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)
I’m curious to know why conservative, but smart, conservative blogger Jim Manzi has chosen to characterize Kevin Drum as he did.
— Chris · Apr 25, 03:37 PM · #
Chris,
So that some conservative readers who might otherwise dismiss his views would be slightly more willing to invest time on the post. I think close-mindedness is distributed on both sides of the political spectrum (and in the middle).
Jim
— Jim Manzi · Apr 25, 04:28 PM · #
Right, but then you could have referred to him as “Liberal and analytical blogger” or just “Liberal, analytical blogger”. I don’t understand your use of “but,” unless you yourself think that “liberal” and “analytical” are somehow in opposition. But maybe it’s an artifact of x-posting at The Corner?
— Chris · Apr 25, 05:03 PM · #
Chris,
Fair enough, I didn’t intend that meaning.
Jim
— Jim Manzi · Apr 25, 05:10 PM · #
All of this is well-taken, but doesn’t a rise in the cost of oil (1) make a jump to other options more likely (ie, act as a shock to move to a different equilibrium), and (2) make research into less oil-based energy sources more likely? Sure, we’ve used steadily more oil over the years, as you point out, but that’s largely path dependence playing out, isn’t it? I don’t see, offhand, why an increase in oil prices doesn’t make a shift to a different path more likely.
I’m not advocating an increase in the price of oil, by taxation or whatever else— I’m of the view that it would be pretty regressive— tho I’d be glad to be persuaded otherwise. I’m just trying to make sure that I understand the other side of the argument.
— reflectionephemeral · Apr 25, 06:26 PM · #
The short-term elasticity of oil demand is low, because it takes time, effort, and investment to create and adopt substitutes (both energy sources and behaviors). And substitutes are what demand curves are all about.
But the long-term elasticity is certainly much greater (and much harder to measure). And it’s the long term that we should care about, no?
— Steve Roth · Apr 25, 07:38 PM · #
The problem with gasoline is that it’s a very volatile commodity. A tax that is intended to stabilize gas prices (at, say, $4 a gallon) would encourage people to make long-term decisions re: lifestyle choices that they don’t make now. Other bad effects of driving (pollution, congestion) should be controlled through other systems of taxation and regulation.
— Louis · Apr 25, 07:59 PM · #
Steve,
I agree that long-run matters. The IMF study claims (though I’m skeptical, as I said in the post, that they can really do this) to estimate long-run elasticity over a 20-year window.
Louis / Steve:
Western Europe, where I live, has enormous gas taxes, on the order of several dollars per gallon. This has surely reduced consumption somewhat, but the whole continent is still desperately dependent on Middle Eastern oil.
— Jim Manzi · Apr 25, 08:16 PM · #
Jim:
If the goal is to reduce oil consumption (for ecological or other reasons) then to the extent that demand is elastic a tax should be efficacious in achieving that goal (because higher taxes should drive down demand).
If the goal is to raise more revenue in an efficient manner (or to reduce the inefficiency of the current code by offsetting the increased revenue with cuts in other taxes that have a bigger economic drag), then to the extent that demand is inelastic the tax should be efficient in achieving that goal (because the tax will not cause material changes in demand, and therefore will not materially distort economic decisionmaking in aggregate – much as a VAT is considered highly efficient).
To the extent that a higher tax on oil has both goals (which is I think the argument most advocates would make), then the real impact of whatever the actual elasticity of demand for oil turns out to be is on which goals are more effectively achieved. The more elastic demand for oil proves to be, the lousier the tax will be as a revenue-raiser, and the more distorting it will be of economic choices, but the better it will be at achieving the ecological goals of the tax. The less elastic demand for oil proves to be, the lousier the tax will be as an ecological measure, but the more effective and efficient it will be as a revenue raiser.
Do you agree?
— Noah Millman · Apr 25, 08:52 PM · #
Noah,
This is a better version of the last argument in Ryan’s post that I respond to above. The key (explicit) assumption is:
I would likely trade out the current income tax for a VAT that raised an equivalent amount of money. Nonetheless, I think a VAT would be bad idea, because “classes of tax” are a more serious barrier to raising revenue than changes in rates.
More VAT / lower MTR is basically the deal that Thatcher took in the UK in the 80s, and what happened is that as soon as New Labor came to power, rates rose across all classes of taxation. I think that restricting the capacity of the government to raise revenues is, to some extent, an important tool to keep the government smaller and more limited than it would otherwise be.
The argument I made over and again here a couple of years ago (that I think was proven out in spades by the cap-and-trade fiasco) was that introducing a VAT-like tax on a special class of consumption (ie, activities that burn carbon) would have this problem, but also exacerbate another – the public choice problems create enormous drag in order to get the deal done. These are not minor transaction costs, but in that case were almost certainly far greater than the total expected benefits from the prospective law.
Always like to bring the cheer,
Jim
— Jim Manzi · Apr 26, 01:04 PM · #
The EIA graph you link to is all you need to realize that fuel consumption is elastic. On the occasion of a price spike like those in the late 70’s, early 90’s, and recently there is a clear decrease in consumption. These were not caused by a shortage of oil because there has not been a shortage since WW2. If you look at a graph of consumption per capita which is what you should be showing, it would also support this.
— Michael Kidder · Apr 27, 08:29 PM · #
Let’s assume these projections are correct, and one solution is “an 80% increase in income taxes.” I assume this means federal income taxes. Assume a family with two kids, with AGI of $50k (or $75k, or $100k). What dollar figure does this represent? What percentage increase does this represent in total tax burden?
— DCCTV · May 6, 08:01 AM · #