One Way to Switch Off the Power Crisis: Taxes

The California electricity crisis never seems to end. The general wisdom is that the state should “step up to the bar and pay.” California’s pioneering effort to deregulate the market has bombed. Now the residents must shell out for the failure.

California is not powerless, however. Indeed, the Legislature holds a tool that it can use to bludgeon utilities and generating companies into submission. That instrument is the power to tax. By imposing a tax on electricity use while cutting the state’s income and profits taxes, the Legislature could in one bold stroke seize the initiative from the electricity industry, promote conservation and reduce the cost of acquiring generating and transmission facilities for a state power authority.

Yet, the opportunity has been available for years. Furthermore, it has been used successfully in other countries. Twenty-two years ago, the world’s oil consumers faced an identical problem. At that time, a greedy, capricious group of oil-exporting nations pushed oil prices from $15 to $40 per barrel. When confronted by consumers, representatives of these countries threatened to push prices even higher. The statements they made in the 1980s are identical to the assertions made by out-of-state generators today.

Economists came up with a way to beat avaricious oil exporters that would work as well today if applied to generators. The tool involved was a disruption tariff. Such a duty would be imposed as a percentage of the oil price. If OPEC demanded $30 per barrel, consuming countries would boost the price to consumers to $60 and keep $30. If OPEC demanded $60 per barrel, consuming countries would boost the price to $120 and keep $60. To stay revenue neutral, proponents of the disruption tax recommended that other levies, such as Social Security deductions, be cut. A disruption tax offset by cuts in other duties was proposed as a means to achieve the maximum short-term conservation effect while minimizing the macroeconomic effect. The taxes were meant to reduce the economic leverage oil-exporting countries held over consuming nations.

The United States rejected this proposal. However, many other countries adopted a variant of the idea. For example, Germany doubled its gasoline tax. In 1980, this tax accounted for 50% of the price of one liter of gasoline. Today, the tax accounts for 75% of the retail price. This higher cost has restrained the growth in use. Oil consumption in Germany has remained essentially unchanged despite strong economic growth.

The success of the strategy can be seen in the complaints of oil-exporting countries. OPEC representatives have bitterly objected to high taxes on petroleum. At the recently concluded world economic forum in Davos, ministers from Saudi Arabia and Algeria blasted the steep European petroleum duties. Their complaints fell on deaf ears. European ministers know that high petroleum taxes have substantially reduced the leverage exporters once held.

California could achieve the same results by imposing taxes on electricity use. High taxes on incremental electricity consumption would dramatically increase the incentive to conserve. The reduction in demand, in turn, would lead to lower prices on spot markets if electricity prices are truly determined by competitive forces.

Revenue from the electricity tax could and should be returned to the state’s residents immediately by cutting other taxes. The state’s high sales tax might be suspended, for example. Alternatively, corporate and individual income tax rates could be lowered. In addition, some revenue might be allocated to a special fund to compensate individuals and firms that suffer extreme hardship from an electricity tax.

In structuring a tax and rebate, the governor and Legislature should keep four points in mind. First, the tax must be applied uniformly to all consumption so that it cannot be challenged as an unfair infringement of interstate commerce. Second, the tax should be set at a rate that maximizes everyone’s incentive to achieve large reductions in electricity use. Third, to the extent possible, the tax should be designed to capture as much revenue for the state as possible while minimizing payments to the generating companies currently extorting the state’s consumers. Fourth, other tax reductions should coincide with the introduction of the electricity tax to minimize the impact on the state.

This is admittedly a bold proposal, but the current situation requires audacity. Furthermore, the current situation requires retaliation, not financial finagling. An electricity use tax would hit generators and utilities where it hurts: at the bottom line.

The governor and the Legislature hold the weapons needed to address the short- and the long-term electricity problems. All they require is the courage to use them.