Windfall taxes, subsidies and the rule of law

The housing lobby wants the government to take special measures to revive its fortunes and the Chancellor is thinking (I use the word loosely) of imposing a windfall tax on energy companies. These two proposals are, as Anthony says, the same thing. They are ad hoc interventions into the economy in violation of the principle that economic affairs should be governed by general laws applicable to all.
Hayek expressed the distinction thus:

Under the rule of law the government is prevented from stultifying individual efforts by ad hoc action. Within the known rules of the game, the individual is free to pursue his personal ends and desires certain that the powers of government will not be used deliberately to frustrate his efforts…
Economic planning of the collectivist kind necessarily involves the very opposite of this. The planning authority…must provide for the actual needs of people as they arise and then choose deliberately between them. It must constantly decide questions  which cannot be answered by formal principles only, and in making these decisions it must set up distinctions of merit between the needs of different people. (The Road to Serfdom, ch VI)

Now, as Hayek said, we can never know precisely the effects of specific interventions. But we might hazard that the following costs would be incurred:
1. A misallocation of investment, as a result of over-riding the market mechanism. Market forces are telling us that there’s been over-investment in house building and under-investment in gas and power generation. Taxing energy companies and subsidizing builders exacerbates this problem.
2. It worsens the quality of business decision-making. As Anthony says, these twin policies would subsidize bad judgment and penalize good. What incentive does this give firms to do well?
3. In showing that the government caves into pressure groups, it gives everyone an incentive to invest in lobbying and rent-seeking rather than in running their own affairs well.
The tragedy here is that there’s no need for all this. The problems raised by high fuel prices and a collapsing construction sector can be tackled within the framework of the rule of law. If you’re worried by “fuel poverty” the solution is to raise the incomes of the poor, ideally through a higher citizens’ basic income. If you think firms’ profits are too high, you can raise corporation tax rates. And if you’re worried by job losses among construction workers, you can raise unemployment benefit rather than treat the jobless as criminals.
What we’re seeing in these proposals, then, is just what to expect when the state and business collude - the drawbacks of arbitrary government, without the offsetting benefit of any genuine egalitarian principle.

Comments

[claudio]

By the way:

"Government subsidies can be critically analized according to a simple principle: You are smarter than the government, so when the government pays you to do something you wouldn't do on your own, it is almost always paying you to do something stupid."
P.J.O'Rourke

[Matthew]

Is there not a problem though in that if the market is telling us there has been too much housebuilding, it was also telling us just a year ago that there had been too little? And it's hard to believe that the amount in between was enough to tip the balance so severely. Furthermore the government is already intervening very heavily in various not unrelated sectors, and always has done.

[TheophileEscargot]

I've just been reading George Soros' book "The New Paradigm for Financial Markets: The Credit Crisis of 2008 and What It Means". In there he points out that while free markets work pretty well, they're flawed in some ways by feedback loops. These create booms and busts. Booms involve prices going much higher than their proper value, and in the subsequent bust prices fall far below.

If so, both those measures could be justified. In the upcoming housing bust, prices will fall too low: it could be useful to take some measures to prop them up higher. Energy prices seem to be driven by a speculative boom in commodity prices: it could be useful for the government to keep that under control.

[Luis Enrique]

I'm not sure, like Matthew says, that what's happening in the housing market equates to a price signal saying fewer houses ought to be built.

On the windfall tax, what would make you change your mind? Presumably there is some benefit accruing from the government revenue raised, although I appreciate some government haters might dispute that. I'd say at the very least the distributional effects would be desriable. So what's the 'bad' that offsets that? Reduced investment in gas and power generation. But how large is that disincentive effect, the investment response, in practise? If you see these energy companies as primarily rent extractors, it's not clear to me that the profit maximising response to a windfall tax would entail a meaningful reduction in investment - that is, sub-optimal from a social welfare p.o.v.

Would you agree that if the gain from additioanl goverment tax revenue was large enough, and the energy sector investment response small enough, that a windfall tax could be a good idea? Or would you object to it on other grounds?

[William McIlhagga]

If a government sets general rules for the conduct of business, might not those rules contain hidden flaws that are only exposed by experience? In that case, maybe a punitive measure (a windfall tax) says two things - first, that those making the rules are fallible, and second, that breaking the spirit of the rule, rather than its letter, is potentially punishable?

[Planeshift]

"Market forces are telling us that there’s been over-investment in house building"

Then "market forces" have been drinking too much. No sane person could think that the problem with UK housing has been too many houses getting built.

[Alex]

What market incentive do they have to do things that would actually solve the problem (like insulation) which have the property of reducing demand for natural gas? (Unfortunately, by the time they are in pain buying wholesale, it's too late.)

But then, granny can always wait for the CBI ponies.

[Charlieman]

Alex: "What market incentive do they have to do things that would actually solve the problem..." How about redefining the problem? Energy companies are in the business of selling energy, so why involve them in energy conservation at all?

A really dumb response:

1. Companies X and Y simply sell me gas and electricity.

2. Company Z sell me wall and roof insulation.

Companies X, Y and Z know their own sector well and provide a service at the right price. In the UK today, there are multiple X, Y and Z suppliers, so there is loads of choice. It sounds all right to me.

[Charlieman]

Please file my last comment under "may contain cr*p". I failed to acknowledge that oil, gas and electricity companies employ people who know how their product will be used.

[reason]

The hidden problem here is that oil and gas are fossil fuels and the oil companies have been given monopoly rights to exploit them. Windfall profits represents mostly RENT not returns on investment. The problem is the lack of proper resource rental charges (royalties if you like to use a pre-democratic term).