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How higher fuel taxes lower inflation

Energy taxes can be used to smooth out the free market's sometimes precipitous price rises, to give greater equity to people on low and fixed incomes, and to stimulate employment and activity in energy conservation of all types. Paradoxically they also reduce inflation. They deserve widespread support.

Yet presidential candidate John B. Anderson has stirred great controversy with his 50-50 plan: a 50-cents-per-gallon tax on motor fuels, and the return of the proceeds to consumers through the reduction of social security taxes on individuals by 50 percent. It is a version of a general energy program which I advocated in this newspaper as early as 1974. Despite the considerable period during which taxes of this form have been debated, there is general misunderstanding of their implications. I would like to set the gasoline tax in its wider context, and to discuss the effects of an energy tax on inflation.

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The general scheme in which the 50-50 fuel tax belongs has been called the modified free market -- one in which decisions are made by consumers and producers but in which those products and activities which impose costs on others are taxed. An essential feature is that the tax money is immediately recycled.

Tobacco taxes, for instance, would be used to defray the huge health costs which use of tobacco imposes on the general public, and those from fires and litter. The tobacco industry and users would have an incentive to reduce the adverse health effects, the litter, and the combination of circumstances which tend to bring about fires, so that the level of taxes would be reduced. (Currently, tobacco taxes go mostly into general revenue, giving an incentive to keep people smoking).

The external costs brought about by the depletion of a scarce resource, such as oil or natural gas or uranium, are less obvious and more diffuse, and to a large extent they will be felt in the future. Taxes to reduce their consumption are justified, but there is no obvious and proper destination for the tax money collected. To repeat, under the principles of the modified free market, they should be immediately recycled.

The tax-recycling method I originally advocated was that, as tax levels on the various fuels were increased month by month, the funds collected would be divided equally among US adult legal residents and returned through the Internal Revenue Service. Taxpayers would have their taxes reduced; nontaxpayers would receive a "negative income tax."

This arrangement had the advantages that lower-income people, using less energy on average than the rich, but receiving equal rebates, would be somewhat advantaged; richer, higher-than-average energy users would be penalized; everyone would have an incentive to use less energy from scarce resources; the use of solar energy and the like would be untaxed and therefore would be encouraged automatically; and government involvement in decisionmaking, regulating, research, and bureaucracy would be very greatly reduced.

The Anderson "50-50" plan would tax just automotive fuels and would recycle the funds through the social security tax. But it has many of the advantages and implications of the more general scarce-resources taxes described above.

Perhaps the principal (but unwarranted) objection to it is that in a time of unprecedented inflation in this country, an energy tax of whatever form would further increase prices. I would like to show that it is desirable that some prices increase; that it is counterinflationary for them to do so; and that a large part of our present inflation is, in fact, due to our decisions to keep prices artificially low.

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This argument requires a rigorous definition of inflation. There are many versions of what we mean by the word, and our national debate on our inflation problems is greatly confused by so many experts using very different definitions. I shall define inflation as the increase, largely uncontrollable, of average expenditures relative to average income.

Let me use natural gas to illustrate how artificially low prices paradoxically bring about inflation. For a long time government regulations held gas prices down to extremely low levels. The free-market supply consequently dried up -- it was not worth it for private producers to sink their capital into operations which were guaranteed to lose money.

The waste that was encouraged was prodigious. (I visited a nuclear power station during the cold spell of 1977 when businesses were shut down all over Ohio through a shortage of natural gas. The nuclear plant had difficulty getting rid of the reactor waste heat, and the buildings were grossly overheated -- but with natural gas.)

The Department of Energy has spent something like $20 billion of the taxpayers' money on largely waste motion designed to keep energy supplies up and prices down -- an exercise similar to rolling water uphill with a spoon. The result was a drastic increase in the average family's uncontrollable expenditures, especially in taxation, a reduction in the supply of what was controlled (natural gas), and a huge increase in the prices of the only alternatives available.

The partial deregulation of natural-gas prices has given us a classic example , in reverse, of the effects of price regulation. Although prices have risen, there is now a surplus of natural gas in many areas, and prices are below those for alternatives. No government taxes need be collected to ensure supply, so that our involuntary expenditures have decreased, and average energy prices are much lower than if natural-gas supplies were still short and if we had been forced to purchase more foreign oil.