The CO2 Tax Redux

Princeton economics professor Alan Blinder's Wall Street Journal op-ed on taxing CO2 emissions has drawn a lot of flak from all sides.   

On the one hand, he has been attacked for wholeheartedly embracing the climate myths of the UN-IPCC and thus for considering CO2 a ‘pollutant.'  He therefore has an ideological reason for promoting a tax on CO2.  On the other hand, he has been attacked by opportunistic ‘emission traders' hoping to make millions through "cap and trade" - an alternative way to reduce emissions.  They and other rent-seekers have lobbied hard and spent much money to promote the 2009 Waxman-Markey bill - only to see the November 2010 elections deal a death blow to C&T.

C&T  -- the trading of emission permits -- is generally favored by those economists who want to cap CO2 emissions and minimize the overall cost; thus Blinder's position is somewhat anomalous.  I will have more to say about this elsewhere; but will note here that the economics argument for C&T is valid only if there were a real need to limit CO2 emissions.

When all is said and done, Prof. Blinder's proposal of a CO2 tax is nothing new -- basically a way to raise revenue for the government.  It is the old energy tax or BTU tax proposal that has been around for decades - and rejected.  Blinder chooses a CO2 tax rather than a tax on all energy sources  -- likely for ideological reasons.  Yet an energy consumption tax can be fine-tuned.  And there are many reasons why one should choose one particular form of energy tax, namely a tax on motor fuels -- including rational tax policy, economic efficiency, environmental and foreign policy considerations, as well as national security.

1.  Most economists would argue that a consumption tax is preferable to an income tax, and that a revenue-neutral combination is probably optimal -  by reducing, for example, the onerous double taxation of corporate profits (first as a corporate income tax - the highest among OECD countries -- and then as a tax on dividends to shareholders).  A consumption tax leads to a more rational economic policy, increasing the dangerously low U.S. rate of saving and investment, and thereby also advancing economic growth. 

2.  But what kind of a consumption tax: a VAT (value-added tax), a federal sales tax, an energy (BTU) tax, or a fossil-fuel (carbon) tax?  The arguments against a VAT are overwhelming:  Lack of transparency; burden of record-keeping; need for a new bureaucracy; plus the inevitable list of exceptions -- for basic necessities (food, etc) and for favored groups (farmers, clergy, municipal services, etc).  One can trust Congress to come up with loopholes.  The VAT is also a sure recipe for increased government spending.

A federal sales tax is only slightly better and might lead to a barter economy and various other ways of tax evasion.  A sales tax is also highly regressive, particularly when applied to food and other necessities that consume a large fraction of the spending of low-income groups.  While there are ways to compensate for this, they are all complicated and bureaucratic -and therefore costly and subject to political manipulation.

Compared to all of these, a gasoline (motor-fuel) tax has many advantages, including simplicity, transparency, and negligible transaction costs - since the collection mechanism is already in place.

3.  Energy taxes would penalize all forms of energy, including electric power, which is the mainspring of economic growth.  A similar problem arises with the carbon tax, although it would not (or should not) tax nuclear and hydro-electricity.  But any restriction on the emission of CO2 would penalize the use of coal, America's cheapest fuel, which generates more than half of all electric power. 

4.  Originally, the gasoline tax was designed to finance road construction, on the general theory that motorists should pay for the use of highways and bridges.  But partly because of increases in fuel efficiency in the past three decades, the tax per mile-driven is no longer adequate to support all of the costs.  Substantial funds are needed for failing transportation infrastructure.  The Department of Transportation has identified a need for some $300 billion just for the repair of bridges.  A $1-tax per gallon would yield over $100 billion a year.  Since the demand for motor fuels is quite inelastic, an eventual $4-tax might yield in the vicinity of $400 billion annually; it would nicely complement any plan to cut income tax rates permanently or eliminate some taxes altogether.

5.  Is a gas tax regressive?  Not entirely clear, according to the Congressional Budget Office.  The very lowest income group in our population does not own cars.  In any case, since the gas tax is construed to be revenue-neutral and accompanied by a reduction in income taxes, the overall tax structure can be adjusted to remove any regressivity.  In 2010, income taxes accounted for $899 billion (42 %) out of a total of $2162 billion in federal revenues.[CBO]   An oft-mentioned (but somewhat misleading) fact is that the top 1% of earners pay about 38% of all income taxes; the top 5% pay 59% and the bottom 50% pay only 2.6%. [, 2008 numbers]  The gas tax could therefore relieve nearly 95% of all earners from paying taxes, including the highly regressive payroll tax (FICA) that currently hits low-wage earners the hardest.  This step alone would save taxpayers and their employers a major fraction of the $368 billion now spent annually for documenting and filing. [, 2010 numbers]

6.  Traffic congestion imposes a huge economic cost on the nation and also directly on individuals; even a small improvement would be worthwhile.  A major argument for a motor-fuel tax is that it reduces driving and therefore also congestion and traffic accidents.  [The annual death toll now tops 37,000, with large economic losses also from injuries.] []  To be sure, it is not as effective as toll roads or toll bridges, where the charge can be adjusted to match the volume of traffic.  But since it is proportional to the number of miles driven, the gas tax is a reasonable second-best solution; a Congressional Budget Office report ["Using Pricing to Reduce Congestion", March 2009] quotes congestion costs ranging up to $78 billion. Similarly, if the cost of car insurance were linked to the number of miles driven, it would further reduce congestion and all other impacts of road transportation.

7.  By contrast, raising the fuel-efficiency standards of future vehicles (by stricter CAFE legislation) is not particularly effective.  With the existing fleet of cars, it would in any case take many years before there is an impact on average-miles-per-gallon and oil consumption.  Higher efficiency also lowers the cost-per-mile and therefore encourages more driving.  If efficiency is improved simply by shaving weight, it impairs safety and raises traffic deaths, as is well documented.  In addition, CAFE raises the cost of new cars to consumers and penalizes the U.S. automobile industry for building what the public wants to buy.  The higher cost of new cars would also keep older, less-fuel-efficient, and more-polluting vehicles on the road longer.  On the other hand, a gasoline tax would immediately discourage driving additional miles, especially of gas-guzzling vehicles.

8.  To make a noticeable impact on driving habits, the gasoline tax has to be at least a dollar a gallon.  An average motorist driving 10,000 miles per year uses about 500 gallons and would thus pay an additional 500 dollars.  This is a modest sum compared to depreciation, repairs, insurance, and parking charges.  To be effective, the tax would have to increase gradually to several dollars, close to the tax now applied in Europe and much of the rest of the world.

9.  Nearly half of U.S. oil consumption, about the same volume as domestic production, is used for transportation.  A reduction in the consumption of motor fuels translates directly into a reduction of oil imports.  A 10-percent reduction would reduce imports by about one million barrels per day and improve the US trade balance by over $25 billion a year.  This reduction in oil consumption would of course be matched by a corresponding reduction in oil production and exports by OPEC, mainly by the swing producer Saudi Arabia.  It would lower the world price slightly; but more important, it would reduce oil revenues that now provide much of the funding for terrorism.  Reducing our level of imports would therefore enhance national security, might reduce the commitment of U.S. troops overseas, and remove distortions on US foreign policy.  These benefits cannot be easily quantified but they carry great political weight.

10.  Finally, we come to the considerable environmental benefits of reduced oil consumption and reduced driving: less emission of pollutants, less noise, and fewer accidents.  There are also longer-range benefits that should have a special appeal to environmental groups: Reduced oil consumption enhances sustainability; high gasoline prices stimulate the use of ultra-efficient electric cars and public transport; and reduced emission of carbon dioxide should please those concerned about global warming.  There may be benefits also for those who are more concerned about economic growth: Less political pressure to increase CAFE standards and less opposition to Alaskan oil production, which would make a relatively greater impact if our imports were smaller.

11.  There are also foreign-policy benefits.  Europeans have long accused the United States of wasteful use of oil.  Disappointed by American rejection of the Kyoto Protocol, they might appreciate harmonization of gasoline taxes that raise them to the European level.

To avoid any misunderstanding, let me make it quite clear that any increase in the gas tax must be made "revenue-neutral."  I am certainly not in favor of increased government spending.  But I do find the arguments in support of a gas tax compelling.

How might such a tax come about?  Presidents Reagan and Clinton raised the federal gas tax to its present value of 18.4 cents - and there was no outcry.  [The total tax now averages 41 cents per gallon.  The mandate for the addition of ethanol adds a large cost that's difficult to quantify; technically, it's not a "tax" because the money does not go to the Treasury.] But "gas tax" is still a dirty word to many.  Maybe we should refer to it as a "Highway User Fee" or" Deficit Filler."  "Energy Conserver" and "Terrorist Funding Cutter" would also do nicely.

Who will touch the third rail of higher gasoline taxes?  Well, why not the legislators who have been advocating the environmental benefits of reduced driving, reduced oil imports, and reduced CO2 emissions?   Plus all of the legislators who voted against an income- tax reduction because it would increase the budget deficit.

S. Fred Singer is emeritus professor of environmental sciences at the University of Virginia and former Chief Scientist of the U.S. Department of Transportation.  He is a Senior Fellow of the Independent Institute and the Heartland Institute.  He is the author of a monograph on The Price of World Oil and co-author of Free Market Energy.  He has been a consistent advocate of higher motor-fuel fees for more than 25 years.