A Tale of Two Taxes

Whether they are called “revenue enhancements” or “user charges,” fear of the political consequences of taxes restricts debate on energy and environmental policy options in Washington. In a March 7th post on “Green Jobs,” in which I argued that it is not always best to try to address two challenges with a single policy instrument, I also noted that in some cases such dual-purpose policy instruments can be a good idea, and I gave gasoline taxes as an example.

Although a serious recession is clearly not the time to expect political receptivity to such a proposal, the time will come — we all hope very soon — when the economy turns around, employment rises, and a sustained period of economic growth ensues. When that happens, serious consideration should be given to increases in the Federal tax on gasoline.

A gas tax increase — coupled with an offsetting reduction in other taxes, such as the Social Security tax on wages — could make most American households better off, while reducing oil imports, local pollution, urban congestion, road accidents, and global climate change. This revenue-neutral tax reform would exemplify the market-based approaches to environmental protection and resource management I examined in previous posts.

Such a change need not constitute a new tax, but a reform of existing ones. It is well known ­– both from economic theory and numerous empirical studies ­– that taxes tend to reduce the extent to which people undertake the taxed activity. In the United States, most tax revenues are raised by levies on labor and investment; the resulting reduction in these fundamentally desirable activities is viewed as an unfortunate but unavoidable side-effect of the need to raise revenue for government operations. Would it not make more sense to raise the revenue we need by taxing undesirable activities, instead of desirable ones?

Combustion of gasoline in motor vehicles produces local air pollution as well as carbon dioxide that contributes to global climate change, increases imports of oil, and exacerbates urban highway congestion. Can anyone really claim that — given a choice between discouraging work and discouraging gasoline consumption — it is better to discourage work?

According to the U.S. Department of Energy, a 50 cent gas tax increase could eventually reduce gasoline consumption by 10 to 15%, reduce oil imports by perhaps 500 thousand barrels per day, and generate about $40 billion per year in revenue.

Furthermore, this approach would be far more effective than on-going proposals to increase the Corporate Average Fuel Economy (CAFE) standards, which affect only new vehicles and lead to serious safety problems by encouraging auto makers to produce lighter vehicles. Also, remember that a major effect of CAFE standards has been to accelerate the shift from cars to SUVs and light trucks (so that overall fuel efficiency of new vehicles sold is no better than it was a decade ago, despite the great strides that have taken place in fuel efficiency technologies). As my Harvard colleague Martin Feldstein pointed out in The Wall Street Journal in 2006, the conventional approach “does nothing to encourage individuals to drive less, to use their cars more efficiently, or to shift sooner to new and more fuel efficient [and cleaner] vehicles.” A more enlightened approach ­— a market-based approach — would reward consumers who economize on gasoline use. And that is what a revenue-neutral gas tax is all about.

The revenue from the gas tax could be transferred to the Social Security Trust Fund and credited to current workers. If $40 billion per year from new gas tax revenues were transferred to Social Security, the payroll tax — the employee contribution to Social Security — could be cut by perhaps a third: a worker with annual wages of $30,000 would take home an additional $750 per year! The extra income would more than offset the cost of the gas tax, unless the worker drove over 35,000 miles per year in a car getting 25 miles or less per gallon. Rebating the gas tax in this way addresses the greatest concern about higher gas taxes — that they can hit hardest those workers who drive to their jobs. Further, a tax of this magnitude could be phased in gradually, perhaps no more than 10 cents per year over 5 years, allowing individuals and firms to adjust their consuming and producing behavior.

Proposals for gasoline tax increases in recent sessions of Congress would have dedicated the revenue to public spending (for transportation and other programs). A key difference is that the proposal I have outlined here is for a revenue-neutral change in which the gas tax revenue would be returned to Americans through reduced payroll taxes. To adopt some of the language I developed in my previous posts, such a change can be both efficient and equitable, and — for those reasons — perhaps even politically feasible.

Of course, such a scheme is not a panacea for U.S. energy and environmental problems. But it would make a significant contribution if enacted. On the other hand, political fear of the T-word in Washington may mean that it is never discussed seriously in public, let alone adopted. Most fear of taxes is due to politicians’ anxieties about asking their constituents to pay more. But an increase in the Federal gas tax, rebated through reduced payroll taxes would not cost most Americans any more and would have significant long-term benefits for the country. Still, fear of the T-word looms large; maybe it should be called an “All-American Ecologically Sound, Fully Recyclable, Anti-Terror, Energy-Independence Assessment.”


Author: Robert Stavins

Robert N. Stavins is the A.J. Meyer Professor of Energy & Economic Development, John F. Kennedy School of Government, Harvard University, Director of the Harvard Environmental Economics Program, Director of Graduate Studies for the Doctoral Program in Public Policy and the Doctoral Program in Political Economy and Government, Co-Chair of the Harvard Business School-Kennedy School Joint Degree Programs, and Director of the Harvard Project on Climate Agreements.

8 thoughts on “A Tale of Two Taxes”

  1. Rob:

    What do you think of taxes on VMT or what our own MA DOT is now calling “fee-bates”, i.e., differing registration fees based on carbon efficiency?


  2. In the “great minds think alike” department, I published a similar piece recently:
    http://www.rockymountainnews.com/news/2008/dec/31/blomberg-a-tax-neutral-way-to-lessen-fossil-fuel/ .

    I have several further comments:
    1. A VMT tax would be far more palatable if it included a vehicle weight multiplier to account for the damage to roads and obstruction to traffic flow that larger vehicles cause.

    2. A higher gasoline tax would reduce oil consumption to be sure, but might increase the % of imported oil, if that oil is cheaper to extract than is domestic. But I think that’s a “who cares.”

    3. The reduction in consumption will immediately be felt on the worldwide crude market (oil is fungible). This in turn should put **downward pressure** on the benchmark price, in effect rebating some of the gas tax (or seen another way, shifting that tax to OPEC). This would make such a revenue-neutral shift a net revenue-positive, and accrue to the overall wealth of the US, and probably help us in the foreign policy department, since many oil exporters are quasi-enemies and dictatorships.

    4. My proposal was more acute than Dr. Slavins’ was – I had the tax starting around $2/gallon. This should result in severe enough reductions in consumption and pollution that things like CAFE could be **eliminated,** thereby resulting in savings of not having to administer that.

    5. This tax shift would reduce the cost of hiring labor (just what the doctor ordered in these times of high unemployment) and produce a natural demand for high-mileage vehicles, just what Detroit also happens to need right now. The current ideas about buying back old clunkers and providing tax credits for hybrids, plus the cost of administering such programs, could be done away with as the market would be self-sustaining w/o any extra help.

    On a related issue, here is another piece where I propose a revenue-neutral shift between property taxes (local level) and carbon energy (electric, gas, propane, heating oil) consumed on the property:
    Again, space limited the detail I could present, and there would be many details to haggle over in implementing this, but the benefits would be great, market-oriented, and self-sustaining. This program too would move us closer to being able to eliminate complex rebate and tax schemes which require monitoring and are always subject to abuse.

  3. Interesting article.

    Here in the UK the government introduced a new taxation scheme based upon emissions after 2001. This has worked to a certain extent very well until 2006 when they decided to rack up the cost of taxation on vehicles even more on anything with high Co2 output to such a rediculous amount it has caused the car market to suffer.

  4. We’ve also had fuel duty (a tax on gas) since the 1920’s in the UK. All it has done is increase the cost of living. Food, Clothing, Consumer Goods, Raw Materials, … they all need to be transported.
    The Goverment has tried encouraging people to get our of their cars and use public transport, buy ‘green cars’, walk / cycle more – none of it has worked.

    It is a fair way to charge for using the road but it does come at a cost to your economy.

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