Sunday, October 01, 2006

Varian on the Incidence of Gas Taxes

In ec 10, we have been studying supply and demand and applying the model to issues such as tax incidence (see chapter 6 of my favorite economics textbook). In an old NY Times column, economist Hal Varian uses this logic to argue for higher taxes on gasoline.

Here is how Hal makes the case:

A gasoline tax in a small country falls mostly on the residents of that country. The world price of oil is essentially independent of the taxing policies of most countries, since most countries consume only a small fraction of the amount of oil sold.

But the United States consumes a lot of oil -- almost a quarter of the world's production. That means it has considerable market power: its tax policies have a major impact on the world price of oil, and economic analysis suggests that in the long run, a significant part of a gasoline tax increase would end up being paid by the producers of oil, not the consumers.

Nearly 20 years ago, Theodore Bergstrom, an economist who is now at the University of California at Santa Barbara, compared the actual petroleum tax policies of various countries with policies those countries would adopt if they wanted to transfer more OPEC profits to themselves.

He found that if each major oil-consuming country pursued an independent tax policy, the tax rates in European countries should be somewhat lower than they are now, while the tax rate in the United States should be much higher. If the United States, Europe and Japan all coordinated their oil-tax policies, they would collectively want to impose net tax rates of roughly 100 to 200 percent. This is not as scary as it sounds since such a coordinated tax increase would mostly affect oil producers; the price at the pump would increase much less.

Mr. Bergstrom's analysis was focused entirely on transferring profits from oil-producing to oil-consuming nations. If we factor in the pollution and congestion effects mentioned earlier, the optimal petroleum taxes would be even higher.

I am happy to welcome Hal into the Pigou Club.

Thanks to Mark Thoma for pointing out the Varian article.