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May 08, 2008

Energy Policy – The Hard Work is Done

Mustering the political will to drive up the price of gasoline to a level where alternatives make economic sense would have been impossible – note the pandering attempts to knock it down a few cents for a few months. But the expansion of the world economy to include China and India in a big way has done that for us; there'll be ups and downs in the graph of gas and oil prices but, absent a world-wide depression, the trend line is up.

So now it's time to live with it. Hard as it is to take in the short term, higher prices for oil-based energy are a good thing in the long term. Too much money has been leaving our economy to pay for oil; the money's been going to all the wrong places; and, quite possibly, burning fossil fuels contributes to accelerated global warming.

Absent the recent run up in oil prices, we would have needed an elaborate systems of subsidies and penalties in order to get meaningful development of alternatives to oil any time soon. Now we're in a position where we can start unraveling those subsidies already in place – starting, I hope, with the subsidy for ethanol.

The trouble with subsidies is that they require the subsidizers to pick the winners and losers – always a hard thing to do with new technologies and something governments are notoriously bad at. Subsidies are also very hard to unwind. With the price of gas and oil up, private capital becomes available to finance any number of promising new technologies – there'll be some huge winners and lots of losers but that's the way technology and economies move forward. There'll be lots of parallel development.

If we want to maximize the private capital available, we have to avoid the urge to subsidize particular solutions. That's because private capital is rightly leery of competing with "free" capital from the government.

An important set of subsidies to unwind as soon as we contractually can is those that we've given to oil companies for drilling and refining. This may seem counter-productive since more domestic oil would reduce the economic and strategic harm of importing. But, if these incentives were ever needed, they're certainly not needed now with current prices for the end products. What would be really crazy – but is politically quite possible, even attractive – would be to leave the subsidies in place but also have an "excess profits tax" on oil companies which attempts to determine how those companies invest.

The subsidies for "mineral extraction" are woven deep into the tax code; I have some investments which take advantage of this. These subsidies can and should be undone legislatively, not countered with another set of taxes.

Now that the market has raised oil to a price that's relatively easy to compete with, the most important reason for not subsidizing one form of energy over another is that we'll get the "right" mix of alternatives more quickly if we let private investors take the losses and gains and explore all the niches and crannies. But, if we're not subsidizing, we also save tax money (or raise more by reducing the subsidies hidden in the tax code). That money should be used to reduce the pain for low-income working Americans by reducing social security taxes collected from worker's pay checks and making the social security trust fund whole with the foregone subsidies.

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