Today, Senators Jim DeMint (R–SC) and Mike Lee (R–UT) introduced legislation that would move the United States a giant step forward in making our country’s energy market freer by eliminating targeted tax credits for energy sources and technologies.
Their legislation, a companion to Representative Mike Pompeo’s (R–KS) bill, would force any tax policy that picks certain industries as winners and losers in the market to expire at the end of the year and expedite sunsets for tax credits extending multiple years. And it goes after all targeted tax credits: oil, renewables, nuclear, alternative fuels and vehicles, and advanced coal and gasification. And since eliminating these economically unsound tax credits would raise revenue and thus be a tax increase, the bill would offset the tax increase by lowering the corporate tax rate permanently.
The common argument against removing the tax credits is that it would destroy jobs. But these are jobs that tax credits artificially created in the first place. It means the government diverted resources to politically preferred sectors of the economy and away from projects that demonstrate economic value. And if these producers do have an economically viable idea, then they shouldn’t need the handouts from Washington in the first place, and our taxpayer dollars are merely offsetting the investments a company would’ve made regardless.
The detriment caused by subsidies extends well beyond wasting taxpayer dollars and propping up uneconomical ventures. It adversely affects a company’s or industry’s incentive structure by placing less emphasis on innovating to compete in the market and more emphasis on clamoring for special treatment from the government. It allows an ignorance of true production costs. The clearest example is Solyndra, the now-bankrupt solar company. Although it was a recipient of a loan guarantee, not a targeted tax credit, a breakdown from solar industry analyst Peter Lynch explains the problem with subsidies. He said of Solyndra:
Here’s the bottom line. It costs them $6 to make a unit. They’re selling it for $3. In order to be competitive today, they have to sell it for between $1.5 and $2. That is not a viable business plan.
In a market without subsidies, you find ways to make your product profitable. In a market with subsidies, you can ignore production costs to a certain degree, but in most cases even that model is unsustainable. Ask Solyndra, Evergreen, Ener1, and Beacon, for instance.
Subsidies also have the additional effect of promoting lobbying rather than efficiency and affordability. In an environment of government handouts, political viability is much more important than economic viability. When the government dictates how private-sector resources are spent with targeted tax credits, those industries that benefit greatly from such policy decisions will spend more money lobbying for tax credit extensions and expansions. The American people will ultimately bear the costs of these policies through increased taxes (or deficits) and higher energy prices.
There are three key pieces to making America’s energy production more robust than it is does: (1) open access, (2) reduce onerous regulations, and (3) eliminate subsidies. Senators DeMint and Lee’s legislation embodies the kind of approach that would get us there.