Should US Taxes on Gasoline be Higher? Becker

Gasoline prices have increased rapidly during the past several years, pushed up mainly by the sharply rising price of oil. A gallon of gasoline in the US rose from $1.50 in 2002 to $2 in 2004 to $2.50 in 2006 to over $4 at present. Gasoline prices almost trebled during these 6 years compared to very little change in nominal gas prices during the prior fifteen years. The US federal tax on gasoline has remained at 18.4 cents per gallon during this period of rapid growth in gasoline prices, while state excise taxes add another 21.5 cents per gallon. In addition, many local governments levy additional sales and other taxes on gasoline. Gasoline taxes have not risen much as the price of gasoline exploded upward. The price of gasoline is much lower than in other rich countries mainly because American taxes are far smaller. For example, gasoline taxes in Germany and the United Kingdom amount to about $3 per gallon. Some economists and environmentalists have called for large increases in federal, state, and local taxes to make them more comparable to gasoline taxes in other countries. Others want these taxes to rise by enough so that at least they would have kept pace with the sharply rising pre-tax fuel prices. At the same time two presidential candidates, Hillary Clinton and John McCain, proposed a temporary repeal during this summer of the federal tax in order to give consumers a little relief from the higher gas prices. We discuss the optimal tax on gasoline, and how the sharp increase in gas prices affected its magnitude. Taxes on gasoline are a way to induce consumers to incorporate the "external" damages to others into their decision of how much to drive and where to drive. These externalities include the effects of driving on local and global pollution, such as the contribution to global warming from the carbon emitted into the atmosphere by burnt gasoline. One other important externality is the contribution of additional driving to road congestion that slows the driving speeds of everyone and increases the time it takes to go a given distance. Others include automobile accidents that injure drivers and pedestrians, and the effect of using additional gasoline on the degree of dependence on imported oil from the Middle East and other not very stable parts of the world. A careful 2007 study by authors from Resources for the Future evaluates the magnitudes of all these externalities from driving in the US (see Harrington, Parry, and Walls, "Automobile Externalities and Policies", Journal of Economic Literature, 2007, pp 374-400). They estimate the total external costs of driving at 228 cents per gallon of gas used, or at 10.9 cents per mile driven, with the typical car owned by American drivers. Their breakdown of this total among different sources is interesting and a little surprising. They attribute only 6 cents of the total external cost to the effects of gasoline consumption on global warming through the emission of carbon into the atmosphere from the burning of gasoline, and 12 cents from the increased dependency on imported oil. Perhaps their estimate of only 6 cents per gallon is a large underestimate of the harmful effects of gasoline use on global warming. Yet even if we treble their estimate, that only raises total costs of gasoline use due to the effects on global warming by 12 cents per gallon. That still leaves the vast majority of the external costs of driving to other factors. They figure that local pollution effects amount to 42 cents per gallon, which makes these costs much more important than even the trebled cost of global warming. According to their estimates, still more important costs are those due to congestion and accidents, since these are 105 cents and 63 cents per gallon, respectively. Their figure for the cost of traffic accidents is likely too high –as the authors' recognize- because it includes the cost in damages to property and person of single vehicle accidents, as when a car hits a tree. Presumably, single vehicle accidents are not true externalities because drivers and their passengers would consider their possibility and internalize them into their driving decisions. Moreover, the large effect of drunk driving on the likelihood of accidents should be treated separately from a gasoline tax by directly punishing drunk drivers rather than punishing also sober drivers who are far less likely to get into accidents. On the surface, these calculations suggest that American taxes on gasoline, totaling across all levels of government to about 45 cents per gallon, are much too low. However, the federal tax of 18.4 cents per gallon is almost exactly equal to their figure of 18 cents per gallon as the external costs of global warming and oil dependency. To be sure, a trebled estimate for global warming would bring theirs up to 30 cents per gallon. However, the federal government also taxes driving through its mandated fuel efficiency standards for cars, although this is an inefficient way to tax driving since it taxes the type of car rather than driving. Still, the overall level of federal taxes does not fall much short, if at all, from the adjusted estimate of 30 cents per gallon of damages due to the effects of gasoline use on global warming and oil dependency. Any shortfall in taxes would be at the state and local levels in combating externalities due to local pollution effects, and to auto accidents and congestion on mainly local roads. Here too, however, the discrepancy between actual and optimal gasoline taxes is far smaller than it may seem, and not only because single vehicle accidents are included in their estimate of the cost of car accidents, and accidents due to drunk driving should be discouraged through punishments to drunk drivers. One important reason is that congestion should be reduced not by general gasoline taxes, but by special congestion taxes- as used in London and a few other cities- that vary in amount with degree of congestion (see our discussion of congestion taxes on February 12, 2006). Congestion taxes are a far more efficient way to reduce congestion than are general taxes on gasoline that apply also when congestion is slight. In addition and often overlooked, the sharp rise in pre-tax gasoline prices has partly accomplished the local pollution and auto accident goals that would be achieved by higher gas taxes. For higher prices have cut driving, just as taxes would, and will cut driving further in the future as consumers continue to adjust the amount and time of their driving to gasoline that costs more than $4 a gallon. Reduced driving will lower pollution and auto accidents by reducing the number of cars on the road during any time period, especially during heavily traveled times when pollution and accidents are more common. The effects of high gas prices in reducing congestion, local pollution, and accident externalities could be substantial. These authors estimate the size of local driving externalities, aside from congestion costs, at 105 cents per gallon. Even after the sharp run up in gas prices, this may still exceed the 28 cents per gallon of actual state and local taxes, but the gap probably is small. It surely is a lot smaller than it was before gas prices exploded on the back of the climb in the cost of oil. In effect, by reducing driving, higher gasoline prices have already done much of the work in reducing externalities that bigger gas taxes would have done when prices were lower.

Comments

[Thomason]

Taxes added onto specific commodities often are devoted to the 'public good' and not to fund specific programs. Gasoline taxes often are tied to highway improvements, but is that the best use of increased gas taxes?
Promoting increased taxes on gas could be tied to, for example, improved schools or to veterans benefits. When one feels the pain at the pump, they might be assuages somewhat knowing that it's help to educate their children or care for those who fought a war for our country. How about a self-service pump, where the buyer gets to choose what program his gas taxes will fund?
Just to increase gas taxes, to force adherence to policies on conservation, air quality, etc., is to politicize a basic commodity.

[Peter Pearson]

Note that some of the cost of accidents is internalized by requiring vehicles to carry liability insurance, since the costs of insurance claims are thereby converted back into insurance premiums paid by the vehicle owners.

[A student of Economics]

The relevant question is to compare raising revenues from gas taxes vs. taxes on labor and investment income.

For instance, replacing (some) payroll taxes with gas taxes not only increases efficiency (reducing externalities) in gas consumption (as per Harrington et al.) but also increases efficiency in labor supply (less deadweight loss).

Thus, Becker's analysis underestimates the benefits of the gas tax.

[A student of Economics]

The relevant question is to compare raising revenues from gas taxes vs. taxes on labor and investment income.

For instance, replacing (some) payroll taxes with gas taxes not only increases efficiency (reducing externalities) in gas consumption (as per Harrington et al.) but also increases efficiency in labor supply (less deadweight loss).

Thus, Becker's analysis underestimates the benefits of the gas tax.

[Anonymous]

Professor Becker, is your post a longhand way of saying that you believe in a market econpmy? How about "money got us into this mess and money will get us out."

[prakashTC]

Lets All Join together to force the price of fuel down!

A man eats two eggs each morning for breakfast. When he goes to the Grocery store he pays Rs. 12 a dozen. Since a dozen eggs won't last a week he normally buys two dozens at a time. One day while buying eggs he notices that the price has risen to Rs. 16. The next time he buys groceries, eggs are Rs. 22 a dozen.

When asked to explain the price of eggs the store owner says, "The price has gone up and I have to raise my price accordingly". This store buys 100 dozen eggs a day. He checked around for a better price and all the distributors have raised their prices. The distributors have begun to buy from the huge egg farms. The small egg farms have been driven out of business. The huge egg farms sell 100,000 dozen eggs a day to distributors. With no competition, they can set the price as they see fit. The distributors then have to raise their prices to the grocery stores. And on and on and on.

As the man kept buying eggs the price kept going up. He saw the big egg trucks delivering 100 dozen eggs each day. Nothing changed there. He checked out the huge egg farms and found they were selling 100,000 dozen eggs to the distributors daily. Nothing had changed but the price of eggs.

Then week before Diwali the price of eggs shot up to Rs. 40 a dozen. Again he asked the grocery owner why and was told, "Cakes and baking for the holiday". The huge egg farmers know there will be a lot of baking going on and more eggs will be used. Hence, the price of eggs goes up. Expect the same thing at Christmas and other times when family cooking, baking, etc. happen.

This pattern continues until the price of eggs is Rs. 60 a dozen. The man says, " There must be something we can do about the price of eggs".
He starts talking to all the people in his town and they decide to stop buying eggs. This didn't work because everyone needed eggs.

Finally, the man suggested only buying what you need. He ate 2 eggs a day. On the way home from work he would stop at the grocery and buy two eggs. Everyone in town started buying 2 or 3 eggs a day. The grocery store owner began complaining that he had too many eggs in his cooler. He told the distributor that he didn't need any eggs. Maybe wouldn't need any all week.

The distributor had eggs piling up at his warehouse. He told the huge egg farms that he didn't have any room for eggs would not need any for at least two weeks.
At the egg farm, the chickens just kept on laying eggs. To relieve the pressure, the huge egg farm told the distributor that they could buy the eggs at a lower price.
The distributor said, " I don't have the room for the eggs even if they were free". The distributor told the grocery store owner that he would lower the price of the eggs if the store would start buying again.

The grocery store owner said, "I don't have room for more eggs. The customers are only buying 2 or 3 eggs at a time. Now if you were to drop the price of eggs back down to the original price, the customers would start buying by the dozen again". The distributors sent that proposal to the huge egg farmers but the egg farmers liked the price they were getting for their eggs but, those chickens just kept on laying. Finally, the egg farmers lowered the price of their eggs. But only a few paisa. The customers still bought 2 or 3 eggs at a time. They said, "when the price of eggs gets down to where it was before, we will start buying by the dozen."

Slowly the price of eggs started dropping. The distributors had to slash their prices to make room for the eggs coming from the egg farmers. The egg farmers cut their prices because the distributors wouldn't buy at a higher price than they were selling eggs for. Anyway, they had full warehouses and wouldn't need eggs for quite a while. And those chickens kept on laying. Eventually, the egg farmers cut their prices because they were throwing away eggs they couldn't sell.
The distributors started buying again because the eggs were priced to where the stores could afford to sell them at the lower price. And the customers starting buying by the dozen again.

Now, transpose this analogy to the gasoline industry.

What if everyone only bought Rs 200.00 worth of Petrol each time they pulled to the pump? The dealer's tanks would stay semi full all the time. The dealers wouldn't have room for the gas coming from the huge tanks. The tank farms wouldn't have room for the petrol coming from the refining plants. And the refining plants wouldn't have room for the oil being off loaded from the huge tankers coming from the oil fiends.

Just Rs 200.00 each time you buy gas. Don't fill up the tank of your car. Don’t drive to places where you can walk. Don’t drive to places where you are just driving because you have a vehicle to spare. You may have to stop for gas twice a week, but the price should come down.

Also, don't buy anything else at the fuel station; don't give them any more of your hard earned money than what you spend on gas, until the prices come down..."

Think about it. Share your views, please.

Thanks & Regards,

PrakashTC.

[Richard]

One issue on the revenue-raising side:

In theory, at least, the gas tax is earmarked for road repair, and other driving-related public expenditures.

Gas tax is set at a certain number of cents per gallon. In that sense, it is different from the more general state sales tax, which is a percentage of sales.

As the price-per-gallon of gas goes up, fewer gallons are bought. Therefore, the tax revenue goes down. Meanwhile, in such an inflationary environment, the public expenditure probably goes up.

To cover that deficit, either the tax rate in terms of cents-per-gallon needs to go up, or the tax needs to be converted to a percentage of sales.

Otherwise, road expenses need to covered out of the general fund, which would be unfair, because people would no longer be funding those expenses in (rough) proportion to the amount of driving they do.

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[Jack]

Richard sez:

"As the price-per-gallon of gas goes up, fewer gallons are bought. Therefore, the tax revenue goes down. Meanwhile, in such an inflationary environment, the public expenditure probably goes up."

.......... but perhaps not. In theory "fewer gallons" means fewer miles in smaller cars and less need to expand our roads and highways.

In the "real world" you're probably right as we're some trillion bucks behind on maintenance that we should have begun during past recessions and having missed that opp. should begin during the coming recession. Also, we should quickly address the many choke points of our transportation network that results in energy and productivity wasting traffic jams as a RESPONSE to high fuel prices.

It's not only politically silly to waive the 18 cent tax for, what's left of the summer, but counter-productive as we'd leave a permanent pothole in our road repair funding.

[Jack]

Prakash: Indeed. Last time it was the drop in demand that broke the OPEC strangle hold. Assuming a working "market" in oil (a risky assumption in my book!) your plan would turn the tide on our speculative sharks and they'd have to dump their "contracts". The best numbers I see is oil w/o the speculative bubble effect would be about $80 in today's emaciated dollars. The buck might rise in value were we not beset by economy tanking oil price gouging and give us a price in the $50 buck range.

Oh, and markets don't go directly to equilibrium, as fanny scorched speculators bail out and many begin shorting we could see a drop well past what the price of finding the next bbl of oil "should be."

And I'd add actually responding to posted prices. Even though a penny or two makes little difference we should make an effort to patronize the station with the lowest price. At least pretend there's a functioning market?

[Jack]

A student! Another A!! I agree completely, but it will take a heck of a politician to sell the concept. Americans have become so cynical they'll figure it's just a higher gas tax with no income tax break.

[Rechtsanwalt]

I think they should maintain a certain level and should not raise the price so that the poor can be effected very badly.

[diz]

Congestion taxes are a far more efficient way to reduce congestion than are general taxes on gasoline that apply also when congestion is slight.

Having just arrived into work from the morning traffic, I struggle somewhat with the idea that "congestion" is an unpriced externality.

Rush hour traffic is essentially a closed system with respect to congestion. In aggregate, the costs of congestion are borne by the same people who externalize congestion onto others. It does not seem possible to export it to others without also importing it from others.

While I externalize congestion onto other drivers, they simultaneously externalize congestion onto me. It seems I should expect to internalize about as much congestion as I externalize. On the average, this is tautological.

So, let's say can I leave for work at 8 AM knowing I am going to sit in one half hour of traffic, or leave for work at 6 AM knowing I will sit in no traffic.

When I make the decision to leave at 8 AM, I am implicitly interanlly pricing the congestion I am externalizing onto others by pricing the approximately equal amount of congestion they are externalizing onto me.

I don't think this rules out the possibility of improving the overall welfare by imposing a congestion tax, and there may also arguably be some inefficiencies created by variances in individual driver's utility functions with respect to time spent in traffic. But if the cost of congestion is already largely being internalized, a Pigouvian tax applied as if it isn't is surely overkill.

[Rob]

How does one compute the cost of global warming? In past centuries warm climates have resulted in a flowering of human culture.

How would this calculation change if the fuel was natural gas? Natural gas still produces CO2, but the rest of the pollutants fade to almost nothing. Honda's natural gas car is rated as a "zero pollution" vehicle.

[Jack]

Diz, what would you do if you got to work a couple hours early? How much would the "congestion tax" have to be to cause YOU to go early? If you have a job where the time of the task is not critical why couldn't you and your employer agree to flex time schedule? W/O applying a tax to those whose jobs require opening the store at popular hours et al?

Isn't the congestion itself a tax? Reflecting either a failure to keep up on infrastructure, or...... to spur companies to move to the suburbs or more of the employees to move back to the city?

Do our zoning laws stifle combining residential and business uses?

I'm just trying to point out that it's not a given that one MUST make the trip and to consider other solutions, after all, rush hour or not the trip consumes nearly the same amount of fuel.

[Jack]

Rechtsanwalt: You bring up a good point. The fact that lower income folk often have the fewest alternatives. There are lots of examples in economics, the classic being that tomatoes may sell higher in a poor area as the consumer may not have the mobility to do comparative shopping. Likewise despite being VERY aware of the "market signals" to pop down and buy a new Prius, for now all they can manage is to keep the old gas guzzling P/U running.

I've long been a fan of shifting income taxes onto non-renewables, and as we do that the idea would be to make the shift revenue neutral which may mean a rebate or credit to lower income earners who currently pay no income taxes. There's be no way of selling higher taxes on fuels without balancing it off in some manner.

[Richard]

.......... but perhaps not. In theory "fewer gallons" means fewer miles in smaller cars and less need to expand our roads and highways.

Jack, fewer miles and/or smaller vehicles should reduce the need for highway maintenance. But it seems to me that that would be a long-term effect, while the funding shortfall shows up in the short term.

Also, as you note, we probably have some catching-up to do.

In this inflationary environment, higher costs might offset any reduction in the amount of work needing to be done. And governments have never been good at keeping costs down on their proejcts.

[Mark Shapiro]

The copy of the Resources for the Future study at RFF calculates a range for the global warming externality from 5 to 72 cents per gallon of gasoline. (The lower estimate is from Nordhaus, the higher one from Stern.)

Of course as the study notes, this cost applies to all fossil fuels, not just gasoline, so it should be applied across the board. The global warming tax currently stands at 0 cents.

Two hopes: That we reduce global warming risk by reducing carbon emissions, and that the optimists are right.

[Jack]

Toyota, it's probably silly of me to respond but I think you theory is silly enough to denounce.

A "Prius" or for that matter a big Dodge Ram truck with a 10 cylinder gas guzzler is, for most of us a tool or solution to a problem and if one could walk to work why would they want to begin paying insurance and the other costs of auto ownership?

[Jack]

Richard thanks, and the figures for catching up that I hear are $1.5 trillion, though that may include some public buildings; not sure. So, any drop in the gas tax is a negative in terms of the job that needs to be done.

In my view we've missed three good times to have done some catching up as it would seem that doing road and bridge repair/rebuilding is an ideal thing to do when in recession and contractors are likely to use a bit sharper pencil than during boom times. Also, it quickly spurs employment in a very wide array of jobs from design and engineering, to producing the machinery and materials to general and skilled labor.

And, Ha! as for inflationary times and the gov not capping costs well, sometimes that's not the primary or controlling priority as it's likely not to get any cheaper in the future.

It's difficult to define an "investment" and a return in public policy as all stake holders claim their "pork" to be an "investment in the future" but there are very real returns to be had in saving lives, (I've seen estimates of poor road maintenance claiming 20% of the 40,000 who die every year and I'm guessing the non-fatal accidents are very costly too) time for both leisure and productivity, and fuel.

Despite being left gunnel deep in debt I'd favor getting busy with the best and most urgent of these projects; at least we'd have fuller employment in jobs that pay fairly well, creating the spurring effect that cutting upper end taxes has not, and our beleagured government would be getting income taxes coming in, instead of paying extended unemployment wages out. A balancing act to be sure; we HAVE to get it right for the next decade. Not much room for error!

[Samuel T. Petursson]

Becker seems unaware to the high externalities that free and abundant parking in most US cities imposes on society as a whole. Don Schoup's book "The High Cost of Free Parking" mentions an economic study that calculates the annual external cost of free parking to be somewhere between 25% and 100% of the annual US expenditure on Medicare. Charging drivers a rental fee for parking that internalizes those factors could reap better results than congestion taxes, but would, however, not substitute a green Pigovian tax on carbon emission.

[Anonymous]

Hey, while we are contorting ourselves trying to find the right "formula" for correcting the problem, should we not be looking backward to analyze how we got in this mess in the first place; what wrong-headed policies led us here and who formulated those policies and who carried them out. Isn't there there something about an once of prevention?I can recall a well known political thinker saying shortly ago, "The answers are simple but difficult."

[GP]

"These authors estimate the size of local driving externalities, aside from congestion costs, at 105 cents per gallon. Even after the sharp run up in gas prices, this may still exceed the 28 cents per gallon of actual state and local taxes."

Why would we expect the externality per gallon to decrease as the quantity of gasoline consumed decreases because of a higher before-tax price?

[nathan]

indirectly related to topic ...

Have you blogged or written about the method for selecting
the U.S. president - electoral college vs. popular vote vs. other ?