The Volt: Struck Twice by Lightening

The Obama administration is hell bent for leather on placing one million new-tech automobiles on our highways by 2015.  To help accomplish this goal, the administration intends to increase the subsidy on battery-powered vehicles like the Chevrolet Volts, and on natural gas powered vehicles. 

I believe that the policy is bad economics for two reasons.  First, governments are bad at picking market viable technologies.  Michael Boskin recently quoted Larry Summers who was at the time President Obama’s chief economic advisor who said, “the government is a crappy venture capitalist” (“Washington's Knack for Picking Losers”).  Second, the demand for vehicles like the Volt is probably inelastic meaning that it would take a large increase in the subsidy to cause a significant increase in the number of cars sold.  The average Volt buyer earns $170,000 annually and approximately 50% drive a Prius or BMW (“Obama hikes subsidy to wealthy electric car buyers”).  My guess is that the buyers are trying to make a personal statement about their commitment to the environment and this statement is not particularly dependent on price.

The graph of the “Market for the Chevy Volt” provides some important economic details of the Volt market and the impact of the federal tax credit subsidy.  As with my first attempt to describe the possible outcome of a subsidy for the Volt, (“The Chevy Volt”), a lot of guess work went into the shape of the supply and demand curves.  In this graph, I made demand more inelastic; I did try to find a realistic price but not sales volume.  I almost certainly exaggerate sales.  The supply (S) and original demand curve (DO) represent the market for the Volt prior to the federal tax credit subsidy. Without a subsidy Chevrolet sells 38,800 Volts at approximately $42,400 a piece (point E0).  The $10,000 federal tax credit increases demand (D0 to DN).  At the new equilibrium (E1), Chevrolet sells 4,000 more Volts and equilibrium price increases by $2,000 to $44,400.  With the $10,000 subsidy, the buyer’s price falls to $34,400.

The EPA gives the Volt a combined gasoline/electric fuel economy of 60 mpg, or about twice the mileage of a similarly sized car.  Assuming that a typical Volt owner will drive 15,000 miles per year, and that gasoline costs $4.00 per gallon, the Volt will save its owner approximately $1,000 per year in fuel expenses.  If a traditional subcompact costs $20,000, and assuming the buyer does not respond to the lower operating cost by driving more, the Volt will have a fourteen year payback period ([$34,400-$20,000]/$1,000 per year=14.4 years) for the owner.  

The private market has a new partner, the taxpayer—the forgotten man.  The yellow rectangle is the subsidy paid by taxpayers.  It is $428 million dollars ($10,000 times 42,800 Volts).  The government estimates that approximately one third of buyers will not qualify for the subsidy, reducing the taxpayer’s bill to approximately $285.3 million, or approximately $71,300 per additional Volt sold.  To benefit society, the sale of Volts must generate sizeable positive externalities like a reduction in pollution or a more rapid technological development, etc.  I have a hard time believing that there will be a positive return on societal investment.

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Glaeser on Green Energy

Yesterday, I linked to Daron Acemoglu’s article “The Real Solution Is Growth” in which he suggested that policy should focus

ON green technology, the next area that has the best promise of creating a platform for more innovation…The United States is lagging behind other countries in these activities. To regain leadership, we need both more and smarter subsidies to research in green technologies and a carbon tax that naturally encourages the use of cleaner technologies and triggers more research to seek such technologies.

Another exceptional economist from a nearby institution, Edward Glaeser, explains why green technology is not an engine for job creation, why it increases productivity, and what types of activities should be subsidized in “Why Green Energy Can’t Power a Job Engine.”

He uses Evergreen Solar which had a factory that received $40 million in subsidies and recently announced that it was moving production from Massachusetts to China as a case study.  Evergreen’s comparative advantage was its proximity to one of America’s foremost centers of engineering, Boston, and its principles worked with MIT profession Emanuel Sachs who invented the “string ribbon” process for producing solar cells. 

The new company’s innovative product brought international partners willing to finance the company’s expansion.  When the time came to begin commercial production, the lure of cheap labor enticed Evergreen to move production to China.

Glaeser conclusion expounds on Acemoglu’s recommended policy that government funds research in green technologies.

Failed public investments, like the money spent in Devens, reflect the fact that public officials are rarely skilled venture capitalists and that governments pursue many objectives that lead them away from solid investments. It’s easy to see why any governor would be excited about a green-energy manufacturing plant in a less prosperous area of his or her state. But the same forces that made Devens political catnip meant that it was unlikely to be a long-term success…

Massachusetts’s edge lies in ideas, not products. Those ideas are best produced in creative clusters, built around cities, where knowledge moves easily from inventor to entrepreneur. The only production that really needs to occur in greater Boston is the early-stage manufacturing that can be an important part of the research process. Mature companies, like Evergreen Solar, naturally move their factories to lower-cost areas…

As long as solar panels are getting cheaper, we shouldn’t worry about where they are being produced. We should continue financing research on solar technology as long as that research continues to produce cost-cutting breakthroughs, like “string ribbon” technology, but we shouldn’t pretend that cheaper solar energy will end up employing millions of our less-skilled citizens.

For decades, local economic success has come from entrepreneurship and education, not large-scale manufacturing. The Devens closing doesn’t imply that there is anything wrong with clean energy, but it does suggest the difficulties inherent in trying to beat China at cheap manufacturing. In the long run, America will be richer than China only by having smarter citizens, and that requires the skills that come from schools and cities, not dispersed factories.

If this post is of interest, read Glaeser’s entire article linked above.  If the article leaves you wanting more, read his book, Triumph of the City: How Our Greatest Invention Makes Us Richer, Smarter, Greener, Healthier, and Happier.

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Special Tax Breaks for Big Oil?

The Senate recently concluded a debate on ending Section 199 deductions of the American Job Creations Act of 2004 for the five largest American oil companies.  With a few exceptions, the debate was framed by language that I believe was designed to elicit an emotional rather than an informed response from voters.  After reading or listening to news accounts of the debate, I was unable to express an informed decision.  I went back to the original legislation and read it.  Because it uses both arcane accounting and legal language, I searched the Internet for short descriptions of the legislation.

William Perez does a nice job of summarizing Section 199 (“Domestic Production Activities Deduction: Section 199 Deduction”).  The entire article is well written and worth the time spent in reading it.  In part, he writes

Here's the basics:

Businesses with "qualified production activities" can take a tax deduction of 3% from net income. This is a tax break pure and simple. The more complicated the business, the more complicated the math for calculating the Domestic Production Activities Deduction. In a nutshell, businesses engaged in manufacturing and other qualified production activities will need to implement cost accounting mechanisms to make sure their tax deduction is accurately calculated.

Domestic Production Activities Deduction

A business engaged in a qualfying production activity is eligible to take a tax deduction of 3% in tax years 2005 and 2006. The deduction increases to 6% in year 2007, and 9% in year 2010.

Qualified Production Activities

A business engaged in the following lines of business may qualify for the Domestic Production Activities Deduction. These are the "qualified production activities" eligible for claiming the deduction under Internal Revenue Code Section 199:

• Manufacturing based in the United States,
• Selling, leasing, or licensing items that have been manufactured in the United States,
• Selling, leasing, or licensing motion pictures that have been produced in the United States,
• Construction services in the United States, including building and renovation of residential and commercial properties,
• Engineering and architectural services relating to a US-based construction project,
• Software development in the United States, including the development of video games.

I hope that this information helps readers obtain an informed opinion.Replace this text with...
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Past Policy and Today’s Oil Price

President Obama has correctly stated that there is little that the federal government can do to lower the oil prices in the short run but that is where the story begins, not where it ends.  Recognizing that oil production results in pollution, environmentalists have engaged in a decades long battle to enact policies that restrict the production of oil while subsidizing renewable energy sources like wind, solar and biofuels.  These policies have been consequential; supply has contracted and equilibrium price increased.  Subsidies of wind, solar and ethanol have been expensive to taxpayers and resulted in little if any commercially viable production.  Not satisfied with subsidies alone, the government has often mandated the use of these alternative energies forcing consumers to bear the higher cost.

President Obama supports a continuation of past environmentalist policies.  David Harsanyi provides a couple of quotes that support high oil prices (“Why Isn't Obama Celebrating High Oil Prices?”).

In 2008, candidate Barack Obama was asked by CNBC's John Harwood, "So could the (high) oil prices help us?" Obama: "I think that I would have preferred a gradual adjustment."…That same year, current U.S. "Energy" Secretary…Steven Chu clarified that "somehow we have to figure out how to boost the price of gasoline to the levels in Europe."

In response to rising oil prices, President “Obama reissues call to end oil company tax breaks.”  When you tax something, you get less of it.  Taxing oil would not encourage production.  While calling for more drilling, EPA has denied Shell a permit that would allow it to drill in the Arctic Ocean in Alaska.  Shell is preparing to scrap its five year, $4 billion investment.  Dan Springer writes (“Energy in America: EPA Rules Force Shell to Abandon Oil Drilling Plans”).  The Obama administration dramatically slowed the issuance of permits for deep-water drilling after the BP blowout (“First deep-water drilling permit issued for gulf since BP oil spill”).  These policies will result in higher oil prices in the future just as past policies have resulted in higher prices today. 

There is nothing morally wrong or logically inconsistent with environmentalists’ beliefs.  Oil production, like the production of any form of energy, results in pollution.  A cleaner environment is a worthwhile objective.  Everyone wants it but everybody wants cheap energy as well.  This is where my disagreement with traditional policies supported by President Obama ends. 

Government policies to find a cheap alternative to fossil fuels have failed and there is no reason to believe that future efforts will be more productive.  Traditional environmental policy seems to underestimate the pollution caused by “green” energy sources.  Windmills are ugly and blight areas where they are located.  Ethanol production pollutes air and water and drives up food prices.  I believe the tradeoff between wealth and a clean environment is steeper than traditionalist admit and as wealth falls, pollution increases.  For example, people drive older cars and spend less on maintenance.

With no real evidence to support my opinion, I believe that support for traditional environmental policy comes largely from people earning more than the median income.  This may cause a fissure in the Democrat’s voting coalition.  Highly educated high income Democrats will continue to support these policies but the poor and many union members may not.
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