Raise the Gas Tax

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.

Pumps

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.

congestion

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.

About Lucas Davis

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.
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18 Responses to Raise the Gas Tax

  1. Gerry Bemis says:

    Seems like these discussions need to focus on the cost of gasoline as well at the price at the pump. If the cost goes up 10 cents/gallon, does that really translate into a retail price increase of 10 cents/gallon? In the past, when implementing reformulated gasoline in California, the cost of producing the fuel increased by about 10 cents/gallon, but the retail price went up more than that because the regulations produced an “island market” since very little gasoline produced outside the state could be imported due to the unique formulation.

    So, please tell us about the cost (wholesale) and the price (retail).

    • Lucas Davis says:

      Thanks Gary. Yes, this translates into a retail price increase of $.10 per gallon. Including fuels under the cap increases the marginal cost of fuels by this amount. A substantial literature in economics has examined what happens to retail prices when marginal costs change, and the answer is that increases are passed through one-for-one to consumers. Severin’s post (here) has a bit more discussion of this. Unlike the reformulated gasoline requirements, this impact will be the same across all producers so there is no “island market” and no reason to expect a disproportionate impact in retail markets. -LD

  2. Camille Watts-Zagha says:

    I am convinced. Maybe you will consider the Hansen route and start advocating……..

  3. Ken Small says:

    This is also the perfect time politically to introduce a gas tax increase. When gas prices are falling it will be less noticed, and simultaneously we are in a crises over road financing.

    • Azmat says:

      BUT such taxes are then NEVER removed. I like taxes that last as long as the intended-desired behavior change OR economic/ social need.

      • Ken Small says:

        I don’t think the economic need for a gas tax will go away any time soon, so I would not want them to be removed. My point is that an increase has long been needed as a long-term improvement in highway charging and finance. The overwhelming consensus of economists analyzing highway finance is that we are stymied by unpopularity of raising gasoline taxes, as well as the declining tax base (less gasoline consumed). The need for an increase could go away if we move to a mileage-based charging scheme, which could also be designed to deal with M.Cubed’s comment below, but I am not holding my breath for that to happen.

  4. mcubedecon says:

    Note that congestion, accident and road wear externalties are related cars, not fuel. Switching from gasoline to electricity will not eliminate these, nor will going to fuel efficient cars. So a gasoline tax is only an indirect way at getting at those, and only so long as oil if the primary transportation fuel.

    • Azmat says:

      The idea is that gas taxes are in effect ‘per mile’ taxes; so those who drive longer distances [and-or consume more fuel] will pay more. Also car reg taxes should be mileage based.

      • mcubedecon says:

        I understand what the idea is; however as we have greater penetration of EVs, the gas tax will have no effect on the externalities I listed created by EVs. In addition, increased fuel economy greatly dilutes the “per mile” effect. Too often those who attempt to lump all of these externalities solely on gasoline and diesel taxes ignore these facts. We need to be clear about which externalities are created by fossil fuel use (e.g. GCC, air quality) and which are created by automobiles which will still exist after fossil fuels are gone (e.g., congestion, accidents, road wear and dust). We will have to think of using different instruments to control these separately as EVs and other technologies increase.

  5. Azmat says:

    I love it when we talk in these abstract terms as long as it doesn’t hit us ‘personally’; specially some folks at Harvard’s now faculty squawking regarding healthcare premiums and costs — check out :
    http://www.nytimes.com/2015/01/06/us/health-care-fixes-backed-by-harvards-experts-now-roil-its-faculty.html?hp&action=click&pgtype=Homepage&module=first-column-region&region=top-news&WT.nav=top-news

    The ONLY viable way to have economics [ie costs vs demand] have an equitable impact on behavior as a matter of public policy is to have ‘reasonable’ alternatives. It makes no sense to raise the taxes on gas when there are people whose livelihood depends on driving old clunkers — when we don’t also have alternative means for them to get around.

    I would rather [as a combined matter of economic decision making and of public policy] cut other costs [eg: the bullet-train-to-nowhere-$100+BILLION-project] and allocate part of those funds for subsidizing non-fossil-fuel vehicles [such as hybrids] for those who can least afford them. Current policy subsidies are for those who CAN afford the cost, and we even give them ‘commute-time-savings’ access to HOV lanes. I KNOW I am talking socialism-like policies.

  6. Jan Dietrick says:

    Have you weighed the economic modeling of the Schultz-Bender legislative proposal for federal revenue neutral carbon fee and dividend against the implied strategy from a focus on California’s programs? If you assume that Citizens Climate Lobby has the systematic strategy to achieve a bipartisan agreement on it, isn’t that the direction to focus on right now. Enough people, especially those like you, creating political will can make that Congress do its job.

  7. dzetland says:

    I agree with higher gas taxes to discourage the use of polluting fuels (It’s about $5.60/gallon in the Netherlands!), but you should clarify that these can complement OTHER taxes aimed at other problems, i.e., time of use tolls for congestion and weight * distance taxes for road damage. Also don’t forget that the taxes are too low to keep the Federal Highway Trust Fund(ed), so other gov’t revenues are subsidizing drivers…

  8. Michaela Ballek says:

    May I throw in another thought: Less than 50% taxes on gas sounds extremely reasonable to me. In many European countries, including Germany, the tax rate is 200+%. (And this does not prevent the German car industry from building high quality cars.) German roads are also maintained quite well, compared to what I experienced in the US. Maybe we should consider quality (of goods & services) instead of quantity?
    Otherwise I agree with most of the things said before me. Taxes should be as targeted and purposeful as possible. In fact, I would like most of the gasoline taxes used for building more public transportation and safe bicycle lanes.

  9. Lucas Davis says:

    Cynthia Lin just wrote to send me a link to her 2009 paper “The Optimal Gas Tax for California”. Available here…
    http://www.sciencedirect.com/science/article/pii/S0301421509005539
    I hadn’t seen this before but it looks quite interesting. According to her analysis, the optimal gasoline tax for California is $1.37 per gallon.

  10. Michael Colvin says:

    Great post Lucas. Two thoughts:
    1) Is the goal to promote fuel substitution (gas to electric cars) or to promote fuel efficiency? Your post takes about both, but I’m not clear on what you think the right policy objective should be.

    2) Electric prices have been under the cap for several years now and we have a “climate credit” distributed to electric and natural gas rate payers twice a year. Should we consider something similar to help relieve economic burden onto gasoline customers?

  11. Jack Ellis says:

    Lucas, I’ve used public transportation and private transportation in a number of cities around the world and I’m not sure the public option is generally a better use of people’s time. For example, driving from the mid-Peninsula area to either San Francisco or Berkeley is a bit quicker and I’m not bound by the quench of bus service. In New York, I’ve spent half a day on a 35 mile journey that can take as little as an hour by car on weekdays. On the other hand, all the money in the world could not persuade me to drive into or out of London on a weekday.

  12. Tino says:

    The only problem I see with the argument is that it overlooks the fact that fuel taxes will result in food becoming more expensive. Fuel is not only used for transportation of people but also for the transportation of goods. Our whole model of economic development -and life styles, I’d say- is based on consumption of fossil fuels. If my commute, my travels and the food I get at the grocery store becomes more expensive, I’d expect something in return. What is it that we are getting in return? is something that is not clear yet.

    Increasing the gas taxes now is only possible because gas prices are so low at this time and people will not offer much resistance. They will still be glad to pay the tax, as the overall price at pump station is relatively low. I would not expect traffic to diminish any time soon in California. This is a smart political move but useless for society if it is not paired with a plan on how to spend the newly earned money.

  13. Pingback: How (and who) will pay for our energy infrastructure? |

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