Barack Obama: Blinded by "Fairness", II

[Continued from “Blinded by Fairness, I”…]

Energy

Obama’s proposed “windfall profits” tax on oil companies would have a similar secondary effect, though more immediate and more intuitive. However, the senator’s determination to stick it to “Big Oil”, either in a grand pandering gesture to his supporters, has precluded him from heeding the wisdom arguing against such an imposition. Depending on the structure of the tax, it would at best increase the price of a gallon of gas to consumers and at worst discourage investment in alternative energy by those with the best resources to perform such research – Big Oil.

Consider if the tax were truly a tax on profits alone – that is, the government would take, say, 15 percent of Big Oil’s profits. Big Oil, like all firms, must decide whether to reinvest profits in either projects or to distribute them among shareholders. Let’s say that in the absence of this windfall, Big Oil could invest in an alternative energy project from which it expects returns of 7 percent. The alternative is to redistribute funds among shareholders who could otherwise invest in the stock market, from which, in a healthier situation, investors could expect, say, returns of 6.5 percent. Assuming equal risks of both projects, Big Oil would invest in the alternative energy.

Now, consider if Obama imposed a tax of 15 percent on total profits. The expected returns from a given project would shrink by 15 percent from 7 to below 6 percent. In such a circumstance it is most sensible for Big Oil to forego the investment in the alternative energy and to, instead, redistribute its profits to its shareholders, allowing them to invest in the stock market earning a more lucrative 6.5 percent return.

It is doubtful that even if Obama had considered or realized the adverse effects of such a tax to consumers and the environment his position would be considerably different. His Democratic base foams at the mouth at the thought of “Big Oil” and are, undoubtedly, similarly blinded by notions of fairness. Nevertheless, while it might be prudent politically that Obama adopt such policies, it is nevertheless disappointing that the candidate of “change” actually retains the same self-serving and publically costly characteristics of his peers.

Barack Obama: Blinded by Fairness, I

As the presidency of Barack Obama becomes increasingly imminent and as the economy continues to concern voters most, it is necessary to consider Obama’s capacity to handle complex economic issues considering he entirely lacks an academic or professional education on the mechanics and value of business whose singular motivating economic guideline is a pretense of “fairness.”

To be sure, fairness is a noble objective -- except, at the very least, when economic outcomes for all citizens are deteriorated, which Obama stunningly favors. However, like many efforts to promote economic equity, such as raises in the minimum wage, likely accompanying Obama’s proposals are plainly apparent costs tending to effectuate the opposite result. Obama’s alarming provinciality to realize the adverse effects of two of his simplest tax proposals demonstrates his inability to see beyond his subjective notion of fairness in the best interest of Americans.

Education

Obama rightly observes that the rising bill of attending college is problematic. He intends to halt this rapid upward movement by handing out $4000 to any individual who attends college and performs some form of community service. All else equal, students who performed the task would be better equipped to pay for schooling by $4000 per year. That’s hard to debate.

As it happens, however, in a monopolistically competitive market, as universities are situated, students are not the only actors. Universities determine the prices they set, and in the face of systematically greater demand, prices will naturally increase eventually entirely negating the effect of such a price increase. Assuming the supply is fixed in the time period under concern (because of requirements of a school’s charter, desired student-teacher ratios, or housing limitations, for instance) as in the diagram below, prices would ultimately increase $4000. If supply were not inelastic, the price increase would be some fraction of $4000.


Consider the situation mechanically. Let's say that the average family was willing to pay, say, $20,000 per year for college, and suppose that after hundreds of years of operations, the average university has determined that $20,000 is the appropriate price for its education. On the surface Obama’s proposed tax credit now sounds great, because college should cost the average family now only $16,000 per year as opposed to $20,000. However, since the family is willing to buy their child a college education at a cost of to $20,000, it is now willing to spend up to $24,000 to go to college. Recognizing this increased demand via increased application volumes and the well-publicized federal policy, universities desirous of renovating dorms, attracting better professors, or hosting more programs will increase their prices as much as students are willing to pay -- $24,000. Once prices adjust, the tax credit would confer no economic benefit on families, at a cost to the taxpayer of $10 billion.

To be fair, the entire price adjustment would be a “long-run” effect. That is, the price increase doubtfully would occur immediately, but, do not be fooled, in the presence of such a tax credit, prices would rise above and beyond the amount to which they would have risen in the absence of the credit. Indeed, many economists argue that much of the driving force behind the drastic increase in college tuition in the past decade, about double the rate of inflation, has been the proliferation of policies similar to Obama’s proposal.

Further consider the possibility that Obama were not reelected in 2012 and this credit were repealed. As it happens, prices are notoriously “sticky” downwards. Therefore, if the price would have risen naturally to, say, $25,000 in the absence of this tax credit in 2012 and it instead rose to $29,000, families would now have to pay $29,000 without enjoying the luxury of the $4000 credit. In such a circumstance, not only would the tax credit more rapidly effect price increases, but the ultimately represent a $4000 cost to the family.

[The second tax proposal is discussed in the next entry.]