Fuelling discontent23

How much should petrol be taxed?

The tax on petrol varies widely around the developed

world. America's gasoline tax is currently about 40

cents an American gallon, equivalent to 7 pence a

litre. Many Americans are calling for it to be cut, as the

summer increase in prices begins to make itself felt,

and reflecting a more general alarm about the

country's 'energy crisis'. In Canada the tax is half as

big again as in America; in Australia it is more than

double. In Japan and most of Europe, the specific tax

on petrol is around five times higher than in America,

standing at the equivalent of some 35 pence a litre. At

the upper extreme is Britain, where fuel duty (paid in

addition to value-added tax) has risen in recent years

to a punitive rate of just under 50 pence a litre, seven

times the American levy.

You would expect well-designed petrol taxes to

vary from country to country, according to national

circumstances - but not, on the face of it, by a factor

of seven. In America it is taken for granted that

Europe's petrol taxes, let alone Britain's, are insanely

high, and presumably something to do with

socialism. In Britain, on the other hand, it is taken for

granted that America's gas tax is insanely low, part of

a broader scheme to wreck the planet. Protests in

Britain last year showed that petrol tax had finally

been raised all the way up to its political ceiling - but

nobody expects or even calls for the tax to be cut to

the American level.

America and Britain may both be wrong about the

gas tax, but it seems unlikely that they can both be

right. So how heavily should petrol be taxed? A paper

by Ian Parry of Resources for the Future, an

environmental think-tank in Washington, DC, looks at

the arguments.

The most plausible justification for taxing petrol

more highly than other goods is that using the stuff

harms the environment and adds to the costs of

traffic congestion. This is indeed how Britain's

government defends its policy. But the fact that

burning petrol creates these 'negative externalities'

does not imply, as many seem to think, that no tax on

petrol could ever be too high. Economics is precise

about the tax that should, in principle, be set to deal

with negative externalities: the tax on a litre of fuel

should be equal to the harm caused by using a litre of

fuel. If the tax is more than that, its costs (which

include the inconvenience inflicted on people who

would rather have used their cars) will exceed its

benefits (including any reduction in congestion and

pollution).

The pollution costs of using petrol are of two main

kinds: damage to health from breathing in emissions

such as carbon monoxide and assorted particulates,

and broader damage to the environment through the

contribution that burning petrol makes to global

warming. Reviewing the literature, Mr Parry notes

that most recent studies estimate the health costs of

burning petrol at around 10 pence a litre or less. The

harm caused by petrol's contribution to global

warming is, for the time being, much more

speculative. Recent high-damage scenarios,

however, put an upper limit on the cost at about

$100 per ton of carbon, equivalent to 5 pence a litre

of petrol. Adding these together, you come to an

optimal petrol tax of no more than 15 pence a litre.

JAMMED

High petrol taxes also help to reduce traffic

congestion. However, they are badly designed for

that purpose. Curbing the number of car journeys is

only one way to reduce congestion. Others include

persuading people either to drive outside peak hours

or to use routes that carry less traffic. High petrol taxes

fail to exploit those additional channels. As a result,

Mr Parry finds, the net benefits of a road-specific

peak-period fee (the gain of less congestion minus

the cost of disrupted travel) would be about three

times bigger than a petrol-tax increase calculated to

curb congestion by the same amount. Still, if politics

or technology rules out congestion-based roadpricing,

a second-best case can be made for raising

the petrol tax instead. According to Mr Parry,

congestion costs in Britain might then justify an

additional 10 pence a litre in tax.

This brings you to a total petrol tax of around 25

pence a litre. The pre-tax price of petrol is currently

about 20 pence a litre, so this upper-bound estimate

of the optimal tax represents a tax rate of well over

100% - a 'high tax', to be sure. Yet Britain's current

rate is roughly double this. On the same basis, of

course, America's rate is far too low (even a lower

bound for the optimal rate would be a lot higher than

7 pence a litre).

512 STRATEGY ANALYSIS

3. Managers may also anticipate consumer reactions to externalities and

take the necessary actions. Examples of situations where this was not done are

the Exxon Valdez oil spill and the Union Carbide disaster in India. In both cases

consumers saw these firms as uncaring about the externalities that they had

caused and much goodwill was lost, and ultimately customers also.

The final case study in the chapter involves the evaluation of the optimal

level of tax for petrol, based on the externalities involved. In practice, products

are often taxed for reasons other than externalities: they are convenient

sources of revenue. This applies to cigarettes and alcohol in particular. More

recently, speed cameras have come into use to target drivers for fines, which

essentially amount to a tax. Again, the introduction of cameras has largely

been for revenue reasons rather than for safety. All these cases tend to involve

inelastic demand; otherwise they would not be so attractive to governments as

a source of revenue. However, in their desire to obtain such revenue, governments

should not ignore the distorting effects on the market of the taxes

involved, even in the case of speeding fines.

12.5 Imperfect information

As seen earlier, there are two main aspects to this, incomplete information and

asymmetric information. These are not mutually exclusive categories, but in

the first case the main concern of the government is consumers' lack of

information, whereas in the second it is the fact that one party to a transaction

has more information pertaining to the transaction than the other.

Britain's rate, judged according to the

environmental and congestion arguments, looks way

too high - but plainly the British government has

another reason for taxing petrol so heavily. It needs

the money to finance its plans for public spending.

Politically, raising money through the tax on petrol,

protests notwithstanding, has proved far easier than

it would have been to collect the cash through

increases in income tax or in the broadly based valueadded

tax - or, for that matter, through congestionbased

road-pricing (always dismissed as 'politically

impossible').

This seems odd. Supposing that actual and

projected public spending justified higher taxation,

Mr Parry's analysis strongly suggests that the country

would have been better off paying for it through

income taxes than through a punitive petrol tax. And

the petrol tax is not only wasteful in economic terms,

if Mr Parry is right; it is also regressive in its

distributional effects, increasing the cost of living for

poor car-owning households much more than for

their richer counterparts.

At last, Britain has found the political ceiling for the

petrol tax. What is remarkable is just how high it

proved to be.

Questions

1 What are the economic reasons for fuel taxes being

different in different countries?

2 What additional factors are relevant in explaining

why fuel taxes in the UK are seven times the level in

the USA?

3 Why are fuel taxes an inefficient way of reducing

traffic congestion?

4 Given that fuel taxes are higher in the UK than

the rest of Europe, what implications does this

have for UK firms competing with European

ones?