My Views on California Ballot Proposition 87
by Severin Borenstein  (Director of the University of California Energy Institute and Professor at the Haas School of Business at U.C. Berkeley)

I've recently been asked by some members of the press and other people for my views on Prop 87.  I've also been misquoted and quoted out of context a couple times on the subject.  So, I decided to put together this page to present my views.

For the text of the actual ballot proposition, go to http://www.ss.ca.gov/elections/vig_06/general_06/pdf/proposition_87/entire_prop87.pdf

For the California Legislative Analysts Office (LAO) presentation, go to http://www.lao.ca.gov/ballot/2006/87_11_2006.htm
(I recommend reading this one)

For the Yes on 87 view, go to http://www.yeson87.com/

For the No on 87 view, go to http://www.nooiltax.com/

The main thrust of prop 87 is that it would create an oil severance tax, a tax paid by oil producers at the time they remove oil from the ground in California.  The tax would be in effect until it raises $4 billion, at which point it would be discontinued.  The $4 billion would go towards research on and subsidies for use of alternative energy.  Most, but not all, of the money would be focused on alternative transportation energy.  The proposition's impact on State taxation and expenditures has many complexities including its effect on other oil property tax assessments and the associated tax revenues and its effect on state mandates for schools to get a fixed percentage of tax revenues.  I don't claim to be an expert in those areas.

For the reason I lay out below, I am really unsure of how I will vote on this proposition.  That said, some of the rhetoric coming out of both sides is highly questionable or just plain wrong.
 

WHAT EFFECT WOULD PROP 87 HAVE ON GASOLINE PRICES?

Prop 87 would not raise the price of gasoline in California to any noticeable extent.  Oil companies often remind us that the price of oil is set in a world market and they are right when they say that.  They are wrong when they say that taxing oil produced in California would raise the price of California oil and, thus, the price of California gasoline.

California already imports more than half the oil we use.  The price of oil in California is already set by the cost of importing oil from the world market.  Some oil produced in the state has lower production costs, but those producers still sell that oil for the market price.  They don't lower their price because they have lower costs any more than you are willing to sell your house for below the market price even though you bought it for a much lower price 20 years ago.  So, the fact that prop 87 would increase oil imports, at least in the short run, does not mean that it would raise oil prices.

In reality, prop 87 would have a very small impact on California oil production.  Some old wells would be abandoned slightly earlier because the tax would make them uneconomic slightly sooner.  Some new wells that were planned won't be drilled because they were just barely economic before and the tax would make them uneconomic.  But not even the opponents of 87 claim the reduction would be a large percentage of the oil they pump.

Consultants for the opponents of the ballot proposition have issued a report claiming that the tax would decrease California oil production by 56,000 barrels per day or about 9% of California production.  The report presents no analysis to support this number, and it seems implausibly high to me, but let's assume for a moment it was correct.  That is less than 0.07% of world oil production (about 86 million barrels per day).  This would have no noticeable effect on world oil prices.

In the short run, California would have to import more to offset whatever reduction in state oil production occurred.  But we already import oil, and the cost of that oil -- including the cost of importing it -- is already in the California price.  The extra imports would not drive up the California price of oil and, thus, they would not drive up the California price of gasoline.
 

SO WHO WOULD PAY FOR THE TAX?

For the most part, this is simply a tax on oil producers and they would end paying for most of the $4 billion it would take in.  Some of it would be paid for by taxpayers in the form of lost revenues from other taxes, as I discuss below.

I'm not exactly happy about this effect.  This is part of a trend of public policy initiatives in which voters are told that no sacrifice is required from them to solve serious public policy problems.  I would rather see an increase in the gasoline tax, which would make it clear to consumers that using gasoline creates real external effects, in the form of pollution, climate change, and increased geopolitical tensions.

I'm also philosophically opposed to levying new taxes on whatever sector of the economy happens to be making a lot of money right now.  I would much rather see a strongly progressive overall tax system that is not constantly changed to favor or disfavor one group or another.

That said, I also don't think that people or companies have a right to continue whatever the current regulatory or tax system is in perpetuity.  The fact that there is no severance tax now in California does not give the oil companies a right to that public policy forever. (For this reason, I am strongly opposed to Proposition 90, which would essentially require losers to be compensated for every public policy change.)  I would, however, like these changes to be made on public policy grounds, not by chasing whoever is making money these days.

It is also worth pointing out that, despite what the supporters say, the oil companies are not all "them".  In many cases they are us.  Anyone who holds stock in these companies, or who owns a stock market index fund, or has a defined-benefit pension plan owns some share of these companies and their profits.

There would also be an effect on other tax revenue.  Oil companies pay income taxes and property taxes in California.  The new severance tax would reduce their income and the value of their property, which would reduce their other tax payments.  The LAO estimates this would be a fairly small offset.
 

WHAT ABOUT MAKING IT ILLEGAL TO "PASS THROUGH" THE TAX?

The drafters of this proposition believed that voters would have to be assured that they would not have to pay for it in higher gasoline prices and that it was too complicated to explain the economics, so they added a clause to make it illegal for oil companies to pass through the tax in the form of higher gasoline prices.  This clause would have no effect on gas prices (a) because the oil companies won't be able to pass through the tax to begin with (see above) and (b) because if they did "pass it through" there would be no way to detect it in the complex partial vertical integration of the oil/gasoline industry.  This clause is completely toothless when it comes to gasoline prices.

But it is not benign.  The clause gives the Board of Equalization the power to investigate whenever there is ever an accusation that the tax is being passed through.  This would result in endless investigations: every time the price of oil goes up, the tax payments would go up.  But when the price of oil goes up, the price of gasoline also goes up.  Some politician will -- I am absolutely certain -- see that the tax revenues and the price of gasoline have both increased and will call for an investigation.  California would have even more completely-ineffectual investigations into high gasoline prices than we already have.
 

WHERE WOULD THE MONEY GO?

The money would go towards subsidizing research, development and usage of alternative energy.  Most of it would go towards alternative transportation energy.  I believe we really do need to spend more on research into alternative energy and on switching to alternative transportation fuels (and/or increase taxes on gasoline to make alternatives more attractive).  I support most of what this money would go for. (DISCLAIMER: Some of this money would go to fund research on alternative fuels.  The University of California would undoubtedly compete for some of this funding and I could, directly or indirectly, end up benefiting.)

Some of the money probably would go towards alternative energy initiatives that I don't support, in particular subsidies for installing photovoltaic panels on houses. (I don't support the "million solar roofs" initiative because solar PV is the least economic of all the mainstream alternative energy options for electricity.  But that's a separate issue.)  More generally, not all of the money would go towards alternative transportation energy.  Most of it, however, would probably go towards the sort of alternative energy and energy efficiency research and usage incentives that I believe make sense.

Opponents of the proposition argue that while they might support funding for alternative transportation energy, the bureaucracy that this proposition would create would be wasteful and have little or no public oversight or accountability.  I've read the proposition and I don't see what they are getting at.  I suspect that the money won't be spent particularly efficiently, but I don't see why it would be spent any less efficiently than in other government programs.
 
 
SOME CONCLUDING THOUGHTS ON BALLOT PROPOSITIONS

Like many Californians, I am very frustrated with the ballot initiative process and feel that it is out of control.  Voters should not be asked to make detailed policy decisions through the ballot box.  Instead, the legislature should do its job of developing good policy through discussion with experts and stakeholders.  For that reason, I am inclined to vote no on most propositions unless I think there is an overwhelming argument in favor.  Increasingly, however, I am coming to realize that my view may be unrealistic in the near term: California's legislative process is seriously broken due primarily to legislator term limits.  So, legislating through the ballot box may be more of an unfortunate necessity.  I'm not sure where that leaves me on ballot initiatives in general, but I am evaluating prop 87 on its own merits apart from those considerations.
 
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Update on November 3, 2006

Though I am still not taking a position on Prop 87, there are two more things I should address:

1. The anti-87 folks are circulating and advertising a letter signed by about 100 people who they describe as economists, which says that prop 87 will raise gasoline prices.  I was very surprised to see this.  I took a closer look and found that some of the people are not economists by any stretch of the definition and many of the university affiliations are misleading (these people are adjunct faculty or have only a weak very part time affiliation with the institution). The majority of the people are from outside California and none would be described as an expert in energy economics.

A few of the signers, however, are successful research economists and/or are at well-regarded institutions.  I emailed the 25 on the list who I thought plausibly fit in one of those categories.  I explained my reasoning and asked them by what mechanism they believed that prop 87 would raise gasoline prices (I may be ambivalent about Prop 87, but I'm not when it comes to the appropriate use of economics in policy analysis).  Of the 9 who responded, 8 said that they agreed with my argument that prop 87 would not raise gasoline prices, but that they were opposed to prop 87 for other reasons.  The one other person said that (s)he wouldn't speculate about the magnitude of the change but still believed that the direction would be to increase prices.

2. One aspect of the tax imposed by the proposition has been mentioned in the press as being a bit uncertain, whether the progressive tax rate is a marginal or overall rate.  If it were a marginal tax rate like the income tax, then when the price of a barrel of oil goes from $60.00 to $60.01, the point at which the tax increases from 4.5% to 6%, the extra one cent would be taxed at 6%, but the price up to $60.00 would still be taxed at 4.5%.  The alternative would be a bump up in the overall tax rate at this point.  If that is the case, the tax payment at $60.00 would be $2.70 (4.5% of $60.00), but at $60.01 would be $3.6006 (6% of $60.01).  In other words, raising the price by one cent would raise the tax by about 90 cents.  Unfortunately, this latter structure is what the drafter are saying was intended and should be implemented if prop 87 passes.

This is an error in drafting the proposition that is simply amateurish.  Such a sudden bump in the tax bite creates awful incentives for sellers to either shave the price (in the above example to $60.00 even if the market price is $60.01 or up to $60.90) or to create under-the-table payments.  Taxes are almost never designed this way because of the incentives for prices to be sticky just below the break points.  The effect in this case could be a small, but not insignificant, distortion in the oil market.