The links between Resources and Taxes & Spending

Today I’ll be looking at the intersection between resources and government finances.  This link differs from the previous Under Construction posts in that I’ve depicted this particular connection as a two-way interaction.

I combined the two one-directional links because it looked to me like the implications of a change in the resources sector on government spending are the reciprocal of those from a change in government budgets on the resource sector, so it made more sense to put them together in one article rather than restating them in two separate ones.  However, it may be necessary to split them up if it becomes clear at some point that there is, in fact, sufficient divergence to warrant two separate articles.

The Impact of Taxes and Spending and Resources on each other
The impact of resources on government finances, and vice versa, varies considerably depending on the resource and geographic area in question.  Some resources, like metals and fossil fuels, are highly profitable for private investment, so direct government investment is not required.  Other resources, like water and hydroelectric power, may require extensive government spending on infrastructure like dams and aqueducts.  But even privately-run and -funded resource extraction industries often depend on a government-funded regulatory framework and transportation system.
To complicate matters, the taxes levied from the resource-extraction sector of the economy are an important source of government revenue.  Mostly this is desirable, because it gives state and local governments, in particular, both a reason to maintain the infrastructure that supports extraction and a source of funds for doing so.  The flaw in this relationship, however, is that there is a considerable lag between the spending (or lack thereof) of government funds and any impact on government revenue.  Shortsighted politicians may be tempted to manage budget shortfalls by skimping on necessary work, even though it will have a serious negative impact on economic productivity and government revenue a decade or more later.
At the national level, a great deal of our military budget is dictated by our need to maintain access to resources from around the world.  We spend more on our military than the next ten countries combined.  With the help of our allies, the US Navy acts as the effective guarantor of freedom of the seas for the whole planet.  And we have spent trillions of dollars on either propping up or invading various Middle Eastern countries because of our critical dependence on the oil that flows through the Persian Gulf.

That’s what’s on the site at the moment, but I’m no longer sure that it’s the correct way to approach this link.  The issues of infrastructure spending and our need to spend money on maintaining the freedom of the seas and the global energy market are absolutely true, and very important for the resource section of the Interlock, but I think that they’re better covered in their respective sections.

So, what does belong here, then?  To pin that down, we need to think about the answers to some more questions:

  • What are the resource-related problems that the US is dealing with?
  • Which tax-related decisions and/or policies by governments in the US are direct contributors to these problems?
  • Which spending decisions and/or policies by governments in the US are direct contributors to these problems?
  • How do these spending & tax decisions impact our resource problems?
  • How do those resource problems impact government budgets?

The answer to the first can be summed up as “resource uncertainty” in general, with a couple of instances of “severe shortage.”  Our water, energy, food, and materiel supplies are all subject to disruption, and we are remarkably limited in the backup systems/sources that are in place should such an event occur.  In some instances, though, particularly with regards to water supplies in the western US, we’re actually running out of resources, and we are seriously unprepared for the consequences of continued severe drought.

The direct impact of tax decisions on these resources is something that any economist could tell you:  tax something more, and people use it less; tax it less, they’ll use more of it.  The US has relatively light taxes on energy consumption, and a number of subsidies in place for energy producers.  Most of the US pays a fraction of the real cost of the water that we consume.  Agriculture benefits from many subsidies, and relatively low taxes.  Producers of industrial materials tend to face low taxes, if any, on their production over and above general corporate taxes on profits.  (I included subsidies in the “tax” part of this question because they act on the same principle as taxes, but instead of discouraging the production/consumption of something they encourage it – same spectrum, opposite effect.)

The direct impacts of spending decisions are where this gets complicated.  The indirect impacts – infrastructure and foreign policy – are rather obvious and extremely important to both Resources and T&S.  The direct ones are almost as important, but are a bit subtler and less expensive than dams or pipelines.  Specifically, the government pays for the regulators and oversight agencies that monitor/run the various resource sectors in the US, as well as a fair amount of the R&D efforts to improve those sectors.  (This is also where another indirect link gets mixed in, as corruption of these activities can cause a number of problems.)

The nature and degree of impact of all this is, as I said, rather subtle.  Deciphering what things would have been like if the government had spent more/less on R&D, or had increased/decreased funding to regulatory agencies, is a bit difficult, and economists love to argue about the exact impacts of increasing/decreasing taxes or subsidies.

With that said, there are some definite problems resulting from bad budgetary decisions.  The extremely low price we pay for water (varying by region/locality, but always remarkably below the true long-term societal cost) is directly responsible for the severity of the water crises that we’re dealing with right now.  Increase the price of water, and the droughts would still be there – but they wouldn’t be hitting us so hard because we wouldn’t be in the habit of using so much water.

The situation with respect to energy is similar, in that low taxes and extensive direct and indirect subsidies result in energy prices that are substantially below their true long-term societal cost.  (This is particularly true if one includes the military and foreign aid costs of ensuring energy supplies from the Middle East and elsewhere.)  Severely under-pricing energy leads directly to wasteful and uneconomic overuse and inefficiency.  Our energy vulnerability would be greatly reduced if we had priced energy more realistically.  In addition, higher prices for energy would have generated extensive private sector funding for improving efficiency and developing renewable energy sources, so there would be much less need for government regulations and subsidies to force conservation and alternative energy investment.

In addition, our food, energy, and water supplies are all put at risk (to some degree) by underfunded and understaffed monitoring agencies.  People who complain about the “growth of government” often don’t realize that government spending on transfer programs like Social Security and Medicare has grown enormously, but that total government employment has dropped substantially over the last several decades and that funding and staffing levels have dropped substantially for the agencies that try to guarantee things like a safe, efficient food and water supply, safe pipelines and storage facilities, and so forth.

One of the lessons learned from the major chemical spill and water contamination crisis in West Virginia was that there was effectively zero state or federal oversight of the company in question, which was free to store poisonous chemicals used in coal processing in an old tank on a riverbank directly upstream from the water intakes for a major metropolitan area.  Similarly, one of the major contributing factors in the BP disaster in the Gulf was the crippling of funding for the agency responsible for overseeing drilling safety.  And every food contamination scare and recall is accompanied by a reminder that the FDA and the Department of Agriculture lack the manpower needed to inspect more than a very small fraction of the food we eat.

The impacts of resource issues on government budgets are comparatively straightforward:  shortages affect the bottom line of the economy (an indirect impact) and require the government to take action to deal with them (a direct impact, although the cost of the infrastructure repairs that are sometimes a part of that action would go through the Infrastructure link).  The cost depends on the nature and degree of the problem, as well as how big the local/regional economy is that is affected by it.  California’s current drought is expected to cost the state $5 billion in 2014; the energy crisis that the state went through in 2000 and 2001, caused by too little regulation and too little capacity, cost upwards of $40 billion.

I know this has been long on generalities and short on specifics, but that’s a large part of why I’m doing the Under Construction series: re-thinking what I had assumed about a link, throwing my new construct out and seeing whether it can stand on its merits, and then eventually adding more meat to the bones later.

So.  Thoughts?  Comments?  This has been a tricky one for me, in large part because I’m purposefully defining the problem as not including the easy indirect links like infrastructure.  Am I right in my mental model for how this link/these links work?  Did I cover everything that needed to be touched on?  And, of course, can you point me to any materials that illustrate these points?


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