Monday, February 26, 2007

The Gas Tax-Pigovian?

In this post from the Only Republican in San Francisco, and as many in the blogging world know, Greg Mankiw has been advocating a pigovian tax on gasoline. My collaborator over at The Economics of Sports, is a strong advocate of this type of tax. There is of course, the reaction.

I think the pigovian tax is state coercion dressed up in a warm fuzzy, environmentally sensitive dress. Mankiw lays out his arguments. To sum Mankiw lays out seven reasons to support a $1.00 increase in the gas tax.

1. The Environment
2. Congestion
3. Regulatory Relief
4. The Budget
5. Tax Incidence
6. Economic Growth
7. National Security

Let us look at these one by one. The first argument is that by raising the tax on gasoline, consumption will be reduced and will spur the development of alternatives (supposedly "greener"). The central premise of this argument is that carbon and the byproducts of petroleum consumption are a significant. I don't think anyone who would argue against the ideas that burning petrol is a relatively dirty business. I believe the case for CO2 as a big global warming driver is much weaker due to the relatively low radiative forcing value for C02 compared to other gases such as H20 and methane.

But as Professor Mankiw should know, the cost must be less than the benefit. And it is actually pretty unlikely that a $1.00 increase in the gas tax will do much to reduce consumption. We have already had an increase of well over a $1.00 in the price consumer's pay at the pump, with very reduction in consumption. Is there a magic tipping point at $3 a gallon? $3.50... who knows, but based on the empirical evidence, we know gasoline is a highly inelastic product, and a $1.00 increase in the tax will likely do very little to change that fact. Secondly, by increasing the price of gasoline via a tax, the government is also reducing the price incentives that would be communicated by the market, reflecting actual issues of scarcity and cost. For instance, so even if gas is an elastic good, the price indicator loses some its value when it is distorted by a tax. It is the same reason, many economists oppose taxes in general, because it distorts the workings of the market. Why gasoline would be any different.... remains a mystery to me.

Congestion: The congestion argument is really the same argument as the consumption argument. People will drive less, therefore congestion will decrease. For the same reason a higher gas tax won't reduce consumption, it is highly unlikely that it will do much for congestion. I believe that this has a lot to do with the relative cost of gasoline related to income and that people's homes and jobs are a fixed variable in the short-run, and therefore congestion will not change. In anti-car cities such as Portland, which purposely build less roads and in fact narrow roads to make congestion worse (basically raising the cost of driving), has done little to help with congestion. Raising the cost yet again, is highly unlikely to change American housing preferences and do little to reduce congestion.

Regulatory Relief: Professor Mankiw is treading on weak ground here. He is arguing that a large increase in the gas tax would eliminate CAFE standards, which distort consumer choice. He is right, CAFE standards do, and should be rightfully eliminated on their own merit. If the good Professor believes government would do something so sensible, he has more faith in it that I do. Regulations and agencies never really die. If a gas tax went through it would no doubt be accompanied by an increase in CAFE standards on the basis of an environmental and anti-consumption argument.

Budget: The classic line, we need to raise taxes to close the future budget deficits. Really? Why stop with the gas tax? Why not raise income taxes? Impose a VAT... etc etc etc... the answer to the budget issue is to cut spending, and grow the economy, not raise taxes.

Tax Incidence: Professor Mankiw rests his argument again, that higher prices in the US will reduce consumption. Maybe... maybe not. For one, consumption needs to fall, and unfortunately for the good Professor, oil operates in a global market. IF US consumption did fall, what makes anyone think that other nations will not take advantage of the lower prices to increase consumption. Still, the end result is that the consumers are paying higher prices... hard to see how a net increase of 80 cents as opposed to a dollar... is a great deal.

Economic Growth: Yes, consumption taxes are preferable to income taxes. Agreed. BUT and here is the big but, this rests on the argument that congress will offset a gas tax increase with a decrease in the income tax... which, based on past history is highly unlikely. Increasing the costs of transportation throughout the system, likely will lead to lower economic growth and a general increase in prices... the net result.. is a negative for the economy.

National Security: This is the one argument that conservatives latch on to. We need to stop sending our oil money to Hugo Chavez and the terror supporting Saudis... right?? Raising the tax will do that? Really? Lets accept that the price of oil begins to fall, due to a decrease in consumption (which we already known is pretty darn unlikely)... which fields go first? Well, as we know from Econ 1A producers like to produce where the marginal revenue is equal to the marginal cost... so the highest marginal cost fields will be shut first. Want to guess where those are located? BIG HINT: It isn't in Saudi Arabia or Iran... so, in other words, the higher cost of gasoline, coupled with lower overall oil prices as suggested by Professor Mankiw, will only make the national security situation worse by increasing our reliance on Saudi and other middle eastern oil producers... oops.

The net of all this: The gas tax is a bad idea. An increase in government power via a regressive tax, will do nothing to enhance our national security, nor will it likely help the environment, or encourage alternative energy sources. The gas tax, dressed in pigou clothing is not the free market panacea that its supporters would have you believe. It is a statist solution, that induces government coercion to change private behavior.

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