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Rebrand a gas tax as a carbon tax? Sandmo says "no" but politics says "yes"

posted May 20, 2015, 10:07 AM by Joel Wood

In a recent Globe and Mail commentary, economist Mark Jaccard has recently outlined a detailed proposal for Alberta to implement a carbon tax. Overall the proposal is a good one with commendable detail for a newspaper OPED. However, I have two quibbles with it: First, the proposal is referred to as “revenue neutral”, but since some of the revenue is used for increased government spending it does not fit with the traditional definition of revenue-neutrality. Second, the proposal calls for the recent 4 cent increase in the provincial gasoline tax to be rebranded as a carbon tax. My post today will consider the latter.

Rebranding a gasoline tax as a carbon tax ignores the reason the tax was levied and increased to begin with: To raise revenue. The tax would be levied regardless of whether burning gasoline contributed to climate change. It is good to levy taxes to raise revenue on commodities that have relatively inelastic demand to minimize the behavioural change induced by the tax. This is the Ramsey Rule of optimal taxation.

But what to do when consumption of a commodity, e.g., gasoline, imposes external costs on others (a negative externality)? Norwegian economist Agnar Sandmo’s seminal 1975 article “Optimal taxation in the presenceof externalities” tackles this problem. His theoretical model suggests that environmental taxes should be levied on top of existing excise taxes. More recently, Ian Parry and Kenneth Small develop a model to identify whether gasoline taxes in the US and the UK are too high or too low, and their model shows a similar property: The optimal gasoline tax is comprised of two parts. One part is called the Ramsey component and reflects the efficiency of raising revenue by taxing a commodity with relatively inelastic demand. The other part is called the Pigouvian component and reflects the external costs resulting from the use of the commodity.

The Alberta gas tax was increased to 13 cents a litre based on revenue raising arguments. This was also the first time the Provincial gas tax in Alberta was increased since 1991 and it is not indexed to inflation. Albertans are currently paying less tax on a litre of gas than they would have if the Provincial and Federal taxes had been indexed to inflation. It seems to me that a new carbon tax for Alberta should be levied in addition to the current 13 cent a litre gasoline tax.  

The rationale I can think of to rebrand the 4 cent increase as a carbon tax is political. It may be easier to implement politically if the carbon tax does not raise the price of gas more than the current excise tax does. The carbon tax will then increase the consumer price of gas in the future as the tax is increased according to Jaccard’s plan. Evidence from BC suggests that public support for our carbon tax has grown post-implementation. The gas tax rebrand would overcome status quo bias and then the actual environmental tax would be the later increases.

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