Wednesday, June 24, 2009

Enron Accounting: CBO and EPA Cooked the Books on Cost Estimates for Waxman-Markey Energy Tax

Enron Accounting: CBO and EPA Cooked the Books on Cost Estimates for Waxman-Markey Energy Tax
IER, June 24, 2009

Later this week, the U.S. House will take up the Waxman-Markey global warming bill, the centerpiece of which is a cap and trade program that advocates argue will reduce U.S. greenhouse gas emissions. The bill features a remarkably aggressive timetable, one that would force businesses to cut emissions by 17% (relative to the 2005 baseline) by the year 2020, and by a cumulative 83% by 2050. On cue, “independent” agencies of the government such as CBO and EPA have announced cost estimates that grossly understate the burden Waxman-Markey will place on most U.S. households.

On June 19, the CBO announced that the cap-and trade program contained in Waxman-Markey would cost households an average of $175 in the year 2020 (measured in today’s dollars). On June 23, in an effort to reassert its green bona fides, the EPA came out with an even lower estimate of $80-$111 per household. But even a cursory examination of the methodologies involved in manufacturing those numbers reveals that even the higher CBO figure is far too optimistic, since it leads citizens to believe that energy prices will only go up modestly because of the new cap and trade program.

In fact, very little related to the consequences of Waxman-Markey can be characterized as “modest.” Households will pay far more than $175 per year due to cap and trade, notwithstanding CBO’s attempts to hide it. The EPA study is misleading in the same fashion, but here we focus on the CBO report which can be read by the layperson and states quite clearly how it comes up with its low cost estimate.

Rags to Riches: How the CBO Transforms a Stealth Tax Into a Phantom Tax Cut

There are several major flaws with the CBO approach, but perhaps the most outrageous example of sleight of hand is the CBO’s focus on after-tax income. Because Waxman-Markey will raise prices more than incomes, households will necessarily become poorer. This will push households into lower tax brackets—and thus have lower tax liabilities to the tune of roughly $8.7 billion. Normal people would consider this to be a downside of Waxman-Markey. CBO is not normal. It considers this $8.7 billion as an addition to total household income—money from heaven!—and goes about celebrating the effect of this policy without saying a thing about the cause.

After explaining that some government benefits are indexed to the Consumer Price Index, which means that federal spending will have to increase owing to Waxman-Markey’s energy price hikes, the CBO study points out the silver lining:

Because the federal income tax system is largely indexed to the consumer price index, an increase in consumer prices with no increase in nominal incomes would also reduce federal income taxes. That effect would increase households’ after-tax income but would also add to the federal deficit. In combination, the effect of price changes on the government’s indexed benefit payments and income tax receipts would convey an estimated $8.7 billion to households. (p. 7)

Beyond the absurdity of translating rising prices into a benefit for households—on the basis that poorer people pay less in taxes—the CBO’s treatment of income tax revenues is inconsistent with its treatment of carbon allowance auction receipts. The CBO study acknowledges that households will pay higher energy prices partly because businesses will “pass on” the cost of buying emission allowances. But CBO didn’t include this component as a net cost to households, because the government could spend the auction receipts and thus recycle some of the money back into households.

But if that’s how the CBO wants to do its accounting, then it can’t credit households with a fictitious $8.7 billion “tax cut.” As the quotation above points out, the falling income tax revenues will simply mean a larger budget deficit if the government doesn’t cut other spending. This extra borrowing by the federal government will push up interest rates and transfer $8.7 billion out of the private capital markets. Households will ultimately lose wealth (in the form of greater public debt) that exactly offsets their alleged gain from falling into lower tax brackets.

Impacts on the “Average” Household

The CBO study admits on page 1 that the greenhouse gas (GHG) emission schedule would raise prices for Americans:

This analysis examines the average cost per household that would result from implementing the GHG cap-and-trade program under H.R. 2454….Reducing emissions to the level required by the cap would be accomplished mainly by stemming demand for carbon-based energy by increasing its price…. Those higher prices, in turn, would reduce households’ purchasing power. (p.1)

However, the CBO’s reported annual cost estimate of $175 per household in the year 2020, does not refer to the tallying up of the price hikes acknowledged in the quotation above. The CBO reduces the “gross cost” by mixing in all of the financial benefits that will accrue to “households” from the cap and trade program:

At the same time, the distribution of emission allowances would improve households’ financial situation. The net financial impact of the program on households…would depend in large part on how many allowances were sold (versus given away), how the free allowances were allocated, and how any proceeds from selling allowances were used. That net impact would reflect both the added costs that households experienced because of higher prices and the share of the allowance value that they received in the form of benefit payments, rebates, tax decreases or credits, wages, and returns on their investments. (pp. 1-2)

The problem should be obvious: If the government spends auction revenues, or hands out “free” allowances that possess high market value, to fund alternative energy boondoggles, the CBO study will carefully chalk that money up as flowing back into the pockets of U.S. “households.”

The CBO’s logic makes sense from a certain point of view: A firm that makes solar panels is owned by shareholders who live in houses, right? So when that solar panel firm sees huge profits in the new scheme, the wealth showered on its owners will accrue to households. Even though all electricity consumers will be paying higher prices, the “average” hit will be mitigated to the extent that some of those consumers happen to be on the receiving end of the cap and trade gravy train.

The CBO’s reasoning may be appropriate in some applications, but it is grossly misleading in the current political context. Citizens may come away from the report believing that their annual expenses will rise only $175 because of Waxman-Markey. The real figure is much higher.

The CBO’s Gross Cost

In contrast to the net cost of “$22 billion—or about $175 per household” (p.2), what does the CBO say about the gross cost, meaning the actual reduction in household purchasing power? In other words, how much of a hit will households take in the form of higher prices and lower wages, before the CBO adds back in all the pork spending and other goodies? They tell us on page 4:

According to CBO’s estimates, the gross cost of complying with the GHG cap-and-trade program delineated in H.R. 2454 would be about $110 billion in 2020…or about $890 per household…(p. 4)

We see that the number reported in the press—“$175 per household by 2020”—represents only 20 percent of the CBO’s projected increase in household costs. The other 80 percent of the gross price hikes is transferred away from unlucky consumers and into the pockets of politically-connected beneficiaries. Since this wealth is redistributed, it’s still in “households” (somewhere) and so the CBO doesn’t report the gross figure, which is five times higher than the number bouncing around the press. But that’s not the end of it. CBO didn’t score anything but the “cap and trade” part of the bill…not the renewable energy mandate, not the additional costs of complying with the bureaucratic nirvana of new standards for energy efficiency of lighting for home art and “personal spas,” etc. In some parts of the country, the “You Must Obey” renewable energy mandate could force significantly higher costs on consumers and businesses.

Winners and Losers

The CBO study acknowledges that its estimates are average figures, and that the impacts on particular sectors will be uneven:

The measure of costs described above reflects the costs that would occur once the economy had adjusted to the change in the relative prices of goods and services. It does not include the costs that some current investors and workers in sectors of the economy that produce energy and energy-intensive goods and services would incur as the economy moved away from the use of fossil fuels….Stock losses would tend to be widely dispersed among investors because shareholders typically diversify their portfolios. In contrast, the costs of unemployment would probably be concentrated among relatively few households and, by extension, their communities. (p.8)

In addition to the negative impact on workers in energy-intensive sectors, the Waxman-Markey bill would also hurt energy consumers to different degrees, depending on which region of the country they lived in. The Southern and Midwestern states are much more reliant on coal and other fossil fuels for their electricity production. Consumers in these regions will see their electricity rates jump higher than in other areas of the country.


Make no mistake: Waxman-Markey is a tax that, to work properly, must find a way to drive up energy prices. CBO bends over backwards to try to disguise this fact, but even they admit Waxman-Markey will increase energy prices.

The CBO’s gross cost estimate of $890 per household is also optimistic. Other studies put the figure at $1,500 per family in higher energy costs. That makes the much lower figure of $175 per household extremely misleading.

Bent on disguising the true costs of Waxman-Markey, CBO performed a deeply flawed analysis. They treat lower household income as a good thing because households will be subject to lower tax rates, even though this will increase the budget deficit and help drive up interest rates making economic growth more difficult.

The CBO is also disingenuous in its treatment of free allowances. The financial benefit of the free allowances will go a small subset of the population (and to overseas investors), but CBO merely averages the benefits across the U.S. population. This is deeply disingenuous and misleading. Households are in for much bigger price hikes than the CBO would lead them to believe.
Despite CBO’s heroic attempts to put a nice gloss on Waxman-Markey, cap and trade is what Rep. Dingell said it was—a tax, and a great big one.

On the Perils of Negotiating with Terrorists

Negotiating with Terrorists. By Andrew C. McCarthy
The Obama administration ignores a longstanding — and life-saving — policy.
National Review Online, June 24, 2009 4:00 AM

Bank nationalization will soon be back on the agenda unless the economy picks up

Who Owns the Banks, Round Two? By HOLMAN W. JENKINS, JR.
Bank nationalization will soon be back on the agenda unless the economy picks up.
The Wall Street Journal, page A13

The stress tests came and went, but haven't settled the argument over whether anything short of seizing the biggest banks amounts to recapitulating Japan's experience with zombie banks.
That argument remains relevant -- because bank nationalization will soon be back on the agenda unless the economy picks up.

It would be good to get the parallel straight. Japan's problem wasn't so much zombie banks as zombie borrowers, kept alive with new infusions of money because the political class, speaking for Japanese society, wanted to delay and minimize foreclosures, layoffs and asset fire sales to preserve "harmony." An even more important, but unsung, factor in Japan's so-called lost decade was a relentless series of tax hikes.

Letting U.S. banks slide on their capital ratios is not the same as making "zombie banks." Somebody somewhere has to hold bad loans until they're resolved, either because borrowers make repayment or are forced into liquidation. There's no question that the Obama administration has opted for an unspoken policy of regulatory forbearance with respect to various too-big-to-fail banks. But those banks have no natural reason (aside from political pressure) to keep zombie borrowers alive if it would be financially advantageous to foreclose.

For all that, the Obama stress tests have served a confidence-building purpose -- confidence in Washington, not the banks.

It dispensed with the idea that the problem of how to unwind Washington's massive commitment to the financial sector could somehow be solved at the expense of bank shareholders. That idea was always a distraction -- there was not enough market capitalization in the entire banking sector to make a fig's difference, especially while the prospect of nationalization hung over it.

In climbing down, the Fed and the Obama administration did indeed credit future earnings of the banks with solving a big part of their capital problem. Call it fudge: This is a bet on growth, the only decent solution out there, because neither nationalization nor capital raising by banks can get the Federal Reserve off the hook of inflating away the banking system's massive additional losses on consumer, business and housing loans if growth doesn't come back.

As usual, however, there is no coherence in the administration's approach. Even while it counts on surging bank profits, it attacks the banking system's credit card profits, its mortgage profits, its senior-secured lending profits, etc. This is no way to avoid the rightly frightful prospect of having to add Citigroup and Bank of America to the portfolio of companies Washington is running badly.

Meanwhile, Team Obama is periodically tempted by the pro-nationalizers' claim that giving the big banks time to heal can only stifle recovery by retarding their return to lending. The critics underestimate two things: The dynamism of our financial sector, with plenty of healthy banks, start-ups and foreign investors likely to step into any lending gap if real opportunities for profitable loans present themselves (a difference vs. Japan, whose financial system was relatively closed).

They also underestimate the degree to which the problem is demand for loans rather than supply.

It's good to recall the puzzlement of the early Clinton administration over the "jobless recovery" that prevailed after it took office in 1993. The mystery wasn't the mystery the administration liked to pretend: Business refused to hire or expand out of fear of Bill Clinton's then-pending health-care reforms.

Mr. Obama's own initiatives on climate, labor, taxes and health care are the biggest threat to growth -- thus to the success or disaster of the Fed's giant liquidity bet, failure of which could still send us Argentina's way (as the Fed itself no doubt is discussing in its closed meetings today and yesterday).

Here, a happy happenstance for the nation is that our president is an object of craving utterly independent of the policies he pursues. Mr. Obama, therefore, has an unlikely degree of freedom to throw overboard his agenda and go for growth without fear of his public abandoning him.

From the start, he has seemed uniquely detached and noncommittal about his own policy positions, as if he was entertaining them only to see if they might be useful to him. Let's not underestimate this advantage over lesser politicians, who get trapped by their rhetoric. Let's also hope Mr. Obama takes advantage, becoming the "growth" president and saving the big initiatives for his second term. Otherwise, with the AIG disaster before him, he may be remembered as the president who nonetheless blundered into similar disasters trying to manage Citibank et al.