Now is not a good time to raise the gas tax

According to the Institute for Energy research, the drop in gas prices does not bolster the gas for hiking gas taxes. If a gas tax hike was a bad deal in the summer, then it is a bad deal now. The only thing that has changed is the psychological difference – trying to take away the ‘gift’ the market has given to consumers before they get used to it.

Looking at the argument in other contexts

The argument in favour of raising the gas tax now – since it won’t be as painful with prices as starting out low – would be self evidently absurd in other contexts. IER uses house prices as an example. The price of a typical house collapsed from 2007 – 2009. Would anyone argue that early 2009 was a great time to slap on a 25% tax on house sales, since home buyers would hardly notice it?

The absurdity of such statements carries through to gasoline as well. Just because gas is currently much cheaper than it was a year ago, is no justification for hiking the tax on gas. It still hurts consumers to make a product artificially more expensive than the going market price.

Dealing with negative externalities

The obvious difference between a gas tax (or tax on carbon dioxide emissions more generally) and the housing example is that many people argue that there is a large ‘negative externality’ from the use of gas. In other words, they claim that there is a ‘social cost’ above and beyond the private cost from burning gasoline, and this is why the government should slap on a stiff tax hike, now that prices have come down so much.

Yet even here, the proponents of a tax hike have been quite sloppy. For example, economist Steven Landsburg analysed Larry Summers’ recent call for a carbon tax in light of the fall in energy prices, and showed that Summers left out a crucial part of the argument. Specifically, Summers did not explain why the fall in energy prices meant that it was more important than before to enact a carbon tax.

Landsburg conceded the standard ‘social cost of carbon’ claims for the sake of argument; Summers still had not presented a coherent case. In other words, if Summers thought people were emitting too much carbon back in the summer, then there is no reason to think the gap between how much they ‘should’ use and how much they in fact are using, has grown since then.

Landsburg has isolated a key confusion in the debates over climate change. People often fall into the trap that if some activity carries a downside, then the ‘optimal’ amount is zero. But that is not correct, IER emphasises. As Landsburg points out, when oil becomes cheaper, then yes, of course people use more oil. But they should use more oil; that make economic sense, even if you believe people aren’t correctly taking into account the full social cost of their activities.

This is a crucial point: Suppose the price of gasoline is US$3/gal., and that price the average motorist drives 10 gal./week. However, because of various ‘negative externalities’, the textbook says this is too much gasoline consumption – really the ‘socially optimal; amount of gasoline usage is only 9 gal./week. Notice that the optimal level is not zero gallon; even if the negative externalities are stipulated, it is still a good use of resources for people to burn gasoline in their vehicles, the (alleged) problem is simply that they are burning a little too much gasoline on the margin. So a tax, of say, 50 cents/gal. will induce people to recued their weekly purchases down to 9 gallons, which the textbook says is the right amount.

So far so good. Now suppose that crude oil becomes cheaper, meaning that the (pre tax) price of gasoline falls to US$2/gal. With no tax, the average motorist would now use, say, 13 gal./week, rather than the original 10. What can we say about the new ‘socially optimal’ amount?

Without more information, it is tough to say. But for sure the answer is now higher than 9 gal., and in fact it is probably closer to 12 gal. So the ‘optimal’ level of the corrective tax is probably still approximately 50 cents. To come up with an exact answer using textbook logic, we would need to know how much the ‘optimal’ amount of reducing consumption now was, and whether a tax of 50 cents was too high or too low because of the new baseline market price. This ends up being a complicated question, one for which we would need more information to answer. Since it is not obvious whether the ‘optimal’ gas tax would go up, down, or stay about the same, it is also unclear whether ‘the case for a gas tax’ has gotten stronger, weaker, or stayed about the same.

The purpose of walking through this example is just to isolate the analytical point that Landsburg was making in his own reaction to Summers. Larry Summers actually breezed by a crucial plant in his whole case. Summers took it for granted that because people will be using more energy (now that it is cheaper), that the case for punishing usage with a carbon tax has somehow become stronger compared to the summer.

Aren’t marginal damages rising the level of emissions?

According to the IER, proponents of a higher gas tax and/or a carbon tax have a ready answer to Landburg: Of course the marginal social damage from further emissions goes up, they will say, as we increase the level of emissions. In other words, they will argue that when gas prices fall and consumers drive more, that the social damage from burning one additional gallon of gas is higher than it would have been in the baseline, back when gas prices were much higher.

Although people like Larry Summers and other proponents of a carbon tax think this is obvious, it is actually a tricky issue. We have to know why gasoline prices came down so much, so quickly, in order to begin to answer the question.

For example, to the extent that prices have partially fallen because Saudi officials have announced their intention to continue pumping despite the rise of other producers, then this has little long term effect on total emissions over the next several decades. All that’s happening is that Saudi officials are bringing barrels to the surface earlier than investors implicitly though would be the case, back in June. The specific rate of Saudi oil extraction in 2015 is not really relevant to the global temperature in the year 2050.

On the other hand, advances in US crude production do affect the total amount of emissions, since forecasts made long ago would not have realised how much total oil would be available to humanity. However, it is not as if the surge in US output was a bombshell surprise hitting the world last August for the first time. Back in May 2013 when the Obama Administration Working Group updated its estimates of the ‘social cost of carbon’, they had already seen the sharp uptick in US output, which had been occurring for at least four years at that point. So when they reported their various figures for the social cost of carbon – which would then be the basis of enacting a carbon tax – there is no reason to think those numbers were too low, because of the fall in energy prices that we have witnessed.

In other words, if the Obama team thought the 2015 ‘social cost of carbon’ was about US$38/t when they issued their report in May 2013, then they should still think that is about the right number, even though crude prices have fallen. At the very least, we cannot just take it for granted that their number was always off; we would have to explain what their specific assumptions were, and what changed in the interim, IER highlights. When they issued their report, they knew full well actual energy prices were extremely volatile, and would bounce around over the next century. In the grand scheme, has the recent fall in crude prices really changed their forecast for world fossil fuel use in the 21^st century that dramatically?

Adapted from IER analysis by Emma McAleavey.

Read the article online at: https://www.hydrocarbonengineering.com/petrochemicals/04022015/raising-the-gas-tax-185/