And Global Warming Too!

Sorry, a gas tax won't solve all our problems

The last several weeks have seen the emergence of a surprising phenomenon: conservative magazines and websites' promoting the idea of raising gas taxes. The theory is that if fuel becomes more expensive, we will use less of it, thereby reducing funding for hostile regimes, stimulating the development of new non-carbon technologies, and ameliorating global warming. This is said to be politically feasible right now because consumers have been habituated to $4-per-gallon gas, and the price has collapsed to about $1.65. Slapping on an extra dollar of tax would put the price at $2.65, which would have been a sensational bargain only a few months ago. These proposals typically call for an offsetting reduction in other taxes, such as FICA (Social Security and Medicare payroll taxes); hence, they are usually termed "revenue neutral" tax changes.

The basic idea is superficially appealing. After all, if we have to tax something, why not tax gasoline instead of income, and get all of these side benefits? It sounds like something as close to a free lunch as we are offered in this fallen world. But like most free lunches, it turns out to be expensive. The problems with the proposals are not chiefly philosophical, but arithmetical.

First, revenue neutrality is most likely a mirage. One major problem with trading a gas-tax increase for a reduction in payroll taxes is that FICA rates have had to rise to their current levels for compelling reasons. We would have to maintain the higher gas tax for decades in order to generate the consumption reductions that advocates argue will occur. But it's not likely we will be able to resist the upward pressure on FICA taxes for anywhere near that long.

In 1950, the FICA rate was 1.5 percent; by 1970, it was 4.8 percent; by 1990, it had risen to its current rate of 7.65 percent. It has been stable for about two decades, but meanwhile the programs that it (in theory) funds are in crisis. Over the next few decades, we should expect bitter political fights over changes to retirement ages and benefit levels, the restriction of access to publicly funded medical care, and other measures designed to make these programs financially stable. The FICA rate will not be insulated from this process. Remember, too, that FICA is theoretically a dedicated funding source for Social Security and Medicare. They are already underfunded. This proposal would massively reduce the collections that support these programs, which would serve to ratchet up the pressure to increase FICA tax rates, which would make the gas-tax hike a net tax increase.

Second, a $1-per-gallon gas tax is very unlikely to reduce gasoline consumption enough to de-fund our enemies or to have any serious effect on the theorized global warming.

Gasoline consumption in the U.S. has been quite insensitive to price for several decades. As an example, even the enormous price spike of this past year reduced demand by less than 4 percent. The argument of gas-tax advocates is that a long-run increase in gasoline price will create a greater response because, while it's hard to change your behavior when gas prices go up if you own an SUV and live 20 miles from work without nearby public transit, sustained high prices will lead people to move closer to work or bus stops, buy more fuel-efficient cars, and so on. This notion is surely correct, at least to some degree, but there are limits to it. Germany, for example, is something of a limit case: It combines factors that tend to lead to lower oil consumption—it has a population density higher than America�s, a per capita GDP 30 percent lower than America's, and sustained gasoline taxes of several dollars per gallon—but it still uses a lot of petroleum.

Let's make the very aggressive assumption that a $1-per-gallon tax would reduce aggregate U.S. gasoline demand by 20 percent: Even this reduction wouldn't be nearly enough to accomplish the stated goals of the tax increase. Finished motor gasoline accounts for about half of U.S. petroleum use. The U.S. consumes about 25 percent of global petroleum. So we are talking about a reduction in global demand for oil on the order of 20 percent times 50 percent times 25 percent; in short, 2.5 percent. Ten to twenty years from now. It�s not likely that President Ahmadinejad of Iran is losing a lot of sleep over the prospective volume loss such a tax could create.

Advocates argue, however, that this demand reduction might cause a collapse in oil prices. What�s so surprising about this idea is that it ignores what created the actual collapse in petroleum prices in 1986 that led to almost 20 years of cheap oil. It wasn't reducing demand—it was managing supply by getting the Saudis to increase production, which was was one of Reagan�s greatest, though unheralded, foreign-policy triumphs. This fact exposes, among other things, that as long as the Saudis have the capacity to act as swing producers, attempts to control prices through demand reduction will be pushing on a string. If we try to cut prices by reducing demand, the Saudis can jack the prices right back up by cutting production.

But can the Saudis continue to accomplish this, over time? The idea that the world is running out of oil is a lot less fashionable now than it was a few months ago, but most experts believe that oil will get more expensive over the course of the century as more unconventional sources need to be tapped to meet structurally growing global demand. In such a world, prices might be more subject to big swings based on demand reduction. As a very current example, uncertainty about true production capacity in the face of demand growth probably amplified the huge run-up in prices between 2004 and early 2008, and their subsequent collapse over the past few months as demand projections dropped in the face of a looming global recession. Over the next several decades, it is likely that there will be similar moments at which the ability suddenly to reduce demand could produce big price changes. But the gradual elimination of 2 or 3 percent of demand over decades would be very unlikely to do this.

Similarly, higher gas taxes would not be an effective means of addressing global-warming risks. Even if one accepts current global-warming forecasts, the economics of carbon taxes designed to mitigate emissions are highly unattractive. Such reductions would be wise only if the actual climate impact of carbon emissions turned out to be dramatically worse than even the outer edge of the probability distribution of current predictions. If that highly unlikely disaster came about, the amount of warming avoided by a 2.5 percent reduction in global petroleum use would not make much difference. And it's certainly not wise to base tax policy for one class of carbon emissions on what might happen in one extremely unlikely scenario.

Finally, such a tax is very unlikely to stimulate the development of new technologies that otherwise would not be created. Western Europe is a huge potential market, and its gasoline prices have generally varied between about $3.50 and $7.50 per gallon over the past decade. There is no credible prospect of Europe's radically lowering its gas taxes. How would gas at $2.65 per gallon in the U.S. induce new technologies when much higher prices in Europe do not?

In the end, the current profligacy of various bailout and stimulus programs may force the undesirable necessity of higher taxes on us. In that case, it may be that gasoline taxes will have to be increased, just like many other classes of taxation. But gas taxes won't have some magic power to cure various world ills; they will just be a way for the government to collect more money from people who drive to work every day, in order to give it to others.