We’ve all heard the strategy of not letting a crisis go to waste, but with the fall in gas prices the proponents of a big tax don’t want to let a celebration go to waste. Just when American motorists are getting a break at the pump, out come the calls from both the left and the right that now is the perfect time to slap on a big new federal tax. Yet contrary to these claims, the drop in gas prices per se doesn’t bolster the case for hiking taxes. If a gas tax hike was a bad deal back in the summer, then it’s still a bad deal now. The only thing that’s changed is the psychological difference— trying to take away the “gift” the market has given to consumers before they get used to it.
Looking at the Argument in Other Contexts
The argument in favor of raising the gas tax now—since it won’t be as painful with prices starting out low—would be self-evidently absurd in other contexts. For example, the cost of a gigabyte of computer RAM has dropped tremendously over the decades, going from $6 million in 1980 to $1,100 in 2000 to $6 in 2013. Would anyone dare to suggest that slapping computers with, say, a $10 per gigabyte tax on their RAM would hardly affect consumers? After all, even with such a tax, they’d still be paying a lot less for a given machine compared to just a few years ago.
Or what about houses? The price of a typical house collapsed from 2007 – 2009. Would anyone argue that early 2009 was a great time to slap on a 25% tax on house sales, since home buyers would hardly notice it?
The absurdity of such statements carries through to gasoline as well. Just because gas is currently much cheaper than it was a year ago, is no justification for hiking the tax on gas. It still hurts consumers to make a product artificially more expensive than the going market price.
Dealing With Negative Externalities
The obvious difference between a gas tax (or tax on carbon dioxide emissions more generally) and my examples of computers and housing is that many people argue that there is a large “negative externality” from the use of gas. In other words, they claim that there is a “social cost” above and beyond the private cost from burning gasoline, and this is why the government should slap on a stiff tax hike, now that prices have come down so much.
Yet even here, the proponents of a tax hike have been quite sloppy. For example, economist Steven Landsburg analyzed Larry Summers’ recent call for a carbon tax in light of the fall in energy prices, and showed that Summers left out a crucial part of the argument. Specifically, Summers didn’t explain why the fall in energy prices meant that it was more important than before to enact a carbon tax.
Landsburg conceded the standard “social cost of carbon” claims for the sake of argument; Summers still hadn’t presented a coherent case. In other words, if Summers thought people were emitting too much carbon back in the summer, then there’s no reason to think the gap between how much they “should” use and how much they in fact are using, has grown since then.
Landsburg has isolated a key confusion in the debates over climate change. People often fall into the trap of thinking that if some activity carries a downside, then the “optimal” amount is zero. But no, that’s not correct. As Landsburg points out, when oil becomes cheaper, then yes, of course people use more oil. But they should use more oil; that makes economic sense—even if you believe people aren’t correctly taking into account the full social cost of their activities.
This is a crucial point so let me walk through a simplistic numerical example: Suppose the price of gasoline is $3 per gallon, and at that price the average motorist drives 10 gallons per week. However, because of various “negative externalities,” the textbook says this is too much gasoline consumption—really the “socially optimal” amount of gasoline usage is only 9 gallons per week. Notice that the optimal level is not zero gallons; even if we stipulate the negative externalities, it’s still a good use of resources for people to burn gasoline in their vehicles, the (alleged) problem is simply that they’re burning a little too much gasoline on the margin. So a tax of, say, 50 cents per gallon will induce people to reduce their weekly purchases down to 9 gallons, which the textbook says is the right amount.
Okay, so far so good. Now suppose that crude oil becomes cheaper, meaning that the (pre-tax) price of gasoline falls to $2 per gallon. With no tax, the average motorist would now use, say, 13 gallons per week, rather than the original 10. What can we say about the new, “socially optimal” amount?
Without more information, it’s tough to say. But for sure the answer is now higher than 9 gallons, and in fact it’s probably closer to 12 gallons. So the “optimal” level of the corrective tax is probably still around 50 cents. To come up with an exact answer using the textbook logic, we would need to know how much the “optimal” amount of reducing consumption now was, and whether a tax of 50 cents was too high or too low because of the new baseline market price. This ends up being a complicated question, one for which we would need more information to answer. Since it’s not obvious whether the “optimal” gas tax would go up, down, or stay about the same, it’s also unclear whether “the case for a gas tax” has gotten stronger, weaker, or stayed about the same.
My purpose of walking through this make-believe example is just to isolate the analytical point that Landsburg was making in his own reaction to Summers. Even though one might have expected more from a famous economist, Larry Summers actually breezed by a crucial plank in his whole case. Summers took it for granted that because people will be using more energy (now that it’s cheaper), that the case for punishing such usage with a carbon tax has somehow become stronger compared to the summer. Yet Summers never explained why. That was the whole premise of his article, and yet he never actually explained why we should believe him; he took it for granted.
Aren’t Marginal Damages Rising in the Level of Emissions?
Proponents of a higher gas tax and/or a carbon tax have a ready answer to Landsburg: Of course the marginal social damage from further emissions goes up, they will say, as we increase the level of emissions. In other words, they will argue that when gas prices fall and consumers drive more, that the social damage from burning one additional gallon of gas is higher than it would have been in the baseline, back when gas prices were much higher.
Although people like Larry Summers and other proponents of a carbon tax think this is obvious—so obvious in fact that Summers didn’t even mention it as part of his argument—it’s actually a tricky issue. We have to know why gasoline prices came down so much, so quickly, in order to begin to answer the question.
For example, to the extent that prices have partially fallen because Saudi officials have announced their intention to continue pumping despite the rise of other producers, then this has little long-term effect on total emissions over the next several decades. All that’s happening is that Saudi officials are bringing barrels to the surface earlier than investors implicitly thought would be the case, back in (say) June. The specific rate of Saudi oil extraction in 2015 is not really relevant to the global temperature in the year 2050.
On the other hand, advances in U.S. crude production do affect the total amount of emissions, since forecasts made long ago would not have realized how much total oil would be available to humanity. However, it’s not as if the surge in U.S. output was a bombshell surprise hitting the world last August for the first time. Back in May 2013 when the Obama Administration Working Group updated its estimates of the “social cost of carbon,” they had already seen the sharp uptick in U.S. output, which had been occurring for at least four years at that point. So when they reported their various figures for the social cost of carbon—which would then be the basis of enacting a carbon tax—there is no reason to think those numbers were too low, because of the fall in energy prices that we’ve just witnessed.
In other words, if the Obama team thought the 2015 “social cost of carbon” was about $38/ton back when they issued their report in May 2013, then they should still think that’s about the right number, even though crude prices have fallen. At the very least, we can’t just take it for granted that their number was way off; we would have to explain what their specific assumptions were, and what changed in the interim. When they issued their report, they knew full well actual energy prices were extremely volatile, and would bounce around over the next century. In the grand scheme, has the recent fall in crude prices really changed their forecast for world fossil fuel use in the 21st century that dramatically?
Conclusion
People who have been in favor of higher energy taxes all along are now using the opportunity of lower prices to stick it to consumers. This argument makes no sense in other contexts, and it makes no sense when it comes to energy. Even within the “negative externality” framework, the “case” for a higher tax is just as good—or just as lousy—now as it was last summer. Finally, even if Americans did go along with a gas tax because prices have fallen, does that mean the tax would be removed once market prices went back up?
