David R. Henderson  

Tom Friedman's Gas Tax

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Larry Summers, Neo-Galbraithia... Inclined to Liberty...

I think people make the worst cases for their policy proposals when they write or speak as if they think there is no credible intellectual argument against their position. A case in point is a column in today's New York Times by regular columnist Thomas Friedman. In it, Friedman makes his case for an increase in the federal tax on gasoline.

Friedman writes that we're in a play

where gasoline prices go up, pressure rises for more fuel-efficient cars, then gasoline prices fall and the pressure for low-mileage vehicles vanishes, consumers stop buying those cars, the oil producers celebrate, we remain addicted to oil and prices gradually go up again, petro-dictators get rich, we lose.

Then he adds, "It always ends the same way -- badly."

Notice two interesting things. First, by using the "addiction" terminology, he neatly avoids having to counter the claim that we use as much gasoline as we do because it's low-price. Using a resource intensively when it's price is low is hardly the sign of addiction.

Second, to say that it ends badly, Friedman needs to know when it "ends." It's obvious that he thinks it ends when prices are high, but the reality is that it never ends or, at least, hasn't ended yet. Moreover, in the last 25 years, the price of gasoline has been at or near $2.00 per gallon more often than it has been at a price of $3.50 or more, all inflation-adjusted.

Friedman doesn't seem to understand that to make a case for a tax on the grounds he wants to make it, that is, that it would enhance our prosperity, he needs to make one of two arguments. Either he would need to argue that using gasoline imposes an externality that is so large that the current disproportionately high gasoline tax is too small or that for a given amount of revenue raised, the deadweight loss per dollar raised from an increase in the gasoline tax is less than the deadweight loss per dollar from raising other taxes. Friedman doesn't even try.


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COMMENTS (24 to date)
Robin Barr writes:

Yes. His column was poorly argued. To be fair to him he makes a much better case for a gas tax in his book "Hot, Flat and Crowded".

Why are there so few people arguing (as Al Gore does) that we need to shift our taxes to "externality" taxes from income taxes? So we should have a carbon tax because of the external costs of carbon-burning fuels. But that is not a dead weight on the economy because the same amount that the carbon tax raises is provided as income tax relief. That formula means that we gain from the shift to a carbon tax because we reduce the external costs of carbon and introduce no dead weight because we cut income taxes. So what's the problem? Why don't we do it?

Stuart writes:

The main externality of our using so much petroleum is the leverage that the worst regimes in the world have over us as a result. If taxing gasoline and then giving the money back as tax rebates frees us from having to worry very much about the opinion of Saudi Arabia, Venezuela, Iran or Russia -- or even reduces our dependence, or even reduces the income (and thus freedom of action) of those countries, it's a net national security plus and well worth the relatively minor economic dislocation. If having high petroleum prices makes alternative energy sources more economically feasible so much the better.

A Cassel writes:

If it's true that the large U.S. appetite for imported oil increases our involvement with regimes such as Venzuela, Saudi Arabia, Iran, etc., why do we assume that the leverage is all one way? Is it not possible, in other words, that our massive role in the global oil market also makes these regimes behave better than they otherwise might, just to avoid losing their biggest customer? How do we know that Iran, for instance, hasn't tempered its anti-Israel instincts or that Venezuela's Chavez hasn't refrained from even more intervention around South America to avoid crossing a line that would make the U.S. and other oil consumers boycott their products? I'm not arguing for more oil consumption on our part, just questioning the logic that says global interdependence in this area makes us weaker. Seems to me just as plausible, absent data, that a robust and closely interwined market in energy makes the world more, not less, peaceful and stable than it would otherwise be.

Justin Ross writes:

"...gasoline prices fall and the pressure for low-mileage vehicles vanishes, consumers stop buying those cars, the oil producers celebrate, we remain addicted to oil and prices gradually go up again"


What concerns me about this passage is that Friedman seems to believe that a change in prices causes a shift in demand rather than a movement along the demand curve. Notice how quickly his argument becomes circular when price changes cause price changes.

hacs writes:

That is digression from the real point: the subsidies to Iowan corn based alcohol industry.

Ethanol Bailout? Time To Shuck Corn

By INVESTOR'S BUSINESS DAILY | Posted Friday, December 26, 2008 4:20 PM PT

Energy Policy: The heavily subsidized ethanol industry is the latest to seek a federal bailout. If there is any industry that deserves to go bankrupt, it's this one. Time has come to stop putting food in our gas tanks.

http://www.ibdeditorial.com/IBDArticles.aspx?id=315188051785999

The Cupboard Is Bare writes:

Some thoughts while reading Friedman's article:

" — and then do nothing to shape consumer behavior with a gas tax so more Americans will want to buy those cars."

When I read that, it gave me a bit of a chill and I began to feel like a rat in a maze. It is not the role of government to "shape" my behavior.

"There has to be a system that permanently changes consumer demand, which would permanently change what Detroit makes..."

Allow car companies that don't meet the needs of the American consumer to fail. That would permanently change what Detroit makes.

"A gas tax reduces gasoline demand and keeps dollars in America, dries up funding for terrorists and reduces the clout of Iran and Russia at a time when Obama will be looking for greater leverage against petro-dictatorships. It reduces our current account deficit, which strengthens the dollar.

What is unseen are the things that Americans will have to forego in order to pay the tax.

"...says the Johns Hopkins author and foreign policy specialist Michael Mandelbaum. “A gasoline tax would do more for American prosperity and strength than any other measure Obama could propose.”

The gasoline tax will hurt the poor the most, as they are going to be the ones least capable of buying a new car. How does one set aside money to purchase a new, fuel-efficient vehicle, when one also has to pay a high gas tax? What does that do for American prosperity?

"I know it’s hard, but we have got to stop “taking off the table” the tool that would add leverage to everything we want to do at home and abroad. We’ve done that for three decades, and we know with absolute certainty how the play ends — with an America that is less innovative, less wealthy, less respected and less powerful."

Taxes make us less wealthy. They also reduce innovation by making less money available to manufacturers for R&D. As for being less respected and less powerful, it's my belief that too much government intervention has done that.

Alex J. writes:

Has Tom Friedman had anything especially insightful to say about anything ever? I don't follow his writing closely, because every idea of his that I've ever encountered I evaluate to his discredit. He has to have done something well at some point to have gotten the NYT gig. A quick check on his wikipedia page reveals that he's won the pulitzer prize a few times, but that doesn't guarantee anything.

Dan Weber writes:

Even if there are no externalities that a carbon tax captures, a consumption tax is better for the economy than a production tax.

BT writes:

To understand DH's comments requires a graduate level degree in economics at least. To understand Friedman's article a simple 8th grade education (the reading level of the NY times is 8th grade). Unpopular policy proposals have to understood, and DH's arguments, though sound, read like mumbo jumbo.

Mark T writes:

I can't imagine how giddy our Congress-critters will be if talk of a gas or carbon tax becomes serious, with thoughts of vote-buying abounding. I also can't imagine them creating a tax and giving us back the tax in rebates; once it's in their hands I think it will be there to stay. Someone will need to convince me that they will act differently before I'll buy into it. Money's fungible anyway - how would that change my behavior?

Having said that, I have always thought that the cost of gasoline doesn't cover our military and other costs of dealing with the Mid East et al. I just don't trust the idea of a tax to solve the one problem without creating other problems of generally enlarging our government. Even if you try to put specific restrictions on how the money is spent, it eliminates pressure to spend responsibly - I saw this with FL's state lottery in the '90's that restricted the lottery income to education; once the lottery money came flowing education fell out of the general state budget but the total state budget dollars didn't drop.

Boonton writes:

Is it not possible, in other words, that our massive role in the global oil market also makes these regimes behave better than they otherwise might, just to avoid losing their biggest customer? How do we know that Iran, for instance, hasn't tempered its anti-Israel instincts or that Venezuela's Chavez hasn't refrained from even more intervention around South America to avoid crossing a line that would make the U.S. and other oil consumers boycott their products?

When oil prices spike do we lower our military aid to Israel and generally lower our military profile in the ME? After all, if Iran's getting more money from oil that would make them behave better if the above dynamic is correct.

I suspect when oil prices are high, the incentive for oil producers to misbehave increases and this misbehavior is more problematic since many oil producers are not private companies but government enterprises. Both Iran and Venz. are examples of gov't producers of oil who generally misbehave with high oil profits. The misbehavior is both domestic (basically both countries use oil profits to subsidize state price controls and other interventions to buy pop. support) and international.

Lower prices sock these regimes in two ways. The clearest way is through taking their profits down a notch. The other way is when prices fall the only way to maintain profits is to lower your cost of production, which means being more efficient. State run oil companies are not very good at this so the best way they can do this is by reaching out more to the international market.

Jeremy, Alabama writes:

"petro-dictators get rich" ...

We virtually ban drilling in our own back yard, then we must dress up energy as a national security issue requiring government intervention. As is normal, one intervention requires the next to mitigate the damage.

On consumption tax, TF is right for completely the wrong reason.

aaron writes:

Gas tax is $0.41 on average per gallon (local, state, plus fed). The Nation Research Council estimates externalities to cost $0.26 per gallon (for emmisions and energy dependency). The only Pigou argument there is is that the money should be spent addressing the externalities.

As for a gas tax, it's been a flop. Sure high prices have pushed people into purchasing more efficienct cars (people will continue to seek these out even when prices fall), but it's caused people to drive less efficiently. Since prices started going up around 2005, fuel efficiency has been declining. Despite people driving less and purchasing more efficient vehicles. (And, as noted on this blog before, it pushed more people away from trucks and SUV than is rational.)

We see reductions in consumption due to forgone economic activity, not better usage. We actually get less done with the same amount of fuel when gas prices go up, for several reasons:

1.People are at their limit of how much driving they will tolerate. This means we get giffen behavior when gas prices increase. People spend more time driving for work, when there is lots of traffic, just to tread water, and shift driving away from less congested times.

2. People have misconceptions about what is efficient. Driving slower saves fuel, when driving above 55mph. Below 40mph, driving faster is more efficient. Accelerating faster is about the same, or slightly more efficient than accelerating slowly. Typical car engines don't see efficiency drop off until after 3000rpms.

3. Tragedy of the commons. About the most fuel efficient behavior a person could adopt is avoiding braking. However, doing this during congestion prevents cars from clearing other queues and creates more bottlenecks. Starting from a stop is the big gas waster. A full stop can take 6 times more fuel than a rolling stop.

4. Unfortunately, when times are lean (which happens when gas prices are high) people return to more conservative and traditional office culture and work hours to compete for jobs. This may lead to more congestion.


Gas demand is inelastic in the short term, but I think this is because it is the most basic input of economic activity. It takes a long time for the effects to ripple out to the point that prices rise, incomes fall, and people stop working and investing. When gas prices, and energy prices in general, go up, operating costs go up and returns go down for both businesses and individuals (i.e., risk increases). Smaller incomes and returns and more risk.

But people are pimping a gas tax so hard, it's impossible to see it's fault. That leads me to my prediction for 2009:

Failing to notice that fuel efficiency has declined the past several years as gasoline prices have risen, the media will notice that fuel efficiency falls when gas prices fall this winter. They will totally ignore that fuel efficiency declines in winter due to the weather and that this year's winter has been and is expected to be especially harsh.

aaron writes:

Boonton, I suspect when oil prices are high, the incentive for oil producers to misbehave increases and this misbehavior is more problematic since many oil producers are not private companies but government enterprises.

I definitely think there's something to this. For a while Greenspan has lamented that Venezuala has neglected it's maintenance of producion and investement because of the high oil prices. Krugan wrote about the possibility here. And, we know that excessive rewards can lead to irrational behavior, just like excessive penalties.

Jeppen writes:

A few basic points about gasoline and prosperity in oil consumer countries.

1. Gas taxes reduce the untaxed price b/c of reduced demand. So, gas taxes will hurt oil sheiks' margins and thus benefit consumer countries. Perhaps consumer countries should have a gas tax cartel to counter the OPEC price cartel?

2. There would obviously be a slight loss of prosperity if taxes gradually redirected Americans' money from gasoline and big, powerful cars to other uses. But you may want to consider that you will have to go more frugal at Peak Oil anyway, and that a gradual adaption starting now could save you a lot of pain later on.

Boonton writes:

Jeremy

We virtually ban drilling in our own back yard, then we must dress up energy as a national security issue requiring government intervention. As is normal, one intervention requires the next to mitigate the damage.

This, IMO, is mistaken. Visualize oil as a giant bucket of quarters that someone has been saving for some time. If that person needs some quarters one day, he will grab the ones on the top. Sure, in theory, he could grab some quarters from the bottom but it's hard to force his hand all the way to the bottom and why should he do so when it's so easy to grab the quarters on top. If he starts needing quarters every day (say an arcade has opened next door and he just can't stop), the bucket is eventually going to empty.

Yea we have oil here sitting under hundreds of feet of bedrock and a thousand feet of rough ocean. There's also oil on the other side of the world sitting under a few dozen feet of clay and sand. Which is going to get plucked first and which last?

I'm not making an argument here for whether a particular area should be off limits for drilling or not. I'm pointing out that it doesn't change the dyanmics of the situation. Declaring the bottom of the bucket 'off limits' to the person pinching quarters every day doesn't make it any sweater to have a monopoly on those quarters on the top of the bucket.

Even more important is the fact that the quarter pincher will face a day of reckoning when the bucket will be empty. Even if he declares the bottom 'off-limits' and then retracts that rule when he reaches the bottom, he will eventually confront an empty bucket. He has a hope that someday something will come along to make the quarters irrelevant (a Playstation, Wii, or XBox today will let you play unlimited games that are many times better than any of the arcade games from the days when arcade games were the big thing). If this is his strategy, then tactics that cause him to limit his quarter consumption (or make his quarters last longer) make sense. Every year that bucket holds out increases the odds of the great arcade replacement arriving just in time.

If you want to push this analogy more you can imagine the quarters divided into two buckets. One is a bucket in your basement with a few quarters but a lot of disgusting muck. Another is a bucket with lots of shiny, clean, and new quarters sitting in your mother-in-law's house....whom you're free to tap but when you do so you must endure her 60 minute speeches about you wasting your life away etc. etc. If you think you have eliminated the problem by declaring you're going to tap the basement bucket before your mother-in-law's one you're just kidding yourself.

Joey writes:

I did not read all the remarks in this blog but I want to input my opinion of a gas tax.
It sucks, plain and simple. Let me explain.
Imposing a gas tax on all of us punishes all of us. Why should I have to pay a higher price on gas when I drive a car that gets over 30 miles to the gallon. Im not the problem. The problem is the person down the street who thinks he needs to drive a car or truck or hummer that only gets 9 to maybe 15 miles/gallon.
A tax on all is the wrong thing to do. We all know that most high gas vehicles are not necessary for the average person. Like everything else they're just wants.
Well instead of taxing everyone, why not have a flexible tax. The more econimical your vehicle, the less your taxed on the pump. (please with electronics today it would be very easy to create a gas card that has to be swiped before pumping. Sam's and Cosco's does it.) Also, you want to drive a large vehicle (example a Hummer) you should have to pay a higher registration fee.
It's well known that the more a vehicle weight the more damage to the road. Why are the rest of paying the price because some people feel that they have to drive these monsters. Sure some feel safer in them, well again you should pay more for that safety, why should we. Why should we pay it for you, or help you pay it.
This problem is similar to the medical problem in this country. We hear how it's getting harder to pay for medical insurance because medical care is so expensive. Instead why not ask why are doctors charging such high prices for treatments. Or why companies charge so much money for drugs. (The CEO's have multi-million dollar bonoses) It's amazing how if you go to a doctor in Southern California for treatment you pay so much, and go accross the border to Mexico you get the same treatment for so much less. Yea you'll hear that the treatment in Mexico is not safe. Ya right. For a tooth extraction!!!

I guess what Im trying to say is, lets look at the problem from the consumer side.

Boonton writes:

Imposing a gas tax on all of us punishes all of us. Why should I have to pay a higher price on gas when I drive a car that gets over 30 miles to the gallon. Im not the problem. The problem is the person down the street who thinks he needs to drive a car or truck or hummer that only gets 9 to maybe 15 miles/gallon.

I'm not sure if you realize it or not but you won't pay the tax. At least compared to the guy getting 9mpg you're going to pay much less tax for every mile you drive. Likewise the guy who doesn't use gas at all will pay less tax than you.

There's a more complicated issue when you tax something provided by a monopoly. Essentially a monopoly sets the price to maximize revenue. If a tax is imposed on that product, the monopoly ends up paying the tax out of its pockets, not the consumer. Likewise if a tax is put on something provided by pure competition, then all of the tax falls on the consumer. Gas and oil production is neither pure competition nor pure monopoly but it's a bit closer to monopoly than competition.

At least a good portion of a gas tax would end up being paid by fewer profits for OPEC than consumers. In general, OPEC is not very innovative for the economy so there are a lot worse taxes than a gas one. The idea of cutting the payroll tax and offsetting that with a gas tax is one that is more pro-consumer than you think.

It's well known that the more a vehicle weight the more damage to the road. Why are the rest of paying the price because some people feel that they have to drive these monsters.

Many states do charge more to register a heavy vehicle than a light one. In addition, all things being equal a heavy vehicle takes mroe gas to move around than a light one so people driving monsters do end up paying for it with a gas tax.

aaron writes:

I messed up the link, sorry.

Here is the Krugman article on multiple equilibria for oil. It doesn't have a data, but I believe it's from August 2001.

Joey writes:

Imposing a gas tax on all of us punishes all of us. Why should I have to pay a higher price on gas when I drive a car that gets over 30 miles to the gallon. Im not the problem. The problem is the person down the street who thinks he needs to drive a car or truck or hummer that only gets 9 to maybe 15 miles/gallon.

I'm not sure if you realize it or not but you won't pay the tax. At least compared to the guy getting 9mpg you're going to pay much less tax for every mile you drive. Likewise the guy who doesn't use gas at all will pay less tax than you.

Boonton, your response to my remarks sound good, but financially speaking are wrong. See I don't care what the guy driving the hummer pay's for gas, my point is the rest of us pay the price because of it. When gas bills go from 15 to 40 dollars (per tank) in the future because of imposed taxes we all feel it.
Second there is no industry that would survive for long if it absorbed the taxes that are imposed on its customers. Maybe you know something about the oil business that I don't, but from an economic view I have to disagree with you.
We pay more for gas in California than Arizona for exam. because we have one of the largest taxes in the US.

Boonton writes:

"Second there is no industry that would survive for long if it absorbed the taxes that are imposed on its customers."

This isn't really true. When you get down to it all industries have to use the income from its customers to pay its taxes. In this respect taxes are a cost of doing business that the customers are going to pay for no matter what just like customers have to pay for employee pay, the company Christmas party, and the rent to the landlord.

But think about a tax being lowered. What does a business do? Well all business would love to keep prices the same and pocket the tax cut as profit. But in a highly competitive market this isn't possible very long as the businesses will undercut each other and eventually give the tax cut back to consumers. So just take the reverse, a highly non-competitive market would be able to keep the tax cut to a greater degree. Gas stations are very competitive but oil simply is not so ultimately on an oil tax OPEC ends up paying more of it than you do.

"Imposing a gas tax on all of us punishes all of us. "

No to the degree a gas tax results in higher gas prices it punishes those of us who use a lot of gas more and punishes those of us who use little or no gas less. If the tax is revenue neutral (offset the money raised by lowering some other tax like payroll taxes), there is no net punishment but the incentive for the economy to make more efficient choices regarding gas is increased.

Joey writes:

"Imposing a gas tax on all of us punishes all of us.

No to the degree a gas tax results in higher gas prices it punishes those of us who use a lot of gas more and punishes those of us who use little or no gas less. If the tax is revenue neutral (offset the money raised by lowering some other tax like payroll taxes), there is no net punishment but the incentive for the economy to make more efficient choices regarding gas is increased."

I understand the quid pro quo your suggesting and it makes good sense only if the government allows it, or passes the necessary legislation to lower the income tax. They may just increase the gas tax and leave payroll alone.

"Second there is no industry that would survive for long if it absorbed the taxes that are imposed on its customers.

This isn't really true. When you get down to it all industries have to use the income from its customers to pay its taxes. In this respect taxes are a cost of doing business that the customers are going to pay for no matter what just like customers have to pay for employee pay, the company Christmas party, and the rent to the landlord."

Yes but the company is not absorbing the cost, it will always pass it on to the customer.

"But think about a tax being lowered. What does a business do? Well all business would love to keep prices the same and pocket the tax cut as profit. But in a highly competitive market this isn't possible very long as the businesses will undercut each other and eventually give the tax cut back to consumers. So just take the reverse, a highly non-competitive market would be able to keep the tax cut to a greater degree. Gas stations are very competitive but oil simply is not so ultimately on an oil tax OPEC ends up paying more of it than you do."

True, but your looking at just the company or business side of the problem. Im looking at the cost to the person at the pump. We will end up paying more in the long run.

By the way, right wrong or indiferent, thanks for making me think...

Boonton writes:

I understand the quid pro quo your suggesting and it makes good sense only if the government allows it, or passes the necessary legislation to lower the income tax. They may just increase the gas tax and leave payroll alone.

True but the tax revenue would go for something. If it goes for spending you have to evalute the spending. If it goes for deficit reduction you have to evaluate it against the benefits of deficit reduction and so on. It's kind of complicated to map out all the results if the deficit is $30B less each year than it otherwise would have been but there are benefits.

Yes but the company is not absorbing the cost, it will always pass it on to the customer.

This depends on how you look at it. Since a company typically gets revenue from its customers every check it writes ultimately comes from them. The only time it doesn't is when a company borrows or raises money from investors and then goes bankrupt. In that case at least some of those checks written were paid for by those unlucky people who loaned the company money or brought its stock in the IPO.

But look at it this way. A company makes $5M in profit a year but then the gov't announces a tax that would total $1M a year. If the cost is always passed onto the consumer the company will still make $5M a year because consumers will simply pay the $1M in the form of higher prices. If the company asorbs the cost then consumers pay the same price but the company will only make $4M a year. Those are two extremes, most real life companies fall somewhere in between. In general, the more competition the more it looks like the first case where the tax is passed on, if there's less competition it looks more like the second.

True, but your looking at just the company or business side of the problem. Im looking at the cost to the person at the pump. We will end up paying more in the long run.

But this is a tricky issue. Let's say the gas/oil tax raises $55m on 100m gallons of gas. Simple division will tell you that is $0.55 per gallon. A politician may say this and leave the impression that if that tax was eliminated tomorrow the price you pay at the pump would immediately drop by 55 cents. But that assumes a lot of steps that may not happen. The actual savings might end up being nothing, or 20 cents, or 30 cents. Economic theory would tell us that if gas producers are making any type of monopoly profits at least some of that tax is being paid out of those profits therefore cutting the tax would boost those profits rather than directly go into lower pump prices.

By the way, right wrong or indiferent, thanks for making me think...

Thank you, this has been a very nice thread!

Joey writes:

"True but the tax revenue would go for something. If it goes for spending you have to evalute the spending. If it goes for deficit reduction you have to evaluate it against the benefits of deficit reduction and so on. It's kind of complicated to map out all the results if the deficit is $30B less each year than it otherwise would have been but there are benefits."

All taxes go for something? With this statement you null out any argument against any increase or creation of any tax. Tell you what lets create a smoking tax and have everyone pay for. I don't think that would go well with non-smokers. As far as our deficit, I'd rather see the government reduce it by reducing spending. Not by adding to our taxes.

"But look at it this way. A company makes $5M in profit a year but then the gov't announces a tax that would total $1M a year. If the cost is always passed onto the consumer the company will still make $5M a year because consumers will simply pay the $1M in the form of higher prices. If the company asorbs the cost then consumers pay the same price but the company will only make $4M a year. Those are two extremes, most real life companies fall somewhere in between. In general, the more competition the more it looks like the first case where the tax is passed on, if there's less competition it looks more like the second."

Your right many companies have claimed bankruptcy because of to much competition and unfair business practices. Perfect example, China.

"But this is a tricky issue. Let's say the gas/oil tax raises $55m on 100m gallons of gas. Simple division will tell you that is $0.55 per gallon. A politician may say this and leave the impression that if that tax was eliminated tomorrow the price you pay at the pump would immediately drop by 55 cents. But that assumes a lot of steps that may not happen. The actual savings might end up being nothing, or 20 cents, or 30 cents. Economic theory would tell us that if gas producers are making any type of monopoly profits at least some of that tax is being paid out of those profits therefore cutting the tax would boost those profits rather than directly go into lower pump prices."

I agree completely, which is why the tax should not be implemented in the first place.

I understand what your saying, however, it's easy to rationalize a tax after implementation. Once done, it's harder to get rid off.

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