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Don't buy into the populism: An economist's defence of gas taxes

posted May 15, 2015, 10:28 AM by Joel Wood

Nothing seems to stoke the animosity of anti-taxation populists like gasoline excise taxes. The latest in anti-gas tax populism is coming from a recently launched Canadian Taxpayers campaign in Alberta. This is surprising considering that Alberta has the lowest gas tax in the country, and the recent 4 cent increase is the first increase of the provincial tax since 1991 (from 9 cents a litre to 13 cents a litre).

Gas taxes are one good example of where economists diverge from Joe Sixpack (though I could pass for Joe Sixpack myself considering my first name is close and I like six-packs). In general, economists like gasoline taxes for two reasons: Efficiency and efficiency.

First, the demand for gasoline is relatively inelastic in the short run. This is econo-speak for saying that some of our consumption decisions are difficult to change in the short run in response to day-to-day changes in the price of gasoline. For example, where we live (far from work? far from transit?) and which car we buy are decisions we do not change with every fluctuation in gasoline price. This means that a tax levied on gasoline will not alter behaviour as much as say a tax on corn, a product for which there are lots of good substitutes, e.g., wheat. Altering behaviour imposes costs as it forces people to move in the direction of their next best alternative (e.g., walking 3 blocks to wait 10 minutes for the bus that may or may not be late). This is one reason why economists like gasoline taxes; they will not alter behaviour too much in the short run relative to some other taxes.

The second reason economists like gas taxes is pretty much the opposite rationale than the first reason. We like gas taxes because the use of gasoline imposes external costs on others. Gasoline is an input for driving a car, and driving a car results in traffic congestion and accidents that impose costs on others. And of course just the burning of gasoline releases carbon dioxide, nitrogen dioxide, carbon monoxide, and other air pollutants. Levying a tax on gasoline is a good way to make drivers internalize these costs that they impose on others into their decision-making process.

You might be thinking “hey, I thought you said consumers didn’t respond to gasoline price changes?” Demand for gasoline is indeed relatively inelastic, but it is not perfectly inelastic (i.e., we do respond a little bit!).  One recent study using Canadian data estimated that a 10% increase in the price of gasoline results in between a 5.7% to 7.4% decrease in the consumption of gasoline. So there is some response, it just isn’t a 1-for-1 relationship. There are several small ways people can respond to higher gas prices in the short run. When I lived in the Vancouver suburb of Langley, many families had two vehicles: one massive truck and one compact car. I would presume that when the gas price spiked up (or the CAD/USD spiked up, as many cross-border shopped for gas) they would shift some of their driving to the compact car from the truck.

Those two reasons, tax efficiency and internalizing external costs, are why economists like gas taxes. But is Alberta’s increased tax of 13 cents a litre set at the right level? I don’t know. I would need to plug Alberta specific parameters into my model to see, but I don’t think the necessary data is all available. However, what we do know is that Alberta has the lowest gasoline tax in the country. Furthermore, the last time the Alberta gas tax was increased was 1991! The federal gas tax of 10 cents per litre also hasn’t changed since 1995. Gas taxes are a per unit tax rather than a percentage (e.g., income tax), therefore, they do not automatically adjust with inflation.

 


Suppose the gasoline taxes did rise with inflation, what would we be paying now? The graph shows the Alberta 9 cent excise tax from 1991 and the federal 10 cent excise tax as if they increased at the same rate as the Consumer Price Index in Alberta. By 2014, the Alberta tax on gasoline would’ve risen to 15 cents a litre and the federal tax would’ve risen to 15.6 cents a litre. The recent 4 cent increase to the Alberta gas tax only takes it to 13 cents a litre.

Anti-gas tax populists should be happy the gas tax isn’t indexed to inflation, as it would be even higher than with the recent increase. Income tax on the other hand increases as your nominal income increases; as prices rise, you demand higher wages to maintain the same standard of living. Seems silly to gripe about the tax that hasn’t increased with inflation rather than the one that has.

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