Yes We Can…Put Off Tough Decisions

President Obama, like all men of his stature and station, fancies himself a leader unwilling to defer making difficult decisions on transcendent issues.  He drove home the point during the campaign, sometimes using messianic rhetoric, as when he told supporters on Super Tuesday that, "We are the ones we've been waiting for."  Such grandiosity won the day, but apparently the wait will continue when it comes to one of the most critical challenges facing the country, price fluctuations at the pump.

The Obama Administration has urged moving ahead on its energy plan despite the economic crisis.  The plan's centerpiece is a $150 billion investment over ten years to promote private sector development of alternative sources of energy, which, according to the administration, will ensure that 10 percent of all electricity derives from renewable sources by 2012, and 25 percent by 2025.  It may be the right prescription but it fails to address in the short run the vulnerability of the American economy to rising oil prices.

Such prices have fallen dramatically over the past year, dropping 63 percent from their peak of $147 a barrel to roughly $54 today.  Slowing demand for oil stemming from the global recession is primarily responsible for the precipitous decline (a speculative bubble is also a possible contributor).  Consumers and fuel-dependent industries like aviation have welcomed the drop—when oil prices hit their peak, airlines' fuel costs actually surpassed those for labor.  Conversely, economies dependent on oil exports, such as Russia, Saudi Arabia, and Venezuela are feeling the pain.  We should rejoice.  Or should we?

Cambridge Research Associates, an oil consulting firm, recently released a report warning that falling prices has forced oil companies to dramatically cut back investment in developing new sites for exploration, as sustaining economic investment is impossible in such market conditions.  At least 35 new projects in OPEC nations are being put on the back burner.  The trend, according to the firm, could put 7.6 million barrels a day at risk, reducing total supplies to 101.4 millions barrels a day by 2014.  Cambridge had predicted as late as last year that 109 million barrels would be flowing by then.  Why does the potential shortfall matter?

The answer is the undersupply will cause a price spike when demand returns, an inevitability when the global economy recovers.  "The low that oil prices drop now and the longer they stay low," says John Lipsky, first deputy managing director of the IMF, "the greater the negative impact on future supply."  The spike has the potential to have an enormous impact, especially on modern industrial economies, which rely heavily on fossil fuels.  The US is particularly exposed as a result of its energy profligacy.  America ranks near the bottom of industrialized countries in terms of energy efficiency, largely because cheap gas is seen as a birthright.  Thus, the federal gas tax is a paltry 18.4 cents per US gallon (states can add their own levy) and 24.4 cents per gallon for diesel.  In the UK, equivalent taxes are roughly $3.50 per gallon.

Since the transportation sector consumes 70 percent of petroleum used for fuel, decreased demand from higher gas taxes would significantly lessen dependence on foreign oil.  It would also cushion the affects of the inevitable price spike, as driving and consumption habits (read: smaller cars) will have already shifted.   Environmental benefits would also result; indeed, 30 percent of US greenhouse gases derives from the transportation sector.  The regressive nature of such taxation is a potential concern, but offsetting the levy with a reduction in payroll taxes could fully mitigate the policy's impact.  The best part would be that OPEC countries might actually pay part of the cost of the higher tax.  Former George W. Bush economic adviser Gregory Mankiw argues that reduced consumption would lead the falling oil prices, and consequently "the price of gas to [US] consumers would rise by less than the increase in the tax."  As such, OPEC countries would effectively shoulder some of the burden.

Why, then, has the Obama Administration not taken up the idea?  Apparently, because raising taxes, even when they are offset, is a bridge too far (Obama has gone to great lengths to emphasize that his budget plans reduce taxes on 95 percent of all Americans).  For this reason, his administration favors a highly complex economy-wide cap-and-trade program to reduce greenhouse gas emissions, shown to be highly problematic in Europe, in lieu of a simplified tax on carbon emissions, which many economists advocate.

Obama's defenders might argue that proposing a major tax during the current global recession would be political suicide, but as White House Chief of Staff Rahm Emmanuel points out, a crisis is a terrible thing to waste.  So is gas!  

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