On January 1st, California’s cap-and-trade program was expanded to include gasoline and diesel. Allowance prices are currently $12.58/ton (link), so this increases gasoline prices by $0.10 per gallon and increases diesel prices by about $0.13 per gallon (Severin’s post goes through this calculation). Like Jim and Severin, I strongly support this expansion, and believe this is a necessary step if California is going to follow through on its commitment to reduce carbon dioxide emissions. In fact, I’d like to see much higher gasoline and diesel taxes.
Total motor fuel taxes in California are now almost $0.75 per gallon (here). This may seem high, but gasoline and diesel are unlike most other goods that we consume. Why? Because of externalities. When we drive we impose a long list of negative externalities on others. Economic efficiency requires that prices reflect both private and external costs and the easiest way to achieve this is with motor fuel taxes.
So how high should gasoline and diesel taxes be? Economists have been thinking about this for a long time. Ten years ago the consensus was that the United States should have a tax of about $1.00 per gallon (see e.g., here). But this number has been creeping upward steadily and recent studies put the optimal motor vehicle fuel tax for the U.S. closer to $2.00 per gallon.
The latest study to get a lot of attention on this topic is the International Monetary Fund’s aptly-named report “Getting Energy Prices Right” (here). The study takes on the ambitious task of quantifying energy externalities for over 150 countries. For the United States, they come up with $1.60 per gallon for gasoline, and $2.10 per gallon for diesel.
Why is this so high? Let’s start with carbon dioxide. Burning gasoline emits .008 tons of carbon dioxide per gallon. Views about the external cost of carbon dioxide emissions vary widely, but most recent estimates are considerably higher than current allowance prices under AB-32. For example, the value currently used by the U.S. federal government is $39 per ton (here). This is more than 3 times current allowance prices under AB-32 and corresponds to a tax of $0.31 per gallon for gasoline and $0.40 per gallon for diesel.
And this is just the beginning. Many economists believe that traffic congestion is the most significant negative externality from driving. When you drive, you impose a negative externality on other drivers in the form of reduced driving speeds. Based on available estimates in the literature, the International Monetary Fund concludes that this externality is a whopping $0.85 per gallon for gasoline in the United States. This is about twice as high as estimates from one decade ago, in part because the value of peoples’ time has gone up.
Perhaps even more important is traffic accidents. Our own Max Auffhammer has done innovative research on this topic (here) together with our UC Berkeley colleague Michael Anderson, finding that drivers impose accident-related costs of almost $1.00 per gallon on other drivers. This works both through miles driven and vehicle weight, which they show has a significant impact on the probability that there is a fatality when accidents occur. Interestingly, Auffhammer and Anderson also show that SUVs and trucks are more dangerous than cars, even after controlling for vehicle weight.
There are other externalities too. I haven’t mentioned road damage costs or emissions of nitrogen oxides, VOCs, and other local air pollutants. I haven’t tried to argue that gasoline consumption raises national security concerns by making us dependent on oil-exporting countries. Nor have I talked about how gasoline and diesel taxes would be more efficient than CAFE standards for increasing the fuel efficiency of the fleet.
One could envision more direct approaches for taxing some of these externalities. An efficient congestion tax, for example, would charge people more for driving at 5pm than at 2am. We are beginning to do some of this, for example, with “time-of-use” bridge tolls, but it seems unlikely that anytime soon we will see real-time location-based congestion taxes. Same can be said for more direct taxes aimed at accident externalities, e.g., based on miles traveled, vehicle weight, and other vehicle characteristics. With these more direct approaches out of reach for the moment, gasoline and diesel taxes make sense.
Taxing gasoline and diesel is also a much better way to raise government revenue than taxing wages. Gasoline has even been shown to be a complement with leisure, i.e., people like to drive around when they aren’t working, which means that a gas tax actually helps undo some of the disincentive to work caused by taxing wages. Economists Sarah West and Rob Williams (here) find that this “cross-elasticity” is large enough to matter in practice.
So the $0.10 increase this week is a great step in the right direction. No question. But let’s all join the “Pigou Club” and support higher gasoline and diesel taxes. With gasoline prices at their lowest levels in years and the economy turning the corner, now would be a great time to put through a significant tax increase.
Lucas Davis is an Associate Professor of Economic Analysis and Policy at the Haas School of Business at the University of California, Berkeley. His research focuses on energy and environmental markets, and in particular, on electricity and natural gas regulation, pricing in competitive and non-competitive markets, and the economic and business impacts of environmental policy.