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David Brodwin's blog

The Costs of Corporate Corner-Cutting

Whenever people have a lot of money at stake, they are tempted to take risks they shouldn’t. It’s human nature. When individuals cut corners in their own lives, the costs can be small. But when corporations cut corners, the costs can be immense — both for the corporations and for the public.

Two of the biggest corner-cutters this decade – BP and Pacific Gas & Electric Co. – got their comeuppance this week for disasters they caused back in 2010. For both companies, self-interest wasn’t enough to compel prudent and responsible action. Their experience shows how good and well-enforced regulation might have benefited investors and others.

This week, BP (formerly British Petroleum) was ruled to be “grossly negligent” and guilty of “willful misconduct” in the explosion of its oil drilling platform, Deepwater Horizon. The platform exploded, burned and sank in April 2010, killing 11 workers and polluting coastal waters with more than 4 million barrels of crude oil. The disaster caused widespread job loss and irreparable economic harm to fishing, tourism and other nearby businesses. The judge’s ruling exposes BP to $18 billion in civil penalties in addition to the $4.5 billion BP already paid to settle criminal liability with the U.S. government.

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As Deepwater Horizon burned and sank, Pacific Gas & Electric Co., a gas and electric utility in northern California, was failing to monitor and maintain its decades-old network of gas pipelines. Not six months later, one of the company's 30-inch diameter high pressure gas lines burst into flames beneath a San Francisco suburb. Eight residents lost their lives as fire shot 1,000 feet into the air. This week the California Public Utilities Commission fined the utility company a record-breaking $1.4 billion.

Apologists for these companies would have you believe that the disasters were the result of individual “bad apples” whose errors in judgment or record-keeping could not have been foreseen or prevented. But close examination led the courts and the utilities commission to conclude that the problems were anything but isolated and idiosyncratic. In each case, top management put too much focus on delivering financial performance and gave too little authority to internal quality and safety departments. In the case of BP, critics say management pushed to move too quickly to get the well online, ignored dangerous readings and overruled warnings raised by staff.

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At Pacific Gas & Electric Co., the pressure took the form of resisting necessary inspections and maintenance. Paperwork was repeatedly “lost” which would have indicated that the pipeline that had failed – and others like it – used an old welding technology unsuited for high pressure operation in a populated area. Critics say the pipeline was never properly inspected, and pressures were deliberately spiked to higher-than-safe levels in order to sustain an unjustifiable rating.

In a modern corporation, or any large organization, no individual below the top, no matter how ethical and honest, has the power to resist intense demands for speed and profit. For an individual in management, even in relatively senior positions, the choice is stark. Everyone knows what decision will enhance your career, and what decision will end it. It’s part of the culture. You can meet the demands and cut corners. Or you can resist the demands, be sidelined and ultimately laid off. Or you can take the hard road and become a whistleblower, which leads to decades of abuse, lost wages and mounting legal bills. Nearly everyone complies.

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To be sure, the costs to the economy and society are staggering. For investors in both companies, assuming the judgments are not scaled back on appeal, more than a year's profit will be lost. And many opportunities have been squandered while senior executives managed the disaster instead of the business. But the damages go far beyond economics. Many people have been hurt in lasting ways. Some lost their lives or their loved ones. Some lost jobs or small businesses. Some lost homes. And in the Gulf coast, a valuable fishery has been severely damaged.

It doesn’t have to be this way. If the companies involved had properly funded and empowered their internal quality and safety departments, the tragedy could have been avoided. If regulatory agencies were adequately staffed to monitor policies and processes for hazardous operations, tragedy could have been avoided. If senior regulatory staff were properly restricted from overly-chummy dealings with the companies they regulate, tragedy could have been avoided. And if boards of directors exercised their fiduciary responsibility to review risks independently, all of this could have been avoided.

It’s a good thing that the courts occasionally still work to impose serious fines and penalties in egregious cases such as these. At least they provide some justice for the victims. And it dissuades others from taking similar risks. But it would be even better if well-enforced regulations and properly structured incentives prevented these disasters. The shareholders of BP and Pacific Gas & Electric Co. would agree. So would the 19 people who lost their lives in these industrial disasters.

David Brodwin is a Co-founder and board member of American Sustainable Business Council. This article appeared in U.S. News & World Report September 5, 2014, 2014.

A Carbon Tax Everyone Can Love

This summer, the Environmental Protection Agency took aim at coal-fired power plants, which pump out more than a third of America’s heat-trapping carbon dioxide. The EPA’s approach is controversial, but frankly it is President Barack Obama’s only option given the deadlock in Congress.

Many economists argue that the best approach to climate change is simply to enact a tax on carbon. Economists like William Nordhaus at Yale argue that a tax of around $30 per ton of carbon (about 25 cents per gallon of gasoline) would be enough, as long as it was implemented worldwide. A tax of $30 per ton would be cheap relative to the estimated cost of unchecked climate change, which is about $44 per ton. It would be enough to get the world to use less fossil fuel, and to accelerate the deployment of renewable energy. A carbon tax would be simple to administer, hard to cheat, and free of the risk of government betting on the wrong companies or technologies.

Another advantage of a carbon tax is political. Although very few conservatives risk defying Republican orthodoxy on climate, those who do acknowledge the threat believe a carbon tax is the least bad solution. It’s the approach most compatible with free markets. Former Treasury Secretary Henry Paulson recently made this case, among others.

But a carbon tax faces two major challenges. First, it’s a tax, and as such it’s a third rail for many elected officials. Second, with most new taxes comes a fear of suppressing economic growth at a time when the economy is not yet robust.

Economist Dale Jorgenson at Harvard offered a solution to both of these challenges in a recent interview. He argued that a carbon tax can be fully recycled to support the economy, just like paper, glass and metal are recycled. Recycling a carbon tax means lowering other taxes by exactly the amount as the carbon tax would raise, so total taxes collected by the government would remain unchanged. The carbon tax would generate about $150 billion, which is about 5 percent of the total collected by the U.S. government, and so other taxes would need to be lowered by $150 billion to compensate. This recycling program is both politically expedient and, Jorgenson argued, economically productive

But which taxes to cut? Taxes on capital? Taxes on income? Both? Jorgenson argued that cutting taxes on capital will lead to the greatest economic growth. His case relies on detailed economic modeling, but at a high level it makes sense: raising the cost of carbon-based energy will require companies and households to invest money. Power companies will have to invest money in alternative energy facilities and write off existing plants. Businesses that use energy will invest in efficiency. Households and offices will invest in energy-saving retrofits like insulation, and more efficient heating and air conditioning units. So it makes sense to lower taxes on capital to offset the rise in energy costs.

But now there’s a problem: Raising the cost of energy while cutting taxes on capital is regressive. Poor households spend a much larger share of their income on energy, mainly for heating, cooling and transportation. They’re not going to get any relief from lower taxes on capital since they don’t have any capital to tax.

Jorgenson is a bit cagey on how to balance the equity considerations with the goal of economic growth, but frankly any solution that worsens inequality is a non-starter given the trends of the past 30 years. Fortunately, a carbon tax could be recycled in a way that is not regressive: Take a portion of the $150 billion and send it back to the poor and near-poor in the form of a greater earned income tax credit, or use it lower tax rates at the bottom of the scale. Or share the revenue with the states so they can reduce their sales taxes, which are very regressive.

Then, take the rest of the $150 billion and use it to reduce taxes on newly-deployed capital. This could be applied very broadly, as with a reduction in the already-low capital gains tax rate. But it would be better if done in a way that encouraged economically productive investment rather than speculation, for example, via an investment tax credit on new tangible business assets. The credit could focus narrowly on investment projects that boost energy efficiency and develop new low-carbon or renewable energy sources.

There’s something in this approach for just about everyone. It would not raise taxes on a net basis, so those who are politically committed to tax cuts can accept it. It would not penalize the poor, so those concerned with economic and social justice can accept it. And it would reduce carbon emissions enough to avoid rising seas and other consequences of unchecked warming.

David Brodwin is a Co-founder and board member of American Sustainable Business Council. This article appeared in U.S. News & World Report August 29, 2014.