Now is not the time for a Pigovian gas tax

Wrote this a little while back. The macro policy bits in the second to last paragraph may or may not remain my opinion in the light of some of the data that Mankiw has posted here. Let’s just say my thinking is… fluid on the more Keynesian bits I’ve referenced. I’m going to have to read the whole paper (PDF) in the near future.

Several weekends ago, the Washington Post editorial board came out in favor of a Pigovian gas tax. A guest op-ed in the New York Times advocated essentially the same thing. For those unfamiliar with the concept, a Pigovian tax is a fee levied on a particular good or service designed to reduce consumption of that good or service to compensate for a negative externality. Even if the revenue raised from the tax is returned to the public in the form of an income subsidy, it has a real tendency to reduce consumption of that particular good or service, even though an individual has experienced no real drop in income. (They have not dropped to a lower indifference curve.)

In the case of gasoline, the tax has many reasons: pollution generated by the combustion of fossil fuels isn’t accounted for because clean air never enters a market system, therefore it has no market price so we treat it as free. (Obviously clean air has value even though we don’t buy or sell it.) Another externality is the US’s reliance on foreign oil, often provided by otherwise hostile nations who derive their economic power from US petrodollars. There are several other, more wonkish reasons for desiring a Pigovian gas tax as well.

In general, I consider myself a bandwagon fan of the Pigou club. I agree with their aims, and Pigovian taxes have demonstrated a remarkable ability to meaningfully compensate for externalities otherwise unaccounted for in a free market system. However, now is not the time to institute such a tax. At a time when the federal government is considering a large-scale stimulus package that certain Keynesians think needs to be in the neighborhood of US$600 billion to have any chance of working — a figure that jives with China’s US$585bn package — the tremendous drop in gas prices is equivalent to a US$318 billion stimulus package that Uncle Sam doesn’t have to ultimately borrow from China or sovereign wealth funds to put into play in the here and now.

This trumps any marginal environmental benefit that might be gained by instituting a Pigovian tax at this moment in time.

Recession economics suggest that when all normal tools of correction have been tried, the government should increase spending and/or cut taxes. Trying to close a budget deficit while in the middle of a recession will only exacerbate the economic turmoil, and you run a very real risk of pushing a recession into a depression. (Though a nation’s long-term stability obviously requires fiscal responsibility, which the US has been lacking in recent years.) Raising taxes takes money out of consumers’ pockets, and cutting government spending tends to lead lead to lost jobs. Obviously lost jobs and decreased consumer buying power are undesirable. Doing nothing can cause the recession to deepen, and doing too little is no better than doing nothing at all. The question isn’t whether we need a stimulus package, the question is how big it needs to be. Therefore we should take what the burst petroleum speculation bubble has given us, and let it ride until the current economic crisis has passed.

It would have been better for the WaPo and NYTimes to have published these pieces back in the spring and summer — not in the middle of a recession. During the Democratic primary, Senator Clinton suggested rolling back the federal gas tax, which was a pretty bad idea. Ironically, if we still had $4/gallon gas prices today, her ideas might make more sense, except that a temporary reprieve of the relatively small federal gas tax wouldn’t amount to very much. However given petroleum’s relatively low cost right now, rolling back the gas tax temporarily wouldn’t amount to much in the way of meaningful consumer relief. ($31.46 billion on the generous side — an amount in the same ballpark as the recent Citigroup bailout.) When the seas are calmer, then we should discuss nifty tricks like Pigovian taxes and other consumption taxation vehicles as part of a responsible long-term fiscal policy.

Now is not the time to balance the budget. While there will always be arguments over timing, it seems obvious to me that instituting a Pigovian gas tax today — or even this year — isn’t in the US’s, or the world’s best interest. Let’s revisit this idea sometime in 2010. Hopefully by then, we’ll have weathered the worst of this recession.

  • NPOV

    So you balance out the any pigovian tax on gasoline with bigger income tax cuts.
    There’s no rule that says NO taxes should ever be added during a recession, just that you don’t want to increase the total tax take.

    FWIW, I think now is an excellent time to start phasing in a pigovian tax on gas, given its low price, and the fact consumers have already had to learn to deal with higher prices in the last year or so.

    One other important benefit of a tax, as long as it’s a fixed amount, is that it helps even out fluctuations in the price of gasoline. Such fluctuations make it very difficult for both motorists and car makers to make sensible decisions about what sort of vehicles to buy/manufacture.

  • NPOV

    Oops I meant add one important thing:

    A pigovian tax on gasoline is all very well, but ideally what you want is a tax on pollution. If a car manufacturer can demonstration that a particular vehicle generates less pollution per gal. of gas used, then ideally the pollution tax should be lower. Given it’s not really feasible to do it at the point of purchasing the gas, you realistically have to do it the point of registering the car, based on average usage, which has the added benefit of encourage car buyers to think a bit more long term about the real tost cost of owning and running the car.

  • http://rianjs.net Rian

    So you balance out the any pigovian tax on gasoline with bigger income tax cuts.
    There’s no rule that says NO taxes should ever be added during a recession, just that you don’t want to increase the total tax take.

    In my original draft (that was too long, this was to be published elsewhere with more formal wordcount constraints), I explained that I thought that returning the money in the form of an income subsidy was a bad idea because of the lag time between the tax being instituted and people getting their money back. Folks like Krugman would argue that stimulus needs to happen now, not five months from now in order to have the greatest effect. Any waiting increases the amount of stimulus that will be needed.

    I agree with the phase-in concept. Say 25 cents for six months, another 25 cents after that, etc. Lower the rate of increase and increase the amount of time before the next increase once you get closer to more uncomfortable prices. The way the NYTimes and WaPo bits were talking was that we should do it all at once, right now, and spend the money on infrastructure and healthcare.

    One other important benefit of a tax, as long as it’s a fixed amount, is that it helps even out fluctuations in the price of gasoline. Such fluctuations make it very difficult for both motorists and car makers to make sensible decisions about what sort of vehicles to buy/manufacture.

    I agree, which I why I think any effective Pigovian gas tax should have a price floor built in so it doesn’t send the wrong price signals to the marketplace which is happening now.

    A pigovian tax on gasoline is all very well, but ideally what you want is a tax on pollution. If a car manufacturer can demonstration that a particular vehicle generates less pollution per gal. of gas used, then ideally the pollution tax should be lower. Given it’s not really feasible to do it at the point of purchasing the gas, you realistically have to do it the point of registering the car, based on average usage, which has the added benefit of encourage car buyers to think a bit more long term about the real tost cost of owning and running the car.

    Ideally you’d want both. :) Pollution is but one externality. Another is national security, and our dependence on foreign oil is a big problem. Any country that comes up with green energy technology first is going to have a leg up on the rest of the world in terms of being free from petro-tyranny. This is the main way I would sell a Pigovian tax to climate change deniers.

  • NPOV

    Well the lag-time factor is certainly an argument against introducing the Pigovian tax immediately, but realistically it’s going to take some months to work out all the details anyway, so it could be aimed at being introduced immediately after the next lot of tax returns go out.

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