Taxes: Power Move

When he unveiled his energy tax in February. President Bill Clinton described it as "the best way to provide us with revenue to lower the deficit because it also combats pollution, promotes energy efficiency…and because it does not discriminate against any area." Though Clinton may have believed what he told Congress, his tax on British thermal units (BTUs) does not meet any of those criteria very well. In some cases, it could thwart the administration's goals.

Taxing BTUs rather than, say, gasoline is an attempt to treat all energy sources equally. A BTU is the amount of energy needed to raise the temperature of a pound of water from 39.2 degrees to 40.2 degrees; it's equivalent to 252 calories. Diverse energy sources can be put on the same tax scale by measuring them in terms of how many BTUs they produce. For example, a barrel of crude oil contains about 6 million BTUs. The average ton of coal contains about 20 million BTUs. So an average ton of coal is equivalent to about 31/3 barrels of oil. In theory, taxing BTUs is the purest way to tax energy.

But a BTU tax is a lot simpler in theory than in execution. For starters, you need to decide whether the BTU tax will be imposed on the fuel itself or on the energy that is actually produced for use. (In the case of hydroelectric power, taxing the "fuel" itself, prior to energy production, presents a serious conceptual problem.) Will coal headed for a power plant be taxed at the mine? At the plant? Or will the electricity produced by burning the coal be taxed instead?

More importantly from a political standpoint, a nice, pure, flat-rate BTU tax—unlike, for instance, a dollar-based sales tax—would raise the prices of some energy sources more sharply than the prices of others. One hundred dollars' worth of coal, for instance, contains more BTUs than $100 worth of oil, so coal would be hit harder than oil. Similarly, homes connected to a nuclear power plant would see their electric bills increase more than homes hooked up to a coal-fired plant.

To compensate for some of these disparities—and to appease powerful members of Congress—the Clinton BTU tax is not flat. In a tilt toward coal and natural gas (and toward West Virginia Sen. Robert Byrd and White House Chief of Staff Thomas McLarty, a former natural-gas executive), oil would be taxed at 60 cents per million BTUs, while coal, gas, nuclear, and hydroelectric power would be taxed at 26 cents per million BTUs. So much for treating all fuels equally.

Nor does the BTU tax live up to the president's promises of fighting pollution. It simply does not distinguish between more- and less-polluting energy sources in any systematic way. As a result, even the Environmental Protection Agency projects the pollution reductions in tenths of a percent.

And that's optimistic. In some cases, this supposedly green tax may actually work against environmental goals. It will, for instance, increase the cost of low-sulfur Western coal relative to high-sulfur Eastern coal by jacking up the cost of transporting the coal across the country. (Most coal-fired power plants are in the East or Midwest.) "The added cost would be small, about 2 cents per million BTUs, acknowledges Ronald McMahan, an analyst for Resource Data International in Boulder, Colorado.

But the effect may not stop with transportation costs. Western coal mines pay higher royalty and severance tax rates than Eastern mines; both kinds of taxes are based on the price of coal as it leaves the mine, a price that may include the BTU tax. If the BTU tax is imposed on the coal as it leaves the mine, rather than when it arrives at the power plant, low-sulfur coal will get hit with a double tax whammy—and put at a further disadvantage relative to more-polluting Eastern coal.

Another way the BTU tax could increase pollution is by favoring ethanol, which the administration wants to exempt from the tax. Although gasoline mixed with ethanol is on the EPA's list of environmentally friendly "oxygenated fuels," it produces more volatile organic compounds and formaldehyde than regular gasoline.

Whatever the details of the BTU tax, the claim that it will promote efficiency seems to be based on the undisputed fact that it will make energy more expensive. But if higher prices promote efficiency, why not impose new taxes on everything? Wouldn't a tax on such essentials as clothing, food, and shelter discourage waste of them as well?

In arguing that taxes promote efficiency, the Clinton administration has it exactly backward. Prices that reflect the interaction of supply and demand promote efficiency. Taxes, by distorting market signals, promote inefficiency. A BTU tax, for example, will lead businesses to overinvest in energy conservation and to reject opportunities that would otherwise have been profitable. Discouraging consumption is not the same thing as encouraging efficiency.

But the BTU tax's greatest sham is its claim of regional fairness. The tax not only puts Western coal at a disadvantage but also could cripple the oil industry of California. California oil has to be forced out of the ground with high-pressure steam, usually produced with heat from natural gas. Philip Verleger, a fellow at the Institute of International Economics, estimates the BTU levy will add 50 cents per barrel to the cost of producing this heavy oil.

And the Northwest, which relies heavily on clean hydroelectric power, will be hit hard by the tax, which falls most heavily on energy-intensive manufacturers such as Boeing. Just weeks after he announced the BTU tax, Clinton commiserated with the Seattle company's workers, suggesting that unfair European competition was to blame for 28,000 layoffs. He didn't mention that Boeing would be walloped by his new "pollution" tax, even though 86 percent of Washington state's energy comes from renewable hydro power. In addition to increased energy costs, Boeing will face higher prices for U.S. aluminum.

Boeing's troubles won't end there. Its customers in the already shaky airline industry stand to be hit with $2 billion in higher operating costs, according to estimates by the Airline Transport Association. Meanwhile, the Clinton administration is considering special investment tax breaks and government loans to help the weak airlines. So the federal government could end up doling out money to compensate for the burden imposed by collecting it. There is bipartisan support in Congress for the simpler approach of exempting the airlines from the BTU tax altogether.

As exemptions multiply, the administrative costs of the tax will go up and the already modest revenue will fall. The nation's public-transit systems—the very same ones targeted for more infrastructure spending—are busily lobbying for tax relief. Diesel fuel to run buses and trains is expected to jump by 8 cents a gallon. And because the BTU tax will not be levied at the pump (unlike other motor-fuel taxes), an exemption will be tough to implement. The same will be true of electric light-rail systems: The tax can't tell who is using a kilowatt-hour. Nonetheless, Chip Bishop, a spokesman for the American Public Transit Association, hopes an exemption for such "public enterprises" can be designed. If not, either fares or state and local government subsidies (or both) will have to increase.

The prospect of higher transit subsidies is not the only added cost facing the states. States will see their gas-tax revenues go down as the BTU tax pushes the price of gas up by 7 cents to 10 cents a gallon. A National Conference of State Legislators position paper notes that the rise in gas prices may depress consumption and cut into gas-tax revenues. But the nation's governors, always suspicious of federal excise-tax hikes that threaten state revenues, have been reluctant to criticize the BTU tax out of fear that it will be replaced by a federal sales tax.

A broad BTU levy would hit things—renewable energy, airlines, the poor—that Clinton claims to favor. How did a policy team replete with Rhodes Scholars come up with an idea so inimical to its own values? Maybe the contradictions were overlooked in the rush to build "a comprehensive plan." Perhaps Clinton expects to fix the problems in Congress. But if one set out to create more voters dependent on federal assistance programs and more suppliant industries eager for special treatment, a BTU tax would be an excellent start.

Jeff A. Taylor is a national political reporter for Evans & Novak in Washington.