For fossil-fuel taxation

Gasoline demand is pretty inelastic in the short run, much more elastic in the longer run. And the producers wind up paying some of the tax.

Atrios says a gasoline tax isn’t such a good idea because demand for gasoline is highly inelastic. I’m pretty sure that’s not right. I don’t have the paper handy, but as I recall studies of the 1973 crunch showed that the short-run price-elasticity of demand for gasoline was about -0.1. But over five years, as people bought smaller cars (today, of course, they could by hybrids), and either moved closer to work or found jobs closer to home, the elasticity was rougly 1.0: a 10% increase in gasoline prices decreased consumption by about 10%.

Much more importantly, that assumes that all of the tax increase is paid by consumers. That’s almost certainly wrong. U.S. gasoline consumption is a big piece of world oil consumption. As prices go up and the quantity consumed falls, the equilibrium price of a barrel of crude falls, too. So some of those taxes get paid by owners of oil-wells in the U.S., and some of them get paid by, just for example, Saudi Arabia, Iran, and Russia.

Gasoline, or even petroleum, is probably the wrong thing to tax; it would be better to tax fossil fuels generally by putting an effluent fee on carbon emissions.

Author: Mark Kleiman

Professor of Public Policy at the NYU Marron Institute for Urban Management and editor of the Journal of Drug Policy Analysis. Teaches about the methods of policy analysis about drug abuse control and crime control policy, working out the implications of two principles: that swift and certain sanctions don't have to be severe to be effective, and that well-designed threats usually don't have to be carried out. Books: Drugs and Drug Policy: What Everyone Needs to Know (with Jonathan Caulkins and Angela Hawken) When Brute Force Fails: How to Have Less Crime and Less Punishment (Princeton, 2009; named one of the "books of the year" by The Economist Against Excess: Drug Policy for Results (Basic, 1993) Marijuana: Costs of Abuse, Costs of Control (Greenwood, 1989) UCLA Homepage Curriculum Vitae Contact:

21 thoughts on “For fossil-fuel taxation”

  1. Kevin Drum has different take on price elasticity – it was CAFE
    In terms of elasticity studies, it is important to separate oil elasticity from energy elasticity. Because we do not want to simply end up switching to coal based fuels or biofuels. (A lot of biofuels end up with poor net carbon reductions.)
    I like the following because it separates oil and energy elasticity, and also income and price elasticity. It finds good oil elasticity, good income elasticity, but poor response of energy demand to price alone.
    Page 23 – table 7
    (Note I've stripped the protocol out of URLs – let us see if it posts.)

  2. You are certainly right to point out that long-term elasticities are much higher than short-term elasticities. But even once you have overcome that objection, you're going to have a hard time using climate change to justify the level of gas tax increases to which you are ideologically inclined.
    If you look at estimates (a la Nodrhaus or Stern) of the "social cost" of CO2 emissions and convert them into dollar/gallon gasoline taxes, you find values between 2 cents/gallon and 65 cents/gallon. In other words, even the most extreme estimates of the impact of CO2 emissions don't justify a Pigou tax much different from the level of gasoline taxes we already have.

  3. On the other hand, if you're looking for revenue, there are advantages in taxing something with inelastic demand.

  4. Actually, I guess one of the points is that of elasticity in response to income changes is high, and elasticity in response to price changes is low, and income is rising, then income elasticity will tend to overwhelm price increases until income starts falling.
    If we don’t this kind of response that is a very good argument for not relying on prices. I will note that RAND also thinks price elasticity is low – while acknowledging that low real prices until recently make this kind of judgement difficult.
    One last point from the first study, is that price elasticity may be low, but it is asymmetrical in a way with good implications. Once demand drops, a lowering of price usually does not bring an increase. In other words, while elasticity is low, what you do gain tends to stick.

  5. I worked on CAFE in the 1970's, and it wasn't CAFE. CAFE was not necessarily a bad policy, but it was prudent preparation for higher gas prices, not a policy with much chance of actually reducing gas consumption.
    What we found out was that it is as Mark says, while the very short-term elasticity of demand for gasoline is very low, because people have gas consumption built into the structure of their lives: where they live and where they work and how they get from one to the other, the long-term elasticity of gas is quite high.
    And, it isn't just that people will buy a more economical automobile, although that's a large part of it. There are also some subtle, but very important changes in behavior. It turns out miles per gallon is extremely sensitive to how people drive; when gas prices have been high for a while, people will learn to give up acceleration for economy, and that makes a huge difference in gas consumption. You can reductions of 5-10% without changing the fleet at all, and 15-35% with changes in vehicle design, without any other improvement in technology. Right now, our most efficient automotive technologies — hybrids — are designed for great acceleration performance, and not fuel economy, so increasing hybrids in the fleet does not reduce gas consumption at all. This kind of story is pervasive in a low gas price environment.
    In the long-run, of course, in a high gas price environment, all kinds of changes start happening, Hayek-like, across the economy. People move closer to work; people stop going to work and use the internet; people start campaigning for better public transit; work moves closer to where people live; railroads prosper and long-haul trucking suffers.
    The same wisdom applies to a fossil fuel tax or carbon effluent tax. People adapt. Elasticities in the very long run tend to be large and larger.
    As to whether the equilibrium price of crude falls, I have some doubt. There is that peak oil thing. OPEC has an incentive to keep the world addicted, even if the planet fries to a crisp, and that means managing the price. But, there really is not much slack in the world oil market, and probably is not going to be much. Liquid petroleum fuels are way too handy for too many uses in comparison to existing alternatives. And, every conceivable alternative is going to be relatively expensive, probably forever. So, why I would not expect a permanent high plateau price absent taxes, I also would not expect taxes to drive down the price all that much, certainly not as much as happened in the 80's and 90's. Peak oil is here to stay.

  6. In the department of unintended consequences: you can imagine a situation in which a carbon tax increases oil imports. Suppose that you want the carbon tax to both a) reduce greenhouse emissions and b) reduce dependence on foreign oil. Suppose also that the demand for gasoline is elastic, but the demand for *BTUs* is inelastic (e.g., that power plants can shift fuels, that consumers can switch from gasoline engines to charge-from-the-wall electric cars). Under a carbon tax, coal users—paying for over 200 carbon units per BTU—would switch over to gas (120 carbon units per BTU) or petroleum (160-ish carbons per BTU) to get the same amount of power.
    That's great from a global warming perspective, but, if I understand correctly, bad from a energy-independence perspective, since the US mines coal but imports petroleum and natural gas. I don't think the assumptions actually apply, but I just wanted to point it out.

  7. Look at the literature. It seems that the majority says long term elasticity is low for both energy and and oil. I chose the study I did because it is the most convincing case I could find for the minority viewpoint of people who have studied it – that oil has high long term elasticity. But it did that by claiming asymmetry, so that *energy* demand remains highly inelastic. Studies based *only* on the early 70's often conclude that long term elasticity is high, but even there you not all them of think that. Studies that consider more than just the one oil shock overwhelming come to the conclusion that long term elasticties are low. Most of them think the oil shock period was an exception, exacerbated by poor economic performance. (Yes, the oil shock was one cause of that poor economic peformance; but that is not normally what we mean by elasticity.)
    Now this is a majority view, not a consensus. But more studies show long term price inelasticity, than long term elasticity.
    A decent review of literature from 2004:
    Follow up the studies here, and you can see most of the dispute.
    Incidentally, I don't think anyone questions that income elasticity and price elasticity are different. Common sense supports this. As real income rise: if energy prices don't change your demand for energy goes up. Real income rises: if energy prices also rise, the income rise neutralizes at least some of the effect of the price rise on your demand. Further, as income rises, disposable income as a percent of total grows. That reduces sensitivity to price increases in stables even more. That is not even part of the debate, but taken for granted by all sides.

  8. Energy demand may well be inelastic in the long-term, for fundamental reasons, but gasoline demand is elastic in the long-term, and carbon emissions demand is long-term elastic as well.

  9. I'm a planner, and I prefer microecon. When I view the literature on elasticities, I'd like to see more attention paid to the behaviors that Bruce Wilder outlines in his excellent comment. In my view, the literature doesn't capture possible behavioral adaptations well enough to predict elasticities (I'm happy to be incorrect, BTW).
    In fact, we design built environments to enable just the Hayek-like reactions Bruce outlines – I'd also add carpooling, chaining trips, eliminating frivolous trips, choosing non-motorized transportation to his list. These are things that folks do today and why we plan for them, and what others can easily do in the future.

  10. It's cheap and easy to administer an increase in the gas tax, but even if you double my gasoline-per-mile cost you haven't changed my driving behavior much. And you don't give me any incentive to take account of the externalities of what I am doing, in driving at prime commute hours, etc. That's where folks squander really big amounts idling in traffic jams, and push up demand for peak road capacity.
    Tolls can enable much better match between the incentives and what you want to encourage people to do. Tolls used to be dreadful, because any analysis said the deadweight loss of road users waiting in line to pay was far greater than the utility gained – technology has changed this, you can put a bar code on each car and get a bill every month. And Stockholm, Singapore, and London have shown that people will change their behavior in the ways Dan Staley identified above, and which will lower consumption dramatically.
    Further, tolls help you get some money out of the guy burning fast food waste oil, driving a plug-in electric, etc., and it's fair that s/he should pay something towards road upkeep.

  11. Bruce and Dan
    There is something called 'Jevons Paradox' ? I think that basically says that energy conservation is a zero sum game– more efficient cars are driven further, families have more cars (converging on 1 per household per over 16 year old), people move further out, take more trips etc.
    I suspect that gasoline prices have to move a lot, because income substitution overwhelms energy efficiency gains.
    My data point, such as it is, is here in the UK. GDP per head is 60% of the US level (PPP the last time I checked *not* current exchange rates), gasoline prices are something north of $6US/gallon. (90p a litre).
    Yes we drive more efficient cars (in particular, half of new cars are diesels, even though refinery constraints mean diesel is 3-4p/litre more expensive). Only 1/12 cars sold is an SUV (and many are what you would call 'crossovers').
    But we drive our cars *hard*: 90mph on the motorway is not unusual. We have the worst traffic congestion in western Europe, but when we can drive fast, we do.
    We drive shorter distances, but this country is 700 miles long so not a lot bigger than NY-New England (and 85% of us live in the lower half of it).
    The net result is we have something like a 40% better fuel economy.
    So double the price of gas, reduce incomes, and still get only a 40% better fuel economy.
    *that* is the scale of the mountain to climb, and why I think the US needs general carbon taxes (to find efficiencies in the whole economy) and not just to focus on driving.

  12. > It's cheap and easy to administer an
    > increase in the gas tax, but even
    > if you double my gasoline-per-mile '
    > cost you haven't changed my driving
    > behavior much
    I hear this quite a bit in gas tax discussions. If true, it pretty much blows away all of standard microeconomic theory, so it seems to me that there should be a bit more discussion of this point!

  13. That is why we all need efficiency regulations in addition to carbon taxes. (I'm not against carbon taxes, just think the phase should start about five years after infrastructure work begins.)
    So we need CAFE. We need to upgrade bus systems (cause that is something we can do quickly). We need to put in ultra-light rail (which is longer term). We need climate control standards in buildings. (You have tougher standards in the UK than we do, but they are not *enforced*. However nations like Finland have sucessfully enforced much tougher standard than you find in either the U.K. or the U.S.) We need tough appliance efficiency and office equipment standards. In industry we need standards for pumping, motors, and boilers, and refractories. We need standards for water use – because water efficiency save energy too (especially in industry). We need to tax incandescent light bulbs to the point where they cost more than fluorescent. We need more subsidies for Van and carpools.
    And a lot of these things we could subsidize in addition to requiring. I could list some others. There are about 100 things we could subsidize, require, or provide via public works that would produce major savings in five years, and another 100 that would produce major savings over a longer period. Once the five years are past, then kick a carbon tax. And since at that point you would have some alternatives in place, you can start it a a higher level – catch up for the five years you did not have it.
    The long term point is that you need a three legged stool – carbon taxes, regulation, and public works and subsidies. But contrary to conventional wisdom, regulation, and public works and subsidies can kick in more quickly, and you will get more response from carbon taxes if you have some infrastructure in place before you start charging them.

  14. I'm fairly OK with a CARBON tax; I really dislike increased GASOLINE taxes in response to carbon emissions, given that something like twice as much CO2 is emitted in the US by coal-burning power-plants as by personal automobiles.
    It often seems to me that proposals for a high gas tax have at least as much to do with dislike of suburbia as they do with reducing carbon emissions.

  15. Cranky: "If true, it pretty much blows away all of standard microeconomic theory . . ."
    People lie.
    Is that discussion enough for you, Cranky?

  16. >f true, it pretty much blows away all of standard microeconomic theory, so it seems to me that there should be a bit more discussion of this point!
    Umm – no. Macro-economic theory includes the possibility of low elasticities.
    For discussion of this particular case:
    Note though that low elasticity for energy in the short run is taken for granted by almost by everyone including Kleiman. The only dispute is how it shakes out in the longer term.
    (Also note that the commentator immediately above chose not to include a name – not even a pseud.)

  17. Sam Chevre
    I think you've hit the nail on the head. the UK has some of the highest petrol taxes in the world. It generates over GBP20 bn for our government every year.
    Because petrol is price inelastic, it makes a great tax revenue generator (public finance theory: best taxes have the smallest change in end consumer behaviour, and therefore the lowest loss of utility)
    but it does *not* have a big impact on emission (best emission tax: one which causes a big reduction in emissions for a low cost).
    Since most of the gains in reduction of CO2 will come from greater efficiency in energy use, and fuel mix shifts (eg in electric power generation), better to generally tax carbon within the economy, than to vilify SUV drivers in particular.

  18. Gar,
    I am aware of the theory of elasticities, the possibility that the demand curve is itself a function of time, and have even looked at demand curves with non-linear discontinuities (a loooong time ago, so please don't ask me to do it now!). To the extent that my question was faux-naive, I deserved a bit of snarkiness in return (although I agree that not even using a consistent nym to do one's snarking goes a bit far).
    But I stand by the non-snarky observation beneath my question: in any discussion of gas tax, there tends to be a very odd and not-discussed inversion where conservatives who normally trumpet classical microeconomics as the cure for everything decide that gas prices can't and don't influence behaviour, while ultra-leftists who deride classical microeconomics on every possible ground are suddenly converts to the iron law of supply and demand for this one issue only.
    In response to another poster: I personally don't like exurbs, but I acknowledge that most Americans disagree with me. And that given our current housing stock, this isn't likely to change over the next 50 years. To me the conversation is about whether it is really necessary to use a Hummer H2 to go get groceries rather than a Scion xB (the former gets 9 mpg, the latter 40 mpg – and they have very similar usable cargo space).

  19. >conservatives who normally trumpet classical microeconomics as the cure for everything decide that gas prices can't and don't influence behaviour, while ultra-leftists who deride classical microeconomics on every possible ground are suddenly converts to the iron law of supply and demand for this one issue only.
    But I'm pretty far to left, and very much questioning the primacy of markets and the iron law of supply and demand in this area. I'm suggesting we a combination of public works, regulation, and carbon taxes. The way to overcome inelasticity is add the other measures, to make policy a three legged stool. But I'm also arguing that contrary to popular neo-classical belief, that regulation and public works will yield the greatest results in the short term, with price changes having a more long term results.
    Someone noted that elasticity is not fixed in stone. (There is pun in there somewhere if you are willing to work hard enough at it.) That is right, the things that change it are regulations, public works and to some extent subsidies. Fundamentally phasing fossil fuels is an infrastructure change – once we understand that attic insulation and window shutters are as much infrastructure as railways. Infrastructure is always shaped by public decision making – Canals, railroads, highways, airports, electric utilities, sewage. And private infrastructure is very much shaped by public infrastructure. Our houses are very much shaped by the fact that designers count on electricity being there when we flip the switch, water being there when we turn the tap, and highways being there when we start our cars.
    Broaden the frame from abstract economics to how things actually get built, and you will see the public role in decision-making is unavoidable and goes way past price setting. (Note the public roles can take many forms. For example railroads were subsidized by grants of rights of way and public lands almost all of which was stolen from Indians. But the Federal government still decided the broad general route a railway would take.)
    OK – so why delay carbon taxes, and jump start with infrastructure? Because if you wait until at least some modest infrastructural changes have taken place you do change the elasticity, and thus get a much greater responsiveness to your carbon taxes. If there is an improved bus system available that actual gets better passenger mileage than cars, (or bet yet an ultralight rail system) , and the minimum mileage available in any new car is 40 mpg, people are going to have a lot more long term options in responding to higher energy prices.
    Incidentally in terms of nyms, I don't use a nym at all. The name you see is my real name – which may be foolish, but I started with my real name on the net back in the early 90's and my information is out there so many places that I don't think pseuds would do me any good at this point.

  20. Gar,
    I agree with you 101%, personally. I fear that is not where the political conversation is going though.
    In terms of nyms, I was referring to the 1:36 PM poster who didn't even bother making one up. I started using this one for my more controversial posts a few years ago to avoid job-related consequences. I have now used it so much that it seems to be fairly well-known on the political blogs, so I keep using it.

  21. Valuethinker:
    Jevon's paradox is true up to a point, but this presumes that folks have endless time to commute by living further out. This is not true. It is certainly true that some efficiencies are offset by the apparent lower cost of driving. But what happens – what you alluded to in your comment – is that there comes a point where mobility is impacted by so much driving. What we see here is certain segments of society moving back to cities because they are tired of driving everywhere.

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