Cow-dung Economics Guide California’s Oil Tax Initiative

An open letter to a tech billionaire who wants to ding oil company profits

Vinod Khosla, the Indian American co-founder of Sun Microsystems, is a general partner at Kleiner, Perkins, Caufield & Byers and the founder of the VC firm Khosla Ventures. He has been named as the country’s top venture capitalist by Forbes and Fortune. A prominent ethanol proponent, he is currently co-chairing the campaign for California’s Proposition 87, a ballot initiative to create an oil extraction tax.

Dear Vinodji,

You recently jumped into the political fray by putting Proposition 87-the ballot initiative that would tax oil companies to fund research on alternative fuels-before California voters this November. But desis (Indian émigrés) like you and me typically keep a healthy distance from the world of politics, preferring to bury ourselves in our bourgeois existence of work, family and two-and-a-half-car garages (O.K., you probably have a bigger garage). Having lived under the likes of Indira Gandhi, whose Machiavellian machinations make Karl Rove look like Forrest Gump, we have a deep and well-founded revulsion for politics. You might better serve your adopted state and your cause-energy security-by sticking to these desi instincts.

Inviting the government to meddle in the affairs of private business is never a good idea, and if anyone should understand this, it is you. You reportedly left your country because of its hostile business environment and thrived spectacularly in this land of (semi) free enterprise, co-founding Sun Microsystems-one of the most successful computer companies on the planet. Fortune magazine has anointed you the “greatest VC (Venture Capitalist) of all time” because you invested in internet start-ups like Google when everyone else was still nosing through card catalogues.

Now you have become the prophet of alternative fuels that, you believe, are going to revolutionize the energy industry, much as the internet revolutionized communications. You are impatient to cut by half President Bush six-year timetable to bring cellulosic ethanol produced from farm waste to the market.

But, with all due respect, even a man of your stellar track record can’t simply will markets to do his bidding; an economy is not a machine that can be manipulated according to its maker’s grand designs.

If it were, India’s central planners would have made rivers of energy flow into every Indian home. Instead, growing up, we endured chronic power droughts. In scorching summer months, we went hours every day without power, unable to coax an ice-cube out of our lifeless refrigerators to soothe the “prickly-heat” burning our necks. Our dads would wait for hours in long queues to buy a few liters of exorbitantly priced petrol while our moms cooked dinner by candlelight in sweltering kitchens. And we were among the privileged ones living in cities like New Delhi where houses were powered by government-owned thermo- or hydro-electric plants. Villages, if they were lucky, got subsidies for their very own gobar gas plants that supplied homes with methane produced by decomposing dung-India’s equivalent of farm-waste ethanol. Every Five Year Plan contained rosy projections of when all of India’s villages would have gas and electricity generated from gobar or other renewable energy sources. The results? Per capita energy consumption today remains about a third of the world average, meaning that Indians are on an energy-starvation diet.

Granted, you are not advocating a total government takeover of the energy sector as in India. But the combination of taxes, subsidies and mandates you are proposing has striking similarities to India’s socialistic approach-and will produce similar results.

Proposition 87-which you are personally spending $1 million to promote-would force oil companies to pay taxes (or royalties, as you call them) for drilling privileges until the state has raised $4 billion for seed money toward alternative fuel ventures. You argue that California is the only state that does not collect drilling royalties, something that oil companies can well afford to pay given their “abnormally” high profits. But California imposes all kinds of other taxes that make its oil among the highest taxed in the country. Proposition 87 would raise these taxes another 50 percent, forcing Californians, who are already paying among the most exorbitant gas prices in the country, to forego energy consumption.

Yes, I know, your proposal would ban Big Oil from passing on the additional taxes to oil consumers. But who are you kidding? Enforcing the ban would require armies of state auditors to dissect in intricate detail the accounts of oil companies. Regardless of whether they are actually deployed, the potential for harassment will prompt oil companies to flee California just as you fled India, leaving the Golden State not with more energy sources as you intend, but fewer. (Full Disclosure: Oil companies are among thousands of supporters of my employer, Reason Foundation, a non-profit think tank. Their contributions comprise less than 1 percent of Reason’s annual revenue.)

The irony is that your proposal to shackle California’s oil industry comes precisely when India is unshackling its own. Just when you are trying to replace foreign oil with home-grown fuels in the name of energy independence (a misguided goal), India is renouncing its autarkic energy policies and courting foreign oil companies. Furthermore, even as you are advocating taxes on oil to subsidize alternative fuels, India is scrapping its two-decade-old policy of pricing “luxury” fuels such as petrol above market rates to subsidize “basic” fuels such as kerosene.

Some commentators have suggested that your support for Prop 87 is a rent-seeking move, meant to boost your recent investments in ethanol by debilitating competitors. I don’t buy that. Yet, the issue is, if ethanol has all the advantages you says it does-if it is renewable, cleaner, less volatile, more reliable, easily transportable etc.-surely you of all people could convince enough investors to cough up the $4 billion that Prop 87 would raise. Are you not turning to taxpayers because you don’t want to assume that kind of risk-and can’t convince fellow investors to either? That is hardly socially responsible. CEO Richard Branson recently volunteered to divert the entire $3 billion profits from his carbon dioxide-spewing Virgin transportation empire into alternative fuels aimed at combating global warming. He is putting his own money-not someone else’s-where his mouth is.

Indeed, in my view, private investors like you who are accountable to shareholders-or philanthropists like Branson who are spending their own money-are likely to do a far better job of picking winners among new fuel technologies. Entrusting a government board answerable to political interests, as Prop 87 is proposing, has a gobar-gas like odor to it.

Where oil companies have used the government to create barriers or tipped the playing field against alternative fuels, we should fix that. (And, no, it is not an illegitimate barrier, as you claim, when oil companies don’t install enough E-85 pumps in gas stations to distribute ethanol; not carrying products that don’t maximize your profits is not the same as impeding others from offering those products). Let’s end today the billions of dollars they receive in corporate welfare every year, for instance.

Your cause might involve very cutting-edge technologies, but you are promoting it with curiously outmoded economic thinking. It might be worth questioning your Prop 87 crusade by revisiting the lessons of failed policies from home.

Your compatriot expatriate,