Viewpoint: The War on Energy

Critics of President Carter's energy proposals have been understandably confused about the combination of taxing oil and natural gas to make them more costly while strengthening price controls to keep them cheap. After all, the original rationale for price controls was to insulate consumers from the effects of higher prices of imported oil and gas. If foreign energy producers charged more, we would simply pay domestic producers less. That would keep demand up and domestic supplies down, thus creating a growing market for imported oil and liquefied natural gas. It was either a foreign aid program for the Arabs, or a plan to clean up the oceans by putting idle tankers to work.

The new administration's proposals are different. Starting with the clear recognition that the whole problem of OPEC is that the cartel has made oil and gas too scarce and costly, the new plan is to make oil and gas more scarce and costly.

The new energy plan is soundly grounded on the political principle that people hate higher prices (unless paid to foreigners) but love higher taxes.

Normally, we expect that people will demand less of something as its price increases, and that suppliers will be willing and able to supply more at higher prices. As a result, shortages and surpluses are self-correcting, since prices change to balance supply and demand.

The administration acknowledges that energy supplies will increase with rising prices, but only up to the exact point where incentives are "adequate." Beyond this price, which is so perfectly known as to be enacted into law, further increases in price apparently have no effect whatsoever on supply. The supply curve kinks and becomes vertical. And since we will run out of oil and gas sooner or later, the administration figures we might as well run out sooner.

Demand, on the other hand, is apparently unaffected by prices, but it is affected by taxes. Besides, with higher prices we would only get more energy, while with higher taxes, we will get more government. This is a plan to solve the chronic shortage of government.

Since prices are assumed to have no effect on either supply or demand, we clearly must have a ten billion dollar bureaucracy to close the growing gap between what people would like to buy, at controlled prices, and what producers are able to supply. By limiting certain sorts of energy demand, with selective taxes and prohibitions, the government will be able to separate Mr. A's real needs from Mr. B's superfluous demands, and thus eliminate waste. Waste is energy consumed by people who vote incorrectly.

The administration's dynamic, longterm model differs only slightly from this static model. In the absence of enlightened taxes on waste, energy demand would continue to rise at a compound annual rate of 4.36 percent right up until the day the world ran completely dry. It might be supposed that such increasing scarcity would cause rising prices which would dampen demand. But this argument neglects the fact that demand is not responsive to prices (only to taxes), and that if foreign prices got too high, the price controllers would be instructed to roll domestic energy prices back to zero.

The dynamic supply model involves periodic variations in the scope and level of price controls in order to induce more supplies. The idea is to solemnly pledge to domestic energy producers that some portion of oil or gas production will remain free of price controls (new oil before 1976, intrastate gas until now), and then to roll back the price after the costly exploration and development have been undertaken. This should be done annually by creating new categories and prices, such as "new, new oil" or "deep and distant gas." Attempting to vary the rules more often than once a year could conceivably produce a credibility problem, and unsocial producer behavior.

Once this economic model is grasped, the logic of the Carter energy proposals becomes obvious. The logic of the model itself, however, is another matter.

The least mischievous parts of the Carter program (the tax on gasoline and gas guzzlers) appear likely to be diluted or scrapped, while the most destructive portions will probably be enacted. I refer to the tax penalty on producing domestic crude, the confiscatory extension of natural gas price controls to the intrastate markets, and the extremely restrictive definitions of new oil and gas—which alone will be allowed an almost sensible price.

Why should we be willing to pay more for imported oil and liquefied natural gas than we are willing to pay to our own domestic producers? Why should we give every incentive for those lucky enough to get natural gas to use it up quickly at a price that is substantially less than what it will cost to replace it? Our whole energy and environmental policy has been, and continues to be, a policy of encouraging consumption and discouraging production. It makes no sense at all.

An alternative analysis of the energy policy crisis, supplied by two MIT economists in The Public Interest, is that price controls on oil and gas have pushed demand eight percent higher and supply six percent lower than otherwise, adding five million barrels a day to U.S. oil imports. Removing these controls—these subsidies to OPEC—would not be a windfall to producers, but only an offset to previous expropriation. Consumer prices would ultimately be lower with decontrol, not higher, because we would be substituting domestic oil and gas for more-costly imports, and because the added domestic supplies and reduced demand for imports would put some competitive pressure on the OPEC price.

No matter what the problem is, the Carter solution always involves trying to redistribute income from those who earn it to those who don't, as though people would keep on trying to earn more regardless of how little they are allowed to keep.

The administration's curious sympathy for international commodity agreements—more OPECs—seems to anticipate a redistribution of income from supposedly rich countries, like Italy or Britain, to the more deserving poor countries like Uganda, Chile and Brazil.

We don't yet know the precise shape of the coming tax and welfare reforms, but they will probably involve more of the same.

This is too bad, because people are paid well for producing well. Families in the top five percent of the income distribution, for example, have an average of 2-1/2 family members working, while those in the bottom five percent have less than one worker. Tax penalties on productive effort and investment must inevitably reduce the economy's ability to provide enough jobs and rising real incomes.

It is difficult to understand the insatiable political impulse to penalize productive activity, to punish success. Perhaps, because Mr. Carter understands that his voting support lies with the poor and the unemployed, he has a natural incentive to adopt policies that will increase poverty and unemployment.

Alan Reynolds is a vice president of the First National Bank of Chicago and editor of its First Chicago World Report. His Viewpoint appears in this column every third month.