of Tierney’s gas tax.

The idea of funding private accounts for Social Security with a tax increase is certainly not a novel idea. But according to Tierney,this isn’t just any tax increase. This is a tax increase that would be good for society even if Social Security were not the target of its booty.

Unrealistic Assumptions

Finally, to put some “rigor” into his proposal, Tierney turns to a study in the American Economic Review purporting to show that the gas tax “should increase by 60 cents per gallon to compensate for the congestion, pollution and other costs that drivers impose on society.” Besides the fact that none of these revenues would be used to “compensate” anyone for anything, to arrive at such a conclusion the authors of this study had to make assumptions about market prices and what they represent that have no relationship to the real world. When assessing the tax calculations made in these kinds of studies, Nobel laureate James Buchanan concluded in his book Cost and Choice, “[T]he analyst has no benchmark from which plausible estimates can be made.” Ultimately, these calculations require the same information that an all-knowing economic central planner would need to efficiently plan an entire economy. This is why “pollution taxes” advocated by many economists as a “market based” policy are actually a “stealth” form of socialism. Ultimately, taxes of this sort, while derived in an air of rigor and mathematical elegance, are arbitrary and meaningless in terms of their stated goal—increasing economic efficiency and social welfare.

In reality, Tierney’s tax is nothing special. Like a typical “sin tax,” its intentions are paternalistic. And like all other taxes, it coercively transfers wealth and distorts economic decision-making.

In chapter after chapter Michaels dissects the myths surrounding this hypothesis. He examines the alarmist claims regarding melting icecaps, extreme weather, species extinction, and more that are familiar to anyone who reads newspapers or watches CNN. This is done after an opening chapter that makes intelligible to the lay reader the basic science behind climate change.

What might surprise some is that Michaels, probably the best-known global-warming skeptic, accepts both the seemingly undeniable fact that the earth is warming and the proposition that it is in part due to human use of fossil fuels. As he states,“[G]lobal warming is real, and human beings have something to do with it.” What separates him from the alarmists is his caveat: “we don’t have everything to do with it; but we can’t stop it, and we couldn’t even slow it down enough to measure our efforts if we tried.”

Yet Michaels denies that the warming will be either dramatic or will have catastrophic consequences. His position is thus more nuanced than his detractors are willing to acknowledge or many of his supporters realize.

Unfortunately, the most important chapter in the book is at the end. After dispelling all the myths about rising sea levels, melting icecaps, and the possible loss of penguins and butterflies, Michaels gets to the organizing theme of the book—namely, how government funding combined with university tenure leads to the distortion of science and bad public policy. Had this story been told at the beginning, the hyperbolizing of scientific claims, exposed throughout the book, would make more sense. Chapter 11 provides the lens through which the earlier chapters should be read. I suggest that readers start with this chapter and then go to the beginning.

By combining Public Choice theory with the ideas of Thomas Kuhn regarding how paradigms take hold in scientific research, Michaels explains why distortions in climate research should have been expected. (Note the subtitle of the book.) The dominant paradigm in the science of climate change includes the idea that “the major cause of recent climate change is the emission of carbon dioxide from the combustion of fossil fuel.” Furthermore, scientists and statisticians through “improved quantification . . . will give policy makers . . . guidance on what might be required to slow, stop, or reverse those changes.” Over time, a paradigm can be overthrown, but it must first be widely recognized as failing, and there needs to be a coherent replacement available.

Michaels states the alternative paradigm as follows: “We know, to a very small range of error, the amount of future climate change for the foreseeable future, and it is a modest value to which humans have adapted and will continue to adapt. There is no known, feasible policy that can stop or even slow these changes in a fashion that could be scientifically measured.” Unfortunately it is not until this point (on page 222) that the reader is informed that “this book is about the resistance to this new paradigm.”

Michaels explains how established paradigms, which are rarely challenged by the bulk of a profession, have “lives of their own.” For most academic scientists, receiving tenure requires publishing in accepted peer-reviewed journals.These journals have editors and referees who are steeped in the dominant paradigm. Therefore, publishable research must ask only those questions that are generally accepted within it. Hence,the paradigm is perpetuated.

Layered on top of this is the “federalization of science,” in this case the federal funding of climate-change research. Here is where Public Choice theory enters. It is not in the interest of NASA, DOE, the EPA, and other agencies to fund research that does not accept the dominant paradigm, which, by definition, will perpetuate a need for additional appropriations from Congress. This process stifles both research into and public awareness of the alternative paradigm. Government funding reduces the probability that the dominant paradigm, no matter how inconsistent with real-world data, will be overthrown.

Clearly, Michaels’s book is a must-read for anyone interested in getting the straight facts about global warming. But this book is just as important for those who want to better understand the relationship between scientific research and government funding that lies behind it. Professor Michaels makes it clear that government funding of science can be dangerous to both our liberty and to the advancement of science itself.

In his article, Rattner reports sadly, “Over the past 50 years, the share of tax revenue coming to the federal government from business has collapsed. . . . In fiscal 2003 corporate taxes represented just 7.4 percent of federal revenue, down from 32 percent in 1952. . . . Corporate taxes as a percentage of our gross domestic product dropped to 1.2 percent in 2003, compared with as high as 6 percent in the early 1950s.”

In a defensive tone he denies that favoring tougher enforcement of the tax and the closing of “loopholes” is “populist or antibusiness or redistributionist.” All he wants is what any tax system should aim for: “to distribute the burden fairly.”

The corporate income tax has always been the darling of the socialist left. For this group, whose true goal is to transfer increasing amounts of revenue from private to government control, it may be the perfect tax. It gives these self-proclaimed champions of the downtrodden a way to tax the very constituency they claim to represent, while leading that constituency to believe the tax is being imposed on its “oppressors.” Indeed, corporate taxes are the most dishonest taxes used by any level of government.

It is curious that Rattner would call for a fair distribution of the tax burden on corporations, because as Rattner clearly must know, corporations pay no taxes. They appear to pay taxes, but as Henry Hazlitt would remind us, we need to look past appearances to see the true effects of economic polices.

Corporations pay no taxes not because of the litany of loopholes and special breaks that Rattner lists in his article or because of “the . . . sophistication of large multinational corporations in . . . shifting profits to countries with lower tax rates.” It is because corporations can’t pay taxes. All taxes, corporate or otherwise, must come out of some real human being’s pocket.

All this is well known and not at all controversial. Yet Rattner does not even hint at the possibility that the true burden of the corporate tax may be borne by exactly those taxpayers he is presumably championing in his article. The unstated implication of Rattner’s argument is that customers of corporations are paying too little for their products; employees of corporations are being paid too much for their work; and shareholders, even retirees and those putting a few dollars a month into IRAs and 401ks, are getting too much in return for their investments.

But even if corporate taxes were transparent to those who pay (in which case they probably wouldn’t exist), they would still violate every important principle of sound tax analysis. Again, this is a point that Rattner cannot credibly claim to misunderstand. While there is no such thing as an efficient tax, some forms of taxation clearly do more economic damage than others.

A basic principle of taxation is that the tax system should seek to minimize the extent to which some market decisions are favored over others. This means that income should be taxed only once.

Double, Triple Taxation

But the corporate income tax introduces double and in some cases triple taxation into the system. A worker at Wal-Mart pays personal income tax on a salary that has already been reduced by the corporate income tax.

Wal-Mart’s customers are taxed at least twice. Their purchasing power is reduced when they pay tax on their income. Then it is further reduced when the corporate tax raises the prices they pay at the cash register.

A shareholder in the company faces triple taxation. First, when any income is taxed, the tax by definition reduces the potential income stream—interest, dividends, and capital gains—that the income can generate. Second, dividends and capital gains are reduced further by the corporate income tax. And third, when dividends and capital gains are finally earned, they are taxed as part of the investor’s personal income.

Corporate taxes are hidden and fraudulent. The people who pay them do not know they pay them, and thus such taxes help mask the actual cost of government. If it is true that companies are finding ways to avoid these taxes and less revenue is being generated, then we should cheer those companies on. Ultimately corporate taxes should be abolished. Lovers of big government have no better friend than a tax that everyone thinks someone else pays.

—Roy E. Cordato

rcordato@johnlocke.org

John Locke Foundation

The study is important because it influences policy debates, especially in the states, and because the local news media like to focus on the ALA’s ranking of counties and states. In reality every aspect of the ALA report is methodologically flawed. Its reporting of ozone data and the extent of detrimental health effects is hyperbolic, and its grading system and rankings are meaningless.

First, the ALA report is based on data as much as four years old and says little or nothing about current or future trends. Despite its title, “The State of the Air: 2003” focuses on 1999–2001 and says nothing about the state of the air in 2003 or 2002.¹ Ground-level ozone is heavily dependent on the weather, particularly heat, sunlight, and humidity, and can vary dramatically from year to year. For example, from 1999 to 2001 the average number of ozone exceedence days per monitor in North Carolina fell by more than two-thirds, a fact not mentioned in the ALA’s discussion of air quality in the state. In spite of this flaw, the media typically report on the study as if the data were both current and an accurate reflection of past and current trends.

The ALA’s grading system and the comparisons based on this system convey little if any useful information. A county is given an F if there are more than three monitor readings greater than or equal to 85 parts per billion (ppb) of ambient air averaged over eight hours for the three-year period.² This raises several problems.

Imagine county Y and county Z. Y registers ten mild exceedence days of 85 ppb over the period with no other days registering above 70 ppb. Z registers 20 days measuring 80 ppb with no day below 75 ppb. The ALA grading system would give county Y a grade of F and county Z, with no exceedences, a grade of A. According to the Environmental Protection Agency’s Clean Air Scientific Advisory Committee (CASAC), these two grades would tell us nothing about the relative healthiness of the air in these two counties.³ CASAC concluded that when considering a range of 70 to 90 ppb “there is no ‘bright line’ which distinguishes any of the. . . standards . . . as being significantly more protective of public health.” In this case the difference between A and F, while appearing quite dramatic, would turn out to be, in terms of actual protection of public health, no difference at all.

Compounding this deception is the fact that the ALA study uses its conclusions to rank counties and metropolitan areas according to relative levels of ozone pollution. The problem is that different counties, cities, and states all have different numbers of monitors. The more monitors a jurisdiction has the more likely an exceedence will be registered on any given day. That biases the comparisons against areas with more monitors. While the ALA is clearly aware of this problem, it has never attempted to adjust its rankings for the numbers of monitors in each county.

In reporting data from a county, the ALA counts an ozone exceedence from any one monitor against the entire geographical area. Assume a county has four monitors each at a different location, if only one shows an exceedence for a given day, the entire county is reported as being out of compliance. Therefore, a county will always be reported as having considerably more ozone exceedence days in a given year than any location in the county actually experiences. For example, in the latest report, Wake County, North Carolina, was cited as averaging 16 high ozone days per year during 1999–2001. In reality the annual average for the four monitors in the county was only six exceedence days each. In 2001 they averaged only two each.

Exaggerates Risk

In adopting this misleading methodology the ALA exaggerates the number of people who are at risk. Whenever the study cites a county as having an ozone exceedence day, even if only registered on one monitor, the entire population of the county is reported at risk. For example, during 1998 in Wake County, a monitor in the small rural community of Fuquay Varina registered four exceedence days that were not registered on any other monitor. In spite of this, the ALA listed the entire “sensitive” population of the county as “at risk”—including the population of Raleigh, which showed no exceedences on those days.

Along these same lines, the ALA misleadingly reports the identical people as being at risk in several different categories. For example, in stating that “as many as 27.1 million children 13 and under, and over 1.9 million children with asthma are potentially exposed to unhealthful levels of ozone,” the ALA is actually referring to many of the same children twice.⁴ This occurs with several other categories of “at risk” populations. Technically double counting is avoided only because the ALA does not aggregate.

The annual “State of the Air” report is pure propaganda, and its primary purpose is political advocacy. This is clear from the ALA’s website and from the fact that it regularly joins coalitions with leftist environmental pressure groups such as Earth Justice, Environmental Defense, and the Natural Resource Defense Council.⁵ The media and everyone else should view its publications in that light.

1. Found at http://lungaction.org/reports/sota03_full.html.
2. The 85 ppb, eight-hour threshold is central to the controversial EPA standard that was proposed in 1997. But the ALA standard is even more stringent than the EPA’s. For the ALA, if any one ozone monitor crosses the threshold during the day the entire county is in violation of the standard. As the ALA notes in the appendix of its report, “some counties will receive grades of F . . . while still meeting EPA’s 1997 ozone standard.”
3. “CASAC Closure on the Primary Standard Portion of the Staff Paper for Ozone,” Clean Air Scientific Advisory Committee, U.S. Environmental Protection Agency, EPA-SAB-CASAC-LTR-96-002, November 30, 1995.
4. “American Lung Association Fact Sheet Children and Ozone Air Pollution,” American Lung Association, September, 2002.
5. See “Environmental Groups Sue EPA for Weakening Clean Air Act,” February 28, 2003, www.lungusa.org/press/envir/air_022803.html.