Friday, May 30, 2008

The Right Nudge

I've covered the idea of a government-set floor price for petroleum several times in the last couple of years, so I didn't immediately feel obliged to address the latest such proposal from Tom Friedman in yesterday's New York Times. Enough readers sent me links to his column to convince me that it merited another look. The idea of setting a $4.00 per gallon floor under the average retail price of gasoline in the US has far fewer drawbacks than the previous crude oil floor price proposals I have reviewed, particularly in combination with a suggestion for minimizing the impact of this regressive tax on lower-income Americans. But while it's worth examining it both conceptually and in terms of the mechanics of implementation, it must also be considered in the context of other proposals concerning our use of energy. In that respect it comes up short.

The main benefit of setting a fixed floor under the price of gasoline is that it would reduce uncertainty about future prices. Uncertainty is the enemy of action, and informed consumers must surely be torn between two huge uncertainties about oil prices that have recently been dueling in the media. On the one hand, they are confronted by opinions--backed by some evidence--that global oil supplies are approaching, or have already reached, a plateau beyond which they cannot be increased to meet rising demand, and from which they will eventually decline. Adherents of the Peak Oil Meme see $130 per barrel oil as a bargain, compared to what it might cost in a year or two. Meanwhile, other observers suggest that oil may be experiencing a speculative asset bubble, as investors flee to non-perishable commodities for safety from weak stock markets, low bond yields, and the sliding dollar. The Congress heard testimony to that effect last week. If you accept the Oil Bubble Meme, crude could be back under $70 within a year. How should the average consumer decide which view to believe, in deciding whether to replace that gas-guzzler with a hybrid? A floor price resolves at least half of that uncertainty.

Implementing a gasoline floor price tax would involve several key decisions, including whether to set it nationally or regionally. Since local and regional price variations reflect disparate supply and demand factors--the most extreme examples being found in the California market--any such tax should be imposed as a flat addition to the existing 18.4 cent per gallon federal gasoline tax, so as to avoid creating local distortions. An even more serious question is whether it should only apply to gasoline. The best answer appears to be yes, for now. The price of diesel fuel has a strong, direct effect on economic activity, including agriculture and freight, and propping it up with a tax would reinforce its contribution to consumer price inflation. If singling out gasoline for a floor price resulted in consumers switching to more efficient diesel cars, or to cars running on LPG, natural gas, or other alternative fuels, that wouldn't be a bad thing, unless it created an offsetting rebound in vehicle miles traveled.

How should we determine the right level for such a floor price? A year ago, Mr. Friedman thought $3.50/gal. appropriate, when the average US retail price of unleaded regular gasoline was $2.19/gal. Today, with the average pump price only pennies below $4.00, he sees that as the right target, based on the demand destruction it has triggered. From my perspective, a floor has a better chance to succeed if it is set below the current price level, at least initially. Even $3.50/gal. would send a strong signal that consumers would never again see last spring's $2.50/gal. And if oil is in a bubble, and it did revert to $65/barrel, a floor price tax set at $3.50 could ultimately generate more than $1.00/gal. of revenue, or upwards of $142 billion per year, basis last year's consumption. That raises the equally thorny question of what to do with the revenue.

Because of the uncertainties affecting the fuels market, there is no reliable way to predict whether a gas price floor tax would generate any revenue, some, or a huge amount. So it would be hard to use it to fund a specific initiative, such as payroll tax relief or alternative energy R&D, unless it were done retrospectively, based on the previous year's tax receipts. However the government chose to use the proceeds, it would create a new constituency for this tax, with an interest in ratcheting up the level of the floor price over time, if oil prices rise, to keep the money flowing. That might eventually turn a floor price tax into a European-style fuel tax, and that's where my discomfort with the whole idea really kicks in.

I have generally opposed higher taxes on fuel, originally on principle but more recently because I believe setting a price for greenhouse gas emissions would kill two birds with one stone, and the right bird first. Getting our emissions under control will automatically address our energy problems, but the reverse isn't necessarily true. Although a floor price on gasoline wouldn't inherently conflict with the kind of federal cap & trade system for greenhouse gas emissions that is about to be debated in the Congress, the political prospects of enacting both seem poor, and setting a value on carbon emissions is a higher priority than enacting a floor price tax that might never be triggered. Only if cap & trade or its cousin, the carbon tax, proved entirely unworkable should the floor price tax rise to the top of the agenda.

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