Published on Let's Talk Development

Gasoline and Other Fossil Fuel Taxes: Why Are They Not Used?

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When I moved from Norway to Washington with my family almost seven years ago, I went from paying more than $8 per gallon for gasoline in Oslo, to around $3 per gallon in the U.S. Our house is close to a bus stop for getting to the Metro, but the bus service is unreliable.  Here is a first-hand illustration of how the price of gasoline affects people’s behavior.  It is inexpensive to drive, so relatively few people are strongly dependent on bus service; with limited ridership there is less call for more reliable bus service and less money available to provide it.  Where it is more expensive to drive, there is greater demand for higher-quality service and lower demand for more fuel-intensive cars.  And fewer people want to live far away from their jobs or schools, or in very large dwellings that are costly to heat and cool.  Our work in energy and environmental economics confirms how economically sound energy pricing is crucial for inducing more efficient behavior.

In many other countries, including many far poorer than the U.S. or Norway, energy prices are even lower, often below production cost. When energy costs are that low, it becomes difficult to elevate energy efficiency targets to a high level of priority for society, to get support for projects that improve the efficiency of energy use, and implement projects for alternative energy development. Such projects are simply not seen as economical, when ordinary fossil energy is cheap to purchase (though not cheap for society as a whole to use). There are thus compelling economic and environmental rationales to abolish energy subsidies, in developing as well as developed countries.  Going further by imposing energy taxes may well be sound policy, both fiscally and environmentally, assuming that there are adequate mechanisms for enforcement, and for compensating any low-income groups that may lose out from higher energy prices.

These issues have their counterparts in debates over different strategies to reduce greenhouse gas emissions at a global level.  Until recently those debates have focused strongly on negotiating national limits on the quantity of total greenhouse gas emissions – a national “cap” – and then allowing for different forms of “emissions trading,” whereby those with low costs of emissions reduction can over-comply and sell surplus emissions “permits” to others with high cost of compliance.  The alternative idea of coordinating fossil fuel taxes to reduce emissions across countries has been raised in analytical work, but largely ignored in international negotiations, mainly because it is viewed as politically infeasible.  One often-overlooked point is that concerted application of fossil energy taxes by energy-consuming countries can lower high energy prices charged by large producers with market power, by reducing global demand.  The revenues gained from such taxes are paid for in part by the reduction in windfall revenues from the exercise of market power in energy markets.  This effect does not occur when an international cap-and-trade scheme is used.  The coordinated tax approach does however lead to so-called leakage, since lower world energy prices cause demand and emissions to rise in non-participating countries, and it lowers revenues of all energy exporters, not just those exercising market power.  However, leakage arises as well under cap-and-trade.  Some of these effects are documented in a recent paper of mine.
New energy taxes are politically difficult to implement, in the U.S. and many other countries today. Cap-and-trade proposals have been somewhat more successful, but even these typically suffer from a major weakness:  most of the emissions quotas are planned to be handed out for free, providing a windfall to emitters at the expense of the general public.  Governments forego revenue that could be used to reduce other taxes to improve economic performance, provide additional social services to the needy (including assistance with higher energy bills), and finance energy R&D.  

My hope is that such policy changes could be viable options down the road. For the U.S. it is useful to remember that the average gas mileage for private vehicles remains around 23 miles per gallon, not much higher than it was 20 years ago. In Europe, by contrast, where fuel taxes and prices have been set at much higher levels, average mileage is up to 35 miles per gallon; and Europeans drive only half as much on average as Americans, with about the same average incomes.  The U.S. today consumes almost half of all gasoline globally, with only about one third of all cars.  It is easy to relate this to the great difference in gas prices, recently between 3 and 4 dollars per gallon in the U.S., versus more than 8 dollars in many European countries. Today, gasoline consumption and the number of cars in countries such as China and India are increasing rapidly, with fuel prices similar to those in the U.S., and thus lower than in other advanced countries.  Emerging countries will add an increasing burden to global fossil energy demand and global greenhouse gas emissions, which could become very large if their energy prices and tax policies are not changed, along with implementing necessary measures for more compact urban development and mass transit. Otherwise, those countries will join the U.S. in being locked into excessive reliance on private vehicles.


Jon Strand

Economist and World Bank consultant

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