The inverse-floater gasoline tax

By Felix Salmon
June 15, 2009

How to structure a gas tax? You could make it a flat X cents per gallon; alternatively (and this is essentially what a cap-and-trade system does, too) you could make it Y%, with the tax increasing with the price of gasoline.

Today, Jim Surowiecki comes up with a third option, where the tax decreases when the price of gasoline goes up:

Rather than leave so much of our fate to chance, we’d be better off doing what politicians always say they want to do: lessen the U.S. economy’s dependence on oil. One step toward that would be to phase in a gas tax designed to smooth out oil’s spikes and plunges by keeping the price of gasoline fixed (the tax would rise when the price of gas fell, and vice versa).

Surowiecki makes a strong case that consumer behavior, when it comes to reducing gasoline consumption, only really changes when there’s a spike in gas prices. As a result, his proposal would seem designed to have the least possible effect on gasoline consumption, and on our dependence on oil. Sure, it’s a sensible way of raising government revenues and reducing the fiscal deficit.

Either you want to effect consumer behavior and reduce gasoline consumption — in which case you actually welcome price spikes. Or else you want to smooth out price spikes, in which case you slowly boil the frog (to use one of the stupidest metaphors ever) and keep consumption high. But you can’t have it both ways. Which is it to be, Jim?

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It’s neither. It’s a “permanent spike,” say setting a minimum price at $3 or $3.50 a gallon and reducing the tax from there. It holds consumption lower and smooths out the price.

Best would be a tax that increased with the price of oil, not just in dollars, but in %. This would dampen demand for oil when there’s a price spike, effectively giving the windfall to the IRS instead of Saudi Arabia (it’s a close call, but I like the IRS a little better).

Posted by Max | Report as abusive

so why would any gasoline supplier ever reduce prices? if the price is going to be $4 per gallon regardless of what exxon-mobil charges its’ dealers, why wouldn’t they maximize the price, leaving no room for any tax at all, and keeping all of the revenue for themselves? Aren’t we just saying to the oil companies, sell your gas at this price or we will do it for you?

This is a very, very, bad idea. Let’s just start charging a $2 or so per gallon tax, and give back all of the revenue in the form of mass transit subsidies. This would be the simplest and most direct way to change consumer behavior. For people in rural areas, who can’t take advantage of subsidized mass transit, they still get subsidized electricity and subsidized telephone service, and will probably soon get subsidized broadband access, once the rest of the country actually gets real broadband service. So they can buy electric cars and telecommute.

Posted by KenG | Report as abusive

@Felix Salmon:

The dilemma you present is only real if the consumption-reduction goal is to maximize the effect on consumption per dollar of revenue. Why not instead maximize revenue at a given level of consumption-reduction?

Also, I thought James Surowiecki was implying that sudden changes in the price of gasoline affect consumer behavior in ways that disrupt the economy. A smoothed-out (but higher) price would presumably imply a gradual shift in consumption patterns, in a way that makes investment easier to plan and is less likely to cause the supply-demand mismatch in SUVs he refers to.

@KenG:

Presumable the tax would be structured to mitigate the slope of the demand curve not eliminate it entirely. (Cf. the difference between a progressive income tax and 100% confiscation of all income over $X.)

Posted by Benquo | Report as abusive

I think the value of an “inverse floater tax” is that it prevents oil producing countries with excess capacity from using that capacity to prevent serious conservation measures in oil importing countries.

Here’s what I mean. If there is a spike in gas prices, people may adapt measures to use less gas. Initially, they will be short term measures–fewer voluntary trips by car, maybe an increase in mass transit usage, a small increase in the purchase of fuel-efficient cars (small because most consumers don’t have the luxury of buying a new car whenever the price of gas changes).

Long-term changes in law (increased CAFE, lowered speed limits), policy (more spending for mass transit), and habit (citizens taking transit, biking, or walking more; more fuel-efficient cars sold) are less likely to occur if the price increase is a spike as opposed to a sustained increase.

Very long term changes (to denser urban areas, for example) will never happen is the price increase is just a spike.

So if you are an oil exporter concerned with maximizing your revenue, one thing you want to do is make sure that the long term conservation changes above are not implemented–that the urgency for them disappears as gas prices decrease. So you pump a little extra capacity into the market to prevent any permanent change in the oil consuming habits of your customers.

The “inverse floater” tax (depending on what the price level is set at) turns that “spike” into a permanent high price–which might encourage some of those long-term changes in behavior. It might also encourage producers to produce their reserves slowly, as they would want to capture the largest percentage possible of the actual pump price. In other words, they would have no incentive to ever over-produce, while at present, there are all kinds of incentives to over-produce.

price controls worked so well 30 years ago, let’s try it again. Why the heck not.

Any monkeying with gas taxes also monkeys with funding for the Highway Trust Fund…not that maintenance / repair of roads & bridges is a big deal.

It’ll never fly. Try impacting consumption patterns (mass transit, high-speed rail) instead.

Posted by Griff | Report as abusive

The nasty “affect/effect” thing.

What you want to do is affect consumption patterns. In the best case you would effect a permanent reduction in consumption.

Posted by dollared | Report as abusive

Cap and trade is going to be more like a per gallon tax than a per value tax. A gallon of gas produces a fixed amount of carbon; spikes in gasoline prices caused by supply (or foreign demand, which has the same effect on the United States) will reduce the incentive to produce carbon emissions, and will therefore be associated with lower prices of carbon emissions, though spikes driven by U.S. demand would drive carbon prices higher. Insofar as (short-term) gasoline price variations seem more often not to result from domestic consumption, the effective size of the tax will in fact do what Surowiecki wants, though probably not to the degree he might hope for.

Insofar as gasoline demand is more elastic in the long run than the short run, I’ve thought of Surowiecki’s idea before, but with an addendum: the short-term drop in taxes to accommodate the rise in pre-tax prices would be linked to a commitment to raise the taxes in the future. The tax would be based on the deviation of the pre-tax price from a long-run moving average; a rise in the price of gasoline thus raises the baseline for the future. Consumers would be shielded for a short period of time from higher prices, but would be put on notice to make adjustments for the future.

I don’t know how well it would work in practice. Maybe consumers wouldn’t behave rationally; maybe the sharp, unexpected spikes have a non-linear effect. Maybe the political pressure not to raise taxes in a pre-committed way would be different from the pressure to lower taxes. I’d be kind of interested to see. But simply trying to set a fixed (after-tax) price that is entirely unresponsive to supply and demand innovations sounds like asking for trouble.

I repeat: a high gas tax will unfairly affect the rural population who depend on the auto because their governments have never supported real rail and bus travel. Many poorer rural families have more than one car: one each for each working member.

It’s a shame we can’t all bike to work ala Felix.

Posted by Eli Baker | Report as abusive

Felix, the smoothing part you’re talking about is really a gas price cap, except the government would really have to use some of the ‘tax’ proceeds to hedge in order to cap the prices.

Then they would have to subsidize the refiners using the hedge if prices go up. Otherwise, refiners just wouldn’t refine anymore if oil prices went up but gas prices did not. e.g. Hawaii, Alaska.

There are private firms that offer this gas price cap but those firms hedge. The government can’t take this exposure to high prices. If they do hedge they’ll have to redistribute the proceed of their hedge to refiners so there is no complete disruption in supply.

Posted by john | Report as abusive

This stuff is common practice here in the EU.

Posted by eu | Report as abusive

make people drink 0.1% of what they use above a threshold.

Posted by q | Report as abusive

@Benquo, maybe you could provide an example of how such a tax would be implemented. Suroweicki said “the tax would rise when the price of gas fell, and vice versa” – so if demand falls, why would any supplier have an incentive to lower prices, if the tax will increase to offset the price decrease?

A fixed price eliminates the negative feedback path that every control system depends on. If the price never changes in response to demand, then consumers have no cost reasons to change their habits.

Posted by KenG | Report as abusive

@ KenG:

In essence, the tax schedule would set the tax per gallon equal to a constant, less some proportion of the price, with a lower bound on the tax at some point:

T = min(a-bP, c)
with a > 0, c >= 0, and 1 > b > 0.

In this case, a supply price change of d would move the consumer’s price by (1-b)d when T c.

If it’s logistically too difficult to assess the tax rate separately for each retail price, a single tax rate could be calculated based on a national index of gas prices and adjusted automatically). This would have the added benefit of keeping the short-term demand slope at its current steepness — I wouldn’t expect local pressure on price to be affected much at all.

Posted by Benquo | Report as abusive

Oops – read “T c” as “T < c”.

Posted by Benquo | Report as abusive

@benquo, maybe that’s your idea, and not a bad one, but it’s not what Suroweicki is proposing. He wants a fixed price for gas.

And your formula would make politicians’ heads explode, which wouldn’t be a bad thing, except they will just defer to their lobbyists, I mean, advisers.

I would rather a gas tax that is a percentage that is equal to the percentage that consumption is over a target amount. So if the nation is consuming x gallons per month, and we want to get it down to y gallons, the tax would be n(x-y)/y. I threw in n there so that when we get close to the goal, we keep the tax high enough so we achieve the goal.

In the same vein, I would like a national sales tax on (almost) all individual consumption, where the tax rate is proportional to the national trade deficit, as the deficit is a measure of how much more we are consuming than we are producing. If the trade deficit represents 5% of GDP, then we have a 5% tax (it would actually be higher than that, as we would have to exclude basic necessities like food, shelter, health care, and education).

Posted by KenG | Report as abusive

@ KenG:

I had assumed that Surowiecki didn’t mean “fixed” literally, since it’s so clearly a bad idea for the reasons you mentioned above. Maybe I was wrong. Anyhow, it seems like we agree on substance.

My point still stands about local (or short-term) pressures, though: if the tax is calibrated to an index of gas prices across the country (rather than case-by-case), there would still be downward price pressure on individual suppliers.

Posted by Benquo | Report as abusive