Full Disclosure on Fuel Taxes

A pair of opinion pieces in yesterday's New York Times addressed the merits of taxing energy from entirely different perspectives. But while their conclusions weren't quite diametrically opposed, the unconventional views in an op-ed on recycling the revenue from a carbon tax struck me as ultimately much more practical than the entirely predictable viewpoint of a Times editorial lamenting the results of our lack of European-style fuel taxes. Unfortunately, neither one highlighted the role of fuel taxes in reducing consumer uncertainty about future fuel prices, rather than just reducing current consumption. This issue will become a lot less academic, when the Congress takes up the question of a cap & trade system for greenhouse gas emissions, this year or next.

The Times editorial emphasized the shortcomings of the current administration's focus on increasing supplies of conventional energy, instead of curbing consumption, citing the contribution of higher energy taxes in making "other rich countries...more energy-efficient across the board." The projected 2 million barrel per day reduction in projected oil demand expected from the 2007 Energy Bill's fuel economy provisions didn't impress the editors.

Suppose that President Bush's first act in office in 2000--or more plausibly in the immediate aftermath of 9/11--had been to raise motor fuel taxes by $2.00 per gallon. Consumers would have seen average retail gas prices at $3.50/gal. at least seven years sooner than otherwise, and US oil consumption might have leveled off at 2001's 19.7 million barrels per day instead of the recent 20.7 million. However, oil prices wouldn't have stood still. Lower demand growth from the US might have slowed oil's upward trajectory, but some of the slack would have been taken up by the other growth factors cited by the Times. So oil might now be $10 per barrel lower, but instead of $3.25 per gallon, US consumers would be paying $5.00. That seems a better fit with the Times' characterization of "Pain at the Pump."

Now consider the European fuel taxes extolled by the Times. Europeans don't drive smaller cars because fuel prices are higher than here, today. They drive smaller cars because their fuel prices have been high for as long as anyone can remember. Any American who has ever rented a car in Europe, or lived there, as my family did in the 1960s and as I did again in the late '80s, understands that. It's no accident that the "muscle car" in the recent "retro" hit series on the BBC, "Life on Mars," was a 4-cylinder 1974 Ford Cortina--a far cry from a comparable US Ford of similar vintage. European refiners pay essentially the same price for crude oil as ours do, and they receive a similar margin, but for decades European governments have imposed fuel taxes that have typically exceeded the raw materials cost of the fuel. The result has been much greater predictability for consumers. Every car buyer in the EU knows that even if oil were $20/bbl cheaper next year, the price of fuel wouldn't change by enough to make a gas guzzler--or a 100-mile daily commute--a good choice.

Now, the US isn't about to impose a $2.00 per gallon gasoline tax. However, the end result of a cap & trade system or a direct carbon tax might not be as far from that as you might think. With all three presidential candidates talking about carbon caps that would reduce emissions by somewhere between 60% and 80% of their current level by 2050, it's a good bet that the price of the emissions permits in the accompanying trading system would have to be a lot higher than $20 per ton for many years, perhaps over $100 per ton, as some studies have shown. And because oil refineries are unlikely to receive grandfathered emissions allowances under any of these proposals, including the current Lieberman-Warner Bill, $100 per ton of CO2 will translate more or less directly to an extra $1.00 per gallon at the gas pump.

Americans' vehicle preferences and the larger issue of annual vehicle miles traveled won't change overnight, even with the prospect of cap & trade. If we want to get the maximum benefit from policies such as this, which if still not quite inevitable have at least become entirely plausible, then we ought not to wait for consumers to be shocked when they are enacted and cause gas prices to go up. We should be candid with them now about the likelihood of higher fuel prices in the future. At the very least, we should warn them not expect retail gasoline or diesel prices to decline for more than short periods over the useful life of the next car they will buy. By itself, that could hasten the global convergence of car models that some analysts expect, while beginning the harder task of nudging our lifestyles away from choices such as long-distance commuting that will make a lot less sense with eventual $5 per gallon gasoline.