The Price of Paradise Revisited

Blogs, Economy, Energy

In his State of the State address to the Hawaii Legislature on January 22, 2013, Governor Abercrombie proposed raising the hourly minimum wage in Hawaii from $7.25 to $8.50, a 20.7% increase. Noting that the minimum wage had not been raised in six years, the Governor was implicitly acknowledging Hawaii’s high cost of living.

The problem is that raising the minimum wage further distorts the labor market, constraining business incentives to hire workers and potentially engendering some layoffs, while increasing the general cost of living yet more. The combined effect serves as a textbook example of what economists call the dead weight loss of social well being.

Rather than introducing more market distortions and raising the price of paradise, a better approach to reducing the wage/cost-of-living gap in Hawaii is to reduce the general price of paradise by removing distortions in other sectors of the economy. Two sectors immediately come to mind—Shipping and Electricity Production. Both were highlighted in the distinguished lecture presented in early 2012 at the University of Hawaii by Nobel Laureate Joseph Stiglitz (former Chairman, Counsel of Economic Advisors to U.S. President Bill Clinton, 1995-1997, and then Chief Economist, World Bank, 1997-2000).

Shipping between Hawaii and other U.S. ports is hampered by the Jones Act, Section 27 of the Merchant Marine Act of 1920, which requires that shipping between points in the United States be carried by vessels built in the United States and owned and operated by Americans. Plane old protectionism under the guise of national security, the Jones Act restricts competition, boosting the cost of shipping and elevating the overall cost of living in Hawaii. With the change in Hawaii’s Congressional delegation, now is the time for the Governor and the Legislature, working with the new Congressional delegation, to unburden Hawaii from the strictures of the Jones Act and introduce shipping competition in Hawaii, thereby helping to reduce the price of paradise.

Electricity in Hawaii, for the most part, is provided by the utility company, HECO, which operates as a monopoly, regulated by the Public Utilities Commission. As noted by Joseph Stiglitz in his distinguished lecture at the University of Hawaii, electricity rates in Hawaii are triple the national average. (Latest rate reported in the Honolulu Star Advertiser on January 24, 2013, is 32 cents per kilowatt-hour.) Some of this excessive rate can be attributed to the high cost of the principal fuel now used by HECO, residual oil refined from low sulfur crude, imported mainly from Asia. But the State of Hawaii energy policy also contributes to the problem, in particular, renewable energy mandates and subsidies, and HECO’s revenue decoupling scheme. In combination, these policies promise to raise the price of paradise even more, especially for lower wage citizens.

Mandates and subsidies are notoriously inefficient, because they reduce consumer and taxpayer well being. For the fiscal year ending June 2012, Hawaii tax revenue lost due to solar tax credits (i.e., subsidies) are estimated to be as high as $170 million; the council on revenues has adopted forecasts based on the assumption that credits will rise to $240 million in the current fiscal year. That’s very likely to be an under- estimate, given the solar-installation frenzy that the commission’s announcement has engendered in anticipation of a possible credit crack- down by the Hawaii State Legislature.

The revenue loss is a direct burden; but the overall loss is even worse. “Excess burden” is the additional loss of well being of Hawaii residents because subsidies distort prices and incentives in the economy, inefficiently drawing resources from other production sectors into the renewable energy sector. (The renewable sector gains at the expense of jobs and income in the rest of the economy.) On top of that is the added excess burden of tax friction: every dollar of tax revenue raised to finance subsidies costs the economy about another 25 cents. (Economists refer to this friction as the social cost of public funds.) And where do most of the solar panels now being installed in Hawaii come from? China, not the United States. Using welfare analysis made standard by economist Arnold Harberger, my colleague, Professor Jim Roumasset and I estimate that the amount of excess burden due to solar tax credits for this fiscal year will come to about $360 million. That’s $1 million a day swirling down the state drain. (And we wonder why the sewer system overflows from time to time.)

In February 2010, the Hawaii Public Utilities Commission (PUC) approved a new method, known as revenue decoupling, for setting electric rates designed to encourage progress toward clean energy in Hawaii. A dissenting opinion was filed by (former) PUC Commissioner Leslie H. Kondo (Kondo, 2008) and is a matter of public record. In that opinion, Commissioner Kondo describes revenue decoupling and goes on to discuss its welfare implications:

“… decoupling is a rate adjustment mechanism that breaks the link between the volume of electric sales and a utility’s revenues…With decoupling, (the utility) will earn the same amount of revenue by selling one unit of electricity as it will earn by selling ten thousand units. As electric sales decline — whether that decline is caused by the down economy, customers’ energy efficiency efforts, cooler than normal weather or a system power outage — customers will pay more for each unit of energy they use to make up for any shortfall in (the utility’s) authorized revenue requirement…It appears likely that low income, fixed income and elderly customers will feel the greatest impact from decoupling and that those customers have the least ability to reduce their electricity use. Those customers simply cannot afford to, for instance, replace their refrigerators with more energy efficient models or to install solar water heaters.”

In his dissent, Commissioner Kondo highlights the distinction between State energy objectives and the public interest, noting that they are not synonymous; he concludes that revenue decoupling is not in the public interest. I would add that solar tax credits together with revenue decoupling produces a transfer of income from lower-income citizens, most of whom are home renters, to wealthier home owners, the solar industry, and HECO. This seems like a reverse Robin Hood arrangement: take from the poor and give to the rich.

As is well recognized, Hawaii’s geographic location in the middle of the Pacific Ocean surely elevates the price of paradise. Raising the minimum wage won’t solve that problem, but removing policy distortions in other sectors of the economy will help.

In the realm of energy, Governor Abercrombie remarked in his 2013 State of the State address that Hawaii is facing “financing hurdles” and “policy obstacles.” Accordingly, Hawaii will be required to look not only at renewable energy technology, but current alternative energy sources that are available now. One of those is Liquefied Natural Gas (LNG). The Governor deserves kudos for this encouraging proposal.

– Lee H. Endress, Independent Economist and Affiliate Member Graduate Faculty, Economics Department, University of Hawaii at Manoa

Blog posts are intended to stimulate discussion and critical comment. The views expressed are those of the author.

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