Federal Budget Issue: Do We Need an Energy Tax?

Policy Backgrounders | Taxes

No. 127
Friday, June 04, 1993
by Stephen Moore


Would the Energy Tax Reduce the Budget Deficit?

Table IV - Why the BTU Tax Would Not Reduce the Deficit

President Clinton has repeatedly maintained that Americans are willing to pay more taxes and make the necessary sacrifices to reduce the $300 billion budget deficit. Even if that is true, the energy tax, which he is touting as a $72 billion deficit reduction measure, would at best cut the deficit by a fraction of that. And it might not reduce the deficit at all. Here's why.42

  1. Start with $97 billion. This is the amount of gross revenue the administration estimates it would collect from the energy tax over the next five years.
  2. Subtract $25 billion. The Treasury Department concedes that roughly $25 billion of this revenue would be offset by static reductions in income and payroll taxes.43 This leaves $72 billion for deficit reduction.
  3. Subtract another $42 billion. The administration plans to increase welfare spending by roughly $42 billion per year as an offset to the new taxes that low-income families would have to pay. This leaves the administration with $30 billion in net deficit reduction. Hence, according to the administration's own analysis, the energy tax would raise $3.50 in taxes for every $1.00 it reduces the deficit.
  4. Subtract another $5 billion. The administration neglects to take into account the dynamic economic impact of the tax. Independent forecasters have concluded that the energy tax would reduce GDP by at least $140 billion over five years.44 This would reduce tax revenues by roughly $30 billion, $5 billion more than was estimated by the Treasury Department. This cuts the net deficit reduction estimate from $30 billion to $25 billion.
  5. Subtract another $15 billion. The BTU tax would raise the inflation rate by an estimated 0.5 percentage points. As a result, federal expenditures would rise because programs such as Social Security are indexed to inflation. Hence, the inflationary impact of the energy tax would raise federal entitlement spending by roughly $15 billion over five years.45
Figure III - Where BTU Tax Revenue Would Go

"What is touted as a $72 billion deficit reduction measure actually works out to no more than $10 billion."

As Table IV and Figure III show, the amount of deficit reduction is now down to $10 billion - or a scant $2 billion per year. Viewed from the perspective of deficit reduction, the BTU tax (combined with welfare spending offsets) is highly inefficient for two reasons:

  • The BTU tax would raise $9.70 of revenue for every dollar that it (allegedly) would reduce the deficit.
  • Since the BTU tax would reduce GDP by $35 billion per year in order to reduce the deficit by $2 billion, private output would decline by $17.50 for every dollar of net deficit reduction.

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