A Gas Tax: Numbers vs. Words

There are lots of arguments that sound good for raising taxes on fossil fuels to reduce the threat of global warming and/or to reduce our dependence on foreign oil. Liberal, but analytical, blogger Kevin Drum points to a recent IMF study implicitly arguing that this idea is extremely unrealistic, because any such tax at any rate that has ever been discussed just won’t reduce consumption enough to matter. According to Drum’s interpretation of the IMF study, raising the price of oil 50% would lead to a long-term reduction in consumption of less than 2% in the developing world, and less than 5% in developed economies.

Drum can take some comfort from the fact that the kinds of analysis that produce such estimates are highly unreliable.

On one hand, you don’t need a lot of fancy econometrics to reach the basic conclusion that we could double the price of oil, and we’d still be carefully examining succession issues in Saudi Arabia. For example, it’s simple to observe that even really large, sustained price swings haven’t prevented amazingly steady growth in U.S. gasoline usage for more than half a century. Yes, people react to prices, but it’s hard to imagine that we could today impose a price high enough to get out of the structural problems of global warming (to the extent that you accept that) or our dependence on unstable regimes for oil.

And on the other hand, price elasticity in the future cannot be divined by such models. As the available trade-offs change, the price elasticity of oil will change. Specifically, to the extent that we continue to progress in making non-fossil-fuels technology cheaper and more effective for an ever wider array of applications, we can accelerate the ongoing de-carbonization of our economy. The idea of economists to use artificial scarcity pricing to do this is aggressively marketed in blogs, magazines and TV shows, but is extremely unlikely to work, because the current price elasticity of oil is so low. The work of engineers and physical scientists, however, is likely to be determinative.

(Cross-posted at The Corner)