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Would a Carbon Tax Make Higher Gasoline Taxes Unnecessary?

As I argued in an earlier post, any serious effort to bring deficits under control must entail finding additional sources of revenue.  The prospect of new taxes is never pleasant, of course.  But if tax we must, why not kill two birds with one stone by taxing activities that cause harm to others?  By eliminating waste, such taxes actually make the economy more productive.


In addition to being urged to tax carbon directly, President Obama has also been urged by the New York Times editorial board and others to adopt steeper taxes on gasoline.   In contrast, Matt Yglesias of the Center for American Progress and others argue that a carbon tax (or a carbon cap and trade system) would make higher gasoline taxes redundant.  But limiting greenhouse gases is not the only, or even the most important, reason for taxing gasoline more heavily.  Gasoline taxes are required not just to discourage carbon emissions, but also to limit many other costs that gasoline consumption imposes on others. 


Selling carbon permits and levying higher taxes on gasoline will also generate billions of dollars of additional federal revenue.  Unlike the taxes that conservatives bemoan, these taxes will make the economy more efficient, not less.  But because they will raise the prices of basic commodities, they will also cause distress for at least some low-income families.  The traditional remedy has been to return some or all of the tax revenue by reducing the payroll tax, which falls disproportionately on low-income workers.  There is, however, a far more effective way of reducing the burden on the poor.  More on that in a moment.


The Intergovernmental Panel on Climate Change has estimated that a CO2 tax of approximately $80 per ton might be necessary by 2030 to reduce emissions by enough to achieve global climate stability by the year 2100.  A CO2 tax set at that level would add about 70 cents to the price of a gallon of gasoline.  But that tax would attack only one of a long list of external costs associated with additional consumption of gasoline.


Most gasoline is used to power cars and trucks.  When people drive more, they cause additional traffic congestion, which imposes costly delays on others; they generate additional urban smog, which causes increased mortality and morbidity; they generate additional noise; they increase the risk that others will die in accidents; they increase the cost of road maintenance; they send money to petro-dictatorships that support terrorists; and they increase the risk of military conflicts to preserve access to foreign oil. 


Beyond imposing these direct costs on others, low gasoline prices also contribute to various indirect forms of waste.  For example, they foster urban sprawl, which increases all forms of energy use. 


Cheap gasoline also encourages consumers to spend in mutually offsetting, wasteful ways.   One strategy for reducing one’s risk of dying in a head on collision, for instance, is to buy a heavier vehicle.  But when all follow that strategy, everyone’s risk of dying actually rises.  Low gasoline prices also encourage wasteful horsepower arms races.  Many people like fast cars, but how fast a car must be to provide that satisfaction depends on context.  A car that is experienced subjectively as fast is simply one that accelerates more briskly than other cars in the same local environment.  So when all purchase cars with more powerful engines, the same car that once seemed fast no longer does.


No one knows exactly how high gasoline taxes would have to be to induce consumers to take full account of such external costs.  But trans-national experience suggests that gasoline consumption would remain inefficiently high even if taxes were $2 per gallon higher than current levels.  Gas taxes are more than that much higher in Europe, where consumers have responded by buying much lighter and more fuel efficient vehicles than in the United States.  There is no evidence that Europeans are less satisfied with their cars than Americans are, or that European tax levels have fully neutralized all the negative externalities associated with gasoline consumption.


When large gasoline tax increases have been proposed in the past, the tradition has been to propose a simultaneous reduction in the payroll tax, thereby to curb the economic hardships imposed by the tax.  But such hardships are likely to be smaller than most people expect.  And if the aim is to cushion them, there is a much better way to do it. 

If the current price of gasoline were $2 per gallon and an additional tax of $2 per gallon were added, how would that affect the typical family?  On average, an American family of four currently consumes almost 2,000 gallons of gasoline annually.  A family that continued to consume at the same rate after the imposition of the tax would thus pay $4,000 in additional gasoline taxes annually.  But if the family was about to replace its aging Ford Explorer, which gets 15 miles per gallon, it could buy Ford’s Edge wagon, which has almost as much cargo capacity as the Explorer and gets more than 30 miles per gallon.  If it made the switch, its annual fuel costs would remain the same as before, even if it drove just much as it used to.  And if other families adjusted in similar ways, none would feel disadvantaged by driving a smaller vehicle; and none would be at greater risk from dying in a head-on collision.


From the experience of the 1970s, we know that consumers respond to higher gasoline prices not just by buying more efficient cars, but also by taking fewer trips, forming carpools and moving closer to work.  If norms shifted in those ways, a family might actually find itself with greater disposable income because of the higher gas tax.


Inevitably, however, some families would be unable adjust their consumption patterns, and these families would pay a price.  But trying to compensate them by reducing the payroll tax would be extremely inefficient.   For one thing, payroll tax reductions would not help retirees or those who are unemployed.  For another, they would transfer money not just to low-income workers, but also to those already earning high incomes.  Even more troubling, a payroll tax reduction would quickly become invisible.  In contrast, the gasoline tax would remain salient and would continue to draw political fire.


As the political scientist Steve Teles has suggested, a much better approach would be to return some portion of the additional revenue in the form of a yearly rebate check from the IRS issued to every family that files a tax return.  Scheduled to arrive in early December, it would provide a vivid reminder of the offset against the additional taxes.  The size of the rebate could also be inversely related to the family’s income, the better to target relief for those most in need.


Because gasoline consumption generates many external costs besides global warming, carbon taxes do not eliminate the rationale for imposing additional taxes on gasoline.  By encouraging consumers to take account of those external costs, such taxes would make the economy more efficient.  Evidence suggests, moreover, that people have wide latitude to escape the burden of higher energy taxes by changing their behavior.  The taxes would create far less hardship than many expect, and such hardship as they would create could be easily remedied.