Case study: Fuel taxes and optimality
Fuelling Discontent
How much should the petrol be taxed?
The tax on petrol varies widely
Case study 12.3: Fuel taxes and optimality Fuelling discontent fuel. If the tax is more than that, its costs (which How much should petrol be taxed? include the inconvenience inflicted on people who The tax on petrol varies widely around the developed would rather have used their cars) will exceed its world. America's gasoline tax is currently about 40 benefits (including any reduction in congestion and cents an American gallon, equivalent to 7 pence a pollution). litre. Many Americans are calling for it to be cut, as the The pollution costs of using petrol are of two main summer increase in prices begins to make itself felt, kinds: damage to health from breathing in emissions and reflecting a more general alarm about the such as carbon monoxide and assorted particulates, country's 'energy crisis'. In Canada the tax is half as and broader damage to the environment through the big again as in America; in Australia it is more than contribution that burning petrol makes to global double. In Japan and most of Europe, the specific tax warming. Reviewing the literature, Mr Parry notes on petrol is around five times higher than in America, that most recent studies estimate the health costs of standing at the equivalent of some 35 pence a litre. At burning petrol at around 10 pence a litre or less. The the upper extreme is Britain, where fuel duty (paid in harm caused by petrol's contribution to global addition to value-added tax) has risen in recent years warming is, for the time being, much more to a punitive rate of just under 50 pence a litre, seven speculative. Recent high-damage scenarios, times the American levy. however, put an upper limit on the cost at about You would expect well-designed petrol taxes to $100 per ton of carbon, equivalent to 5 pence a litre vary from country to country, according to national of petrol. Adding these together, you come to an circumstances - but not, on the face of it, by a factor optimal petrol tax of no more than 15 pence a litre. of seven. In America it is taken for granted that Europe's petrol taxes, let alone Britain's, are insanely JAMMED high, and presumably something to do with High petrol taxes also help to reduce traffic socialism. In Britain, on the other hand, it is taken for congestion. However, they are badly designed for granted that America's gas tax is insanely low, part of that purpose. Curbing the number of car journeys is a broader scheme to wreck the planet. Protests in only one way to reduce congestion. Others include Britain last year showed that petrol tax had finally persuading people either to drive outside peak hours been raised all the way up to its political ceiling - but or to use routes that carry less traffic. High petrol taxes nobody expects or even calls for the tax to be cut to fail to exploit those additional channels. As a result, the American level. Mr Parry finds, the net benefits of a road-specific America and Britain may both be wrong about the peak-period fee (the gain of less congestion minus gas tax, but it seems unlikely that they can both be the cost of disrupted travel) would be about three right. So how heavily should petrol be taxed? A paper times bigger than a petrol-tax increase calculated to by lan Parry of Resources for the Future, an curb congestion by the same amount. Still, if politics environmental think-tank in Washington, DC, looks at or technology rules out congestion-based road- the arguments. pricing, a second-best case can be made for raising The most plausible justification for taxing petrol the petrol tax instead. According to Mr Parry, more highly than other goods is that using the stuff congestion costs in Britain might then justify an harms the environment and adds to the costs of additional 10 pence a litre in tax. traffic congestion. This is indeed how Britain's This brings you to a total petrol tax of around 25 government defends its policy. But the fact that pence a litre. The pre-tax price of petrol is currently burning petrol creates these 'negative externalities' about 20 pence a litre, so this upper-bound estimate does not imply, as many seem to think, that no tax on of the optimal tax represents a tax rate of well over petrol could ever be too high. Economics is precise 100% - a 'high tax', to be sure. Yet Britain's current about the tax that should, in principle, be set to deal rate is roughly double this. On the same basis, of with negative externalities: the tax on a litre of fuel course, America's rate is far too low (even a lower should be equal to the harm caused by using a litre of bound for the optimal rate would be a lot higher than 7 pence a litre).Britain's rate, judged according to the distributional effects, increasing the cost of living for environmental and congestion arguments, looks way poor car-owning households much more than for too high - but plainly the British government has their richer counterparts. another reason for taxing petrol so heavily. It needs At last, Britain has found the political ceiling for the the money to finance its plans for public spending petrol tax. What is remarkable is just how high it Politically, raising money through the tax on petrol, proved to be. protests notwithstanding, has proved far easier than it would have been to collect the cash through Questions increases in income tax or in the broadly based value- 1 What are the economic reasons for fuel taxes being added tax - or, for that matter, through congestion- different in different countries? based road-pricing (always dismissed as 'politically 2 What additional factors are relevant in explaining impossible"). why fuel taxes in the UK are seven times the level in This seems odd. Supposing that actual and the USA? projected public spending justified higher taxation, 3 Why are fuel taxes an inefficient way of reducing Mr Parry's analysis strongly suggests that the country traffic congestion? would have been better off paying for it through 4 Given that fuel taxes are higher in the UK than income taxes than through a punitive petrol tax. And the rest of Europe, what implications does this the petrol tax is not only wasteful in economic terms, have for UK firms competing with European if Mr Parry is right; it is also regressive in its ones
