Not Ambitious Enough
November 14th, 2007Posted by: Roger Pielke, Jr.
In today’s New York Times, Thomas Friedman has a column lamenting the failure of politicians to enact a gasoline tax following 9/11. I am a strong supporter for a dramatically increased gasoline tax in the United States. The problem with Friedman’s proposed gasoline tax is that it is not ambitious enough.
Here are some data:
Sources:
U.S. gasoline prices
U.S. gasoline usage
U.S. GDP
On September 11, 2001 U.S. gasoline averaged $1.15 per gallon. By May 1, 2006 it was $2.90 per gallon. The difference of $1.75 per gallon is larger than the gasoline tax proposed by Friedman, and thus allows for a natural experiment on the effects on consumption.
US gasoline consumption in September, 2001 was 8.6 million barrels per day. In May, 2006 it was 9.3 million barrels per day. This does not suggest a strong relationship between price and consumption, although it is certainly possible to argue that consumption would have been higher with lower prices. Clearly, the $1.75 increase per gallon did not lead to reduced consumption.
One can look at the figures from the standpoint of the overall economy as well. In 2001 the US economy generated $3.22 of economic activity for every gallon of gasoline burned. In 2006 it generated $3.91 of economic activity for every gallon of gasoline burned. This does not suggest a strong relationship of gasoline use and economic growth. This is good news because it suggests that gasoline prices might be able to increase considerably without large negative economic effects.
One might argue that the $1.00 per gallon tax would be on top of the supply/demand fluctuations in price. But even gasoline at $4 or $5 dollars is unlikely to lead to dramatic changes in behavior or innovation.
Consider that a gasoline tax of $1/per gallon would have raised only about $3.4 billion in tax revenue in 2006, which is small in relation to overall U.S. incomes taxes, which in 2006 were more than $1 trillion (PDF). Thus it is very (!) misleading when Friedman quotes Philip Verleger in his column as saying, “We could have replaced the current payroll tax with a gasoline tax.” Well, I suppose that if the gasoline tax was about $300/gallon under present levels of consumption then that statement would be accurate!
What does the literature say?
There is a very nice review paper on the elasticity of gasoline demand based on a wide range of studies by Graham and Glaister (2002)(PDF). This paper concludes:
There are differences between the short- and long-run elasticities of fuel consumption with respect to price. . . Therefore, it may be right to say that “it won’t make much difference” or “people will use their cars just the same”, but only in the short run. The evidence is clear and remarkably consistent over a wide range of studies in many countries that in the long run there is a significant response, albeit a less than proportionate one. . .
So the effects of a gasoline tax are important and take place over the long term. However, the tax would have to be significant enough to generate significant responses, lest it be more symbolic than effective. I am not sure what that is in the United States, but I am sure that $1 per gallon is only a step in the right direction; it is not all that is needed by a longshot.
Both long- and short-term effects of gasoline prices on traffic levels tend to be less than their effects on the volume of fuel burned. . . Raising fuel prices will therefore be more effective in reducing the quantity of fuel used than in reducing the volume of traffic. . .
Anyone who has driven at rush hour in the UK where gasoline costs a lot more than the U.S. will be well aware of this reality. It is therefore misleading to suggest that a higher gasoline tax will reduce congestion, as some have suggested. It won’t. To reduce congestion would require other strategies.
The demand for owning cars in heavily dependent on income. . . The implication is that fuel prices must rise faster than the rate of income growth, even to stabilise consumption at existing levels.
Consider the difference between dollars of GDP per gallon in 2001 and 2006. US GDP increased over this period by 30% while gasoline prices increased by about 90%, and gasoline consumption still increased by 7%.
If goals of energy policy are to dramatically reduce the U.S. reliance on foreign sources of oil and to rapidly accelerate the decarbonization of the energy system, then a gasoline tax can certainly contribute to that end. However, it is misleading at best to suggest that $1 per gallon can do the job, or make a big step in that direction, when it can’t. Achieving a gasoline tax in the United States would be a monumental political achievement. It would be a shame to see such an achievement undercut by getting the policy wrong by reaching for too little. Of course, that might just be a good characterization of current debates on U.S. energy policy generally.
November 14th, 2007 at 10:46 pm
Roger,
Your analysis of demand elasticity for driving is sound and worthwhile, but what about substitution elasticity? There may be sharp breakpoints at which people would switch to alternate fuels in large numbers. Even when the demand for driving is inelastic, fuel substitution could potentially be significant.
Clearly there are start-up delays to produce and distribute alternate fuels. In the case of hydrogen, no matter what happens to gas prices, it’s at least half a century away. But alternatives, such as cellulosic ethanol become competitive at prices close to today’s so long as investors can be confident gasoline prices will remain high long enough to recover capital investment in production facilities. [see, e.g., B.D. Solomon, et al., "Grain and Cellulosic Ethanol: History, Economics, and Energy Policy," Biomass and Bioenergy 31, 416-25 (2007)]
In this case, I’d suggest that a modest tax might serve better than an equivalent market rise in price because the tax sends a clearer signal about the long-term price of gasoline to people considering capital investments of hundreds of millions in alternate fuel factories.
Not that this quibble detracts from your criticism of Friedman. You’re right that supply and demand shifts produced a much greater price rise than Friedman’s proposed tax and moreover, Friedman quotes Mankiw saying that as higher prices reduced demand, “the price of gas to [U.S.] consumers would rise by less than the increase in the tax.”
November 15th, 2007 at 6:09 am
The increase in consumption between 2001 and 2006 is 0.70 million barrels per day, not 7%. The percentage increase was about 8.14%.
Shouldn’t the consumption be put on a per-user basis? I assume there are more users as time increases.
December 17th, 2007 at 6:25 pm
Implementation of a reasonable gasoline tax in USA seems difficult and may be time consuming. However, such tax would have to be significant enough to generate maximum effects on on U.S. energy policy generally; otherwise it will be more symbolic than effective. I am sure that $1 per gallon is only a step in the right direction.
December 18th, 2007 at 3:09 pm
According to me a gasoline tax can definitely fulfill the goals of U.S energy policy of dramatically reducing its dependence on foreign sources of oil and to rapidly accelerate the decarbonization of the energy system.
December 18th, 2007 at 4:43 pm
Though there is a common misconception that a higher gasoline tax will reduce traffic congestion, It won’t. Some other strategies should be followed to reduce traffic jam in real sense.
December 18th, 2007 at 5:37 pm
In my opinion it would not be wise enough to replace the current payroll tax with a gasoline tax.” Well, I suppose that if the gasoline tax was about $300/gallon under present levels of consumption then that statement would have some value!
December 21st, 2007 at 7:11 pm
Variation in price level of gasoline has great impact on fuel consumption. It not only affects the fuel consumption for domestic purpose but also affect use of gasoline in vehicles. I don’t think that increase $1 per gallon will affect the traffic level up to that extent. So, some other plan should be taken into consideration that can give better and permanent solution for this type of problems.
December 21st, 2007 at 7:26 pm
Variation in gasoline price has great impact on fuel consumption. But I think just $1 per gallon won’t be the most appropriate strategy to control the traffic up to the desired level. Some other strategies should be followed as a better and permanent solution for this type of problems.
December 24th, 2007 at 2:24 pm
The case is nicely represented here to understand the real situation. If we compare the gasoline price in different years here this does not suggest a strong relationship of gasoline use and economic growth. This small increase in gasoline price may not decrease the gasoline use. The entire study proves that achieving a gasoline tax in the United States would be a monumental political achievement.
January 3rd, 2008 at 4:41 pm
With the increasing demand of gasoline, this small increase in gasoline tax may not lead the gasoline consumption up to that extent. This rate does not suggest a strong relationship between price and consumption. It will not able to increase our economic rate without any negative effect. Here Friedman’s proposed gasoline tax is not ambitious enough.
January 13th, 2008 at 2:16 pm
After detailed analysis it seems there is no harm in increasing USA gasoline tax more than $1/per gallon as the fuel consumption or economic growth is least affected with it.