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Sunday, October 01, 2006

Vintage Varian: Raise Gasoline Taxes

Hal Varian from October, 2000 on the need for higher gasoline taxes:

Tax cutting may be in fashion, but it's a good time to raise gasoline taxes, by Hal R, Varian, New York Times, Oct 19, 2000: With all the talk of tax cuts, this may be an inopportune time to propose a tax increase. But it is easier to put tax reforms in place when times are good than when they are bad, and United States policy on gasoline taxation could be much improved.

Gasoline taxes are an emotional issue... But there are several good reasons that increasing the gasoline tax in the United States makes economic sense.

First, it is a good idea to tax the consumption of goods that impose costs on other people. One person's consumption of gasoline increases emissions of carbon dioxide and other pollutants, and this imposes environmental costs on everyone. And even those who do not care much about the environment have to acknowledge that driving contributes to traffic congestion. Increased taxes on gasoline would reduce consumption, cutting both pollution and congestion.

But, you might argue, we already have taxes on gasoline: federal, state and local taxes average about 41 cents a gallon, or 28 percent of the price of gasoline. Isn't this enough? The problem is that the tax is used mostly to pay for road construction and maintenance. True, the gasoline tax decreases the use of gasoline, but the road subsidy increases its use.

If we subtract the subsidy from the tax, we end up with a net tax rate on gasoline in the United States of about 2 percent, which is much, much lower than net gasoline taxes in the rest of the world.

There is another, quite different reason to tax oil products.

Economists like to tax things that are in fixed supply because the same amount is available whether or not the tax is imposed. ...[I]n the long run, there is only so much oil. Taxing petroleum products will not reduce the total amount of oil in the ground, it will just slow the rate at which it is discovered and extracted.

Taxes on gasoline reduce the demand for oil, thereby reducing the price received by the suppliers of oil. And most of those suppliers are foreign: the United States now imports 56 percent of its oil... Taxing foreigners is popular both economically and politically -- they do not vote. Of course, domestic oil producers not only vote, they contribute to campaigns, and a tax on gasoline would be unpopular with them. But deals can be made -- taxes can be traded for depletion allowances and other accounting goodies to make such a plan politically viable.

A gasoline tax in a small country falls mostly on the residents of that country. The world price of oil is essentially independent of the taxing policies of most countries, since most countries consume only a small fraction of the amount of oil sold.

But the United States consumes a lot of oil -- almost a quarter of the world's production. That means it has considerable market power: its tax policies have a major impact on the world price of oil, and economic analysis suggests that in the long run, a significant part of a gasoline tax increase would end up being paid by the producers of oil, not the consumers.

Nearly 20 years ago, Theodore Bergstrom, an economist who is now at the University of California at Santa Barbara, compared the actual petroleum tax policies of various countries with policies those countries would adopt if they wanted to transfer more OPEC profits to themselves.

He found that if ... the United States, Europe and Japan all coordinated their oil-tax policies, they would collectively want to impose net tax rates of roughly 100 to 200 percent. This is not as scary as it sounds since such a coordinated tax increase would mostly affect oil producers; the price at the pump would increase much less.

Mr. Bergstrom's analysis was focused entirely on transferring profits from oil-producing to oil-consuming nations. If we factor in the pollution and congestion effects mentioned earlier, the optimal petroleum taxes would be even higher.

In the past, Al Gore has advocated increasing gasoline taxes for environmental reasons, though he has been pretty quiet about this proposal lately. George W. Bush does not think much of oil taxes, but he likes the idea of a tax cut.

Let me propose a bipartisan plan: raise the tax on gasoline, but give the revenue back to taxpayers in the form of an income tax credit.

Average consumers would be about as well off as they are now, but the higher price of gasoline would tend to discourage consumption -- giving us environmental, congestion and tax-the-foreigner benefits. It would make sense to phase the tax in over several years, so that the next time drivers trade in their sport utility vehicles, they would have an incentive to buy those fuel-efficient cars that Detroit has promised to produce.

Increasing the net tax on gasoline by, say, 2 percent a year for the next 10 years would be pretty painless for most people. Oil prices would almost certainly drop back down in the next few years, tending to reduce the price of gasoline back toward historical levels. A higher gasoline tax would just mean prices would not drop quite as far as they would otherwise.

If something must be taxed, it makes a lot of sense to tax something that is costly to the environment, costly to the users and mostly controlled by foreigners. The United States is passing up a big opportunity by not taxing gasoline at a higher rate.

I haven't strongly supported these proposals, perhaps because I hate the idea of paying more for gas. But that's the point of raising the tax, I'm supposed to dislike it and reduce my consumption, and I can't deny that an increase in gas taxes is needed. Robert Frank has a similar proposal (analyzed graphically here), while Martin Feldstein has called for tradeable gas rights.

    Posted by on Sunday, October 1, 2006 at 12:15 AM in Economics, Environment, Oil, Policy, Regulation, Taxes | Permalink  TrackBack (1)  Comments (7)

          

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