Gas Taxes…

Even with all the bailout and recession fervor, there is actually some talk these days about raising the gas tax. Here. Here. And Here. (HT: Mankiw)

Consider me a supporter of that proposal. The time to enact this would be now, when Americans are getting complacent about the price of gas. Now I would call for something on the order of a dollar per gallon tax, phased in over the next 18-24 months. Which would work out to about a 4 or 5 cent increase per month. A reasonable pace.

The big question then becomes: What do we do with that money? If I were running things, I would try to sell the public on using the money to subsidize alternative energy sources. Reducing the costs of production in that sector would put us on track towards ending not only a dependence on oil (foreign or otherwise) but rather eliminating oil period. Most of the money I would pour into wind and solar. Especially if this report is turns out to be the real deal. Ethanol’s big plus is that it keeps oil money in the country rather than going to abroad (and by “abroad” I mean our largest supplier of foreign oil is Canada, not the Middle East), but anyway you slice it, Ethanol is a dirty renewable.

I’m generally agnostic about global warming, but I have to assume CO2 emissions aren’t helping things. I’ve heard detailed explanations from people (who have expert level knowledge) I respect on both sides of the issue. I think their both right, and that we don’t know. What I’m actually more concerned about it is just moving towards a renewable source of energy. If its cleaner than Ethanol and equally as viable, then that is the icing on the cake.

The detractors of this idea will say that gas taxes hurt the poor. Fine. We can address that concern. If people agreed to the tax and I had to compromise something to get it done, I’d live with not subsidizing alternatives. The tax itself will help the market track towards them anyways, a subsidy would just speed us up.

The compromise would be that I’d make the gas tax revenue neutral. We levy the tax but then give it right back. It still makes gas more expensive but people’s welfare has not been damaged. You could do this two ways, send a check each month with a personal share of the gas tax money, or more simply we could reduce income taxes by some % that would exactly offset the higher gas prices. Either case, we’d get less purchases of gas and people’s welfare would be potentially unchanged. I say “potentially” not because people might be worse off, but rather I contend that people might actually be better off under a gas tax and “give-it-right-back” policy scenario.

Any explanation of this point is going to be technical, so if I lose you, I’m sorry. If you don’t care for the economics graphs stop reading here. My analysis will be conducted with budget line and indifference curve analysis:

As you can see from this graph, this consumers income is divided between AOG1 and Gas1. That consumption bundle leads to U1 level of utility. Simple, easy.

This is the intermediate step graph, we never actually see this point. I’m breaking it into steps for clarity. Basically, with the tax on gas, the slope of the budget-line tilts in reflecting a new higher price for gas and a new price ratio between All other goods and gas. Without any other modifications, yes the consumer would be worse off in terms of welfare. Since we’re not stopping with only the tax and giving it right back, we need a third graph.

From this third graph, you can see how messy this gets. After we levy the tax, we immediately give the money back in the form of a prebate check, or a reduction in income taxes. You pick, doesn’t matter. This keeps the new price ratio the same (slope of red line) but it shifts the budget line out until the blue line crosses exactly where the original consumption bundle was. This new amount of income and higher price for gas, means that even with the tax the consumer can purchase the original number of units of gas and all other goods just as they did before the tax.

The could purchase the same amounts as before, but it is unlikely that they would. They would probably choose to consume at the point marked by the dotted blue lines. AOG2 & Gas2. Even with the higher income, people would choose to spend less on gas and therefore they’d spend more on everything else. Why? Because they can buy more of everything else and end up at a higher level of utility (U2 in the graph). Which means under the scenario in the graph, this consumer would be better off.

I just wanted to do this to undercut the blanket statement that taxes hurt the poor.  We can actually design polices that tax everyone and yet, seemingly a paradox, raise the welfare of consumers. All this while also achieving a societal goal of reducing gas consumption.

Washington is too clever to do something like that though.

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Tags: alternative energy, Democrat, gasoline, graph, indifference curve, Republican, taxes

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