Basic Economics vs. Politics

One of the most hilarious things I found when filling out my absentee ballot last week was the summary of Proposition 87 [PDF]. Proposition 87 proposes to tax oil producers in California to provide funding for alternative energy research.

The hilarious part: The proposition would outlaw passing on the cost of the tax. Supporters of the proposition actually say with a straight face that this tax will have no cost whatsoever to the consumer.

Ignoring the goals of the proposition in general for the moment, this part of it is such complete and utter bullshit. If you know anything at all about economics, you will know that every cost imposed on a business is passed on to the customer. There’s actually no other way around it.

Critics of this will say that the business can just take it out of their profits. However, the primary purpose of a business is to make a profit. If a business cannot or is not allowed to make a profit, it will stop doing business. Businesses are funded by investors. Investors can and will take their investment dollars elsewhere if they can’t make money.

The supporters of Proposition 87 go on to claim that since the market price of gasoline in California is controlled by market forces and therefore the oil producers can’t raise prices. They are only partly correct. Market prices are an intersection of what a seller is willing to sell a good or service for and what a customer is willing to pay for the same.

What this boils down to is that if costs to a business rise, then the price they are willing to sell at will rise as well. Of course they cannot sell at any price because consumers will stop buying as much (because they are not willing to pay the price offered), or they will get some new competitors who are willing to sell for a lower price. However, no business will willingly sell a good or service for less than their cost for long (they will do so temporarily to promote their products or to clear out unsaleable goods but cannot do this on a regular basis). Neither will they continue to operate if the return on investment is less than they could get elsewhere.

In other words, prices will always tend to be at least how much it takes to sell a good or service and make a decent return on investment. So raising the costs to a business will absolutely raise the minimum price the business can charge and still be viable.

Proposition 87 supporters continue by saying that California oil producers also have to compete with outside suppliers. This is somewhat true, however it implies that California oil producers will be put at a disadvantage to out-of-state oil producers. In addition, bringing in gasoline supplies from out of state will increase shipping costs which again will tend to cause an increase in price. Out-of-state oil producers will also be able to raise their prices because they will have less competition to worry about from Californian producers.

In summary, Proposition 87 will limit the return on investment for Californian oil producers and put them at a business disadvantage to out-of-state oil producers. The long term effect of this is that there will be less investment in oil production in California, and supplies will be controlled by out-of-state business interests. In addition, employment in the oil industry in California will decline. This will probably not happen all at once, but do you really think anyone will want to invest in oil production in California under these conditions?

Proposition 87 supporters try to portray this as some kind of sin tax against ‘Big Oil.’ What it really is is an economically faulty money grab for alternative energy research. One of the big supporters of Proposition 87 is Vinod Khosla, a big venture capital investor. How many alternative energy companies are he and his partners invested in?

The propaganda about how the proposition prohibits higher gas prices is completely unenforceable, and has no economic basis whatsoever. It is nothing but a marketing gimmick to try to fool voters into thinking they get free money for researching green energy.

I think it is a good goal to encourage alternative energy research. I think that it is reasonable to tax energy usage to fund such research. However, this proposition is a poorly designed and economically faulty way to go about this, putting California businesses at a disadvantage to out-of-state companies and making false promises about the impact to prices. An honest alternative energy proposition would tax energy use directly.