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Why We Need Certain and Higher Gasoline Prices

December 28th, 2008 . by economistmom

This cartoon by Richard Thompson, from Dave Barry’s excellent Year in Review, reminds me that the “gasoline price roulette” we’ve experienced this year has not been a good thing for Americans–even as we now enjoy sub $2/gallon prices (and as my family’s just made the road trip from Virginia to Ohio).

Why not?  Because just as we were starting to adapt to the $4/gallon prices we saw in the peak of summer–by driving less and more efficiently, shunning gas-guzzling SUVs, and getting on waiting lists for hybrids–the larger forces of a deeper, world-economy-wide recession started to bring gasoline prices quickly back down.  And what happened?  Check out the official data from the Energy Department’s Energy Information Administration.  Here’s the plot of retail gasoline prices over the past couple years:

Note the peak is July ‘08, and the far right trough is where we are now…

And here are the plots of U.S. gasoline production and gasoline demand, over the past year (the yellow and red segments; the blue line compares to same months last year):

The middle of the two graphs above show U.S. production (supply) and demand in July.  That yellow line shows that both did not rise during the peak summer travel period but instead remained flat.  (Contrast with the July-August period in 2007, the blue dotted line.)  And in September-October of this year, both dropped off dramatically, further widening the decline from the prior year.  But since this fall when gasoline prices started rapidly falling, gasoline demand has rebounded just as dramatically, wiping out nearly all of the early-fall decline, and U.S. gasoline production now fully matches its 2007 levels.

Which is why I think–and I’ve said this before–our country needs higher gasoline prices, assisted by government policies that would more appropriately “price” the external costs associated with the use of fossil fuels, such as through a carbon tax or cap-and-trade program.  It’s not just a higher price we need, but a higher and certain price.  And it’s not just us stupid, near-sighted American consumers who need to be forced into the better behavior of consuming gasoline more efficiently (conserving), but also the not-necessarily-stupid-but-profit-seeking, near-sighted Detroit automakers who need to be “incentivized” into the better behavior of producing more fuel-efficient technologies and vehicles.

I’m not talking about enacting and implementing a carbon tax now, in the midst of this awful recession.  But I strongly agree with Resources for the Future’s Richard Morgenstern, who recently argued (in “The Hill” newspaper) that the incoming Obama Administration must make an early and clear commitment to establishing a carbon-pricing policy that would take effect as soon as the economy begins to recover:

Obama clearly supports reductions in oil consumption and an attack on global warming. But a chorus of voices wants him to set aside any significant initiatives in these areas while he struggles to pull the country out of recession. Green elements of the stimulus package, they believe, will provide sufficient push for low- and no-carbon technologies, thus obviating the need for early decisions on a cap-and-trade or other carbon-pricing regime. But announcing at the outset an explicit plan for carbon pricing is essential — for two reasons.

First, setting a carbon-pricing target would strongly signal to both business and consumers that new technologies must be developed and adopted without delay. Without that price incentive, the advent of greener forms of energy will be postponed yet again.

Second, setting a price on carbon emissions will assure a revenue stream to support future climate-related programs — and, quite possibly, other initiatives as well. The stimulus package cannot go on forever, and carbon revenues can give the federal government the wherewithal to fund future initiatives.

Opponents of an early announcement on carbon pricing say it may worsen the recession. The reality is that any such scheme cannot be implemented immediately, given the need to develop legislation and subsequent regulations…the president could propose an explicit mechanism to postpone implementation in the event certain economic conditions are not met…

[I]t is the best way to reduce uncertainty about U.S. climate policy. Without such directives, investors will continue to act as if carbon emissions are free…

A cap-and-trade system will put a price on those emissions, creating an incentive to develop and adopt more carbon-efficient technologies — much like the recent run-up in gasoline prices shifted consumer purchases in favor of fuel-efficient vehicles. As the economy rebounds, the expectation that an already enacted carbon-pricing scheme will soon kick in will trigger green investments. Early action could be further encouraged by distributing allowances — bankable for future use in a carbon-pricing program — to firms that reduce emissions prior to program implementation.

The way I see it is that one consumer’s gasoline bill is another automaker’s return on his green investment.  Detroit isn’t going to “transform” just because the government goes “poof”–and isn’t likely to reform efficiently just because the government says “jump.”

7 Responses to “Why We Need Certain and Higher Gasoline Prices”

  1. comment number 1 by: Dan Rosenblum

    There’s no time or need to wait for the economy to recover. We’ve waited far too long to begin reducing greenhouse gas emissions. With a revenue-neutral carbon tax, as proposed by the Carbon Tax Center, http://www.carbontax.org., and many others, the economy should benefit along with the climate. If carbon tax revenues are used to reduce payroll taxes, the economy will benefit as less energy use results in less dollars being sent out of the country to pay for oil and dollars kept in the economy are reinvested in the economy.

    Interestingly, Morgenstern is correct about the delay that would result while a cap-and-trade program is developed. That’s a powerful reason to prefer a carbon tax over cap-and-trade, since a carbon tax can be implemented in weeks or months while cap-and-trade will take years.

    In addition, you correctly note in your post that a high price and certainty are necessary. A cap-and-trade program, unlike a carbon tax, would result in serious price volatility. The result? Energy users would not have the price signal they need to encourage investment in energy efficiency and less carbon intensive fuels. For a more detailed comparison of carbon taxes and cap-and-trade, see the Carbon Tax Center web site.

  2. comment number 2 by: Brooks

    Technical question:

    The charts show U.S. demand consistently exceeding U.S. production by a great deal, roughly 1/3 of U.S. demand unaccounted for by U.S. production, period-for-period (I don’t know how long it’s in the distribution pipeline). Theoretically, a couple of explanations that come to mind are that imports and/or increased inventories explain the gap, but both seem dubious to me based on my (admittedly very superficial) knowledge of this market. I could be wrong, but it also may be that I’m just missing something here. What accounts for that gap (or am I misreading the charts)?

  3. comment number 3 by: economistmom

    Brooks: Good question! I did not show the total “finished gasoline production” (which includes reformulated gasoline), which if you go to that EIA website is now around 9 million barrels per day–enough to cover U.S. demand. Imports of gasoline are also shown on that website, now around 1 million barrels per day. So the inventories (and imports) are not nearly as large as you would think from the gap between the (partial) supply and demand charts I posted.

  4. comment number 4 by: Andrew Biggs

    I”m hardly an expert on this, but it seems we need a good estimate of the externalities associated with gas consumption (global warming, health costs from pollution, etc.) and then tack that cost onto the price of gas. Cost estimates I’ve seen (e.g., Parry and Small from the AER: http://www.socsci.uci.edu/~ksmall/Parry_Small_fuel_tax_AER.pdf) are pretty small — a buck or so, but not much more than that. I’ve got no issues with going higher than that if warranted, but it seems that a lot of time the case for higher gas taxes is taken for granted.

  5. comment number 5 by: Jim Glass

    I think Andrew is exactly correct.

    Mankiw in pushing Pigouvian taxes on his blog has pointed to a number of studies that indicate the extrernality cost of gasoline is much less than the gas tax imposed in Europe — but I haven’t seen any Pigouvian-taxer ever say that’s a justification for reducing gas taxes there, where they are too high.

    For my job, I’ve watched the political tax-writing committes for years. They’ll take any intellectual justification for a new tax, use it to justify imposing the tax, then *poof* the intellectual justification for any given amount of the tax is instantly forgotten, and the tax lives on forever at as high a rate as the politicians can get it up to for as long as they can.

    Remember the telephone excise tax imposed as a temporary “luxury good” tax to fund the Spanish American war, that lived until the courts declared most of it illegal two years ago, in the 21st century?

    I’ll become much more comfortable with Pigovian taxes on gasoline and carbon and such — and with the people proposing them — when the proponents say how much the tax should be (instead of “more”) and also say that taxes that are too high are as harmful as those that are too low, by the same logic. And thus that, say, gas taxes in Europe should be reduced.

    For instance, Nordhaus has estimates of the externality cost of carbon buring that in tax terms are really surprisingly low … and I’d like to see Tom Friedman discuss them in his column.

    Otherwise, I don’t see any particularly impressive science or intellectual virtue behind the arguments for Pigovian taxes. Science requires specific quantities, not just “more more”. “More” is the claim of politics.

  6. comment number 6 by: Andrew Biggs

    Now Jim’s comment has gotten me thinking, so maybe I’ll expand a little (for what it’s worth - maybe nothing!). The current case for gas/carbon taxes is basically premised on climate change; I believe current taxes cover externalities imposed on current people pretty well (e.g., asthma from pollution, congestion costs, etc.).

    To get the climate change issue right, we want to know a) the expected cost of climate change to future generations; b) the value we place on future generations relative to current ones (it’s not 1-to-1); c) the variation in potential future costs from climate change (since it might make sense to insure against large but unlikely outcomes even if the expected outcome wasn’t worth bothering with); and d) how high current taxes would have to rise to avert the costs to future generations, since that gives you an idea of the welfare cost to current generations.

    It seems that in the public policy debate at least, almost none of this is really being hashed out. In the academic literature these things are discussed, and my basic takeaway is that without uncertainty about future climate change costs (part c above) it probably wouldn’t make sense to do that much. The expected costs of climate change aren’t that high relative to the baseline increase in future incomes that we should impose very large costs on current generations. With uncertainty the case may be different, but these results don’t seem quite fully-baked yet.

    In any case, I think these kinds of questions are worth thinking about as we consider what kinds of taxes we want for the future.

  7. comment number 7 by: Payday Loans

    The bad thing in having a great demand of gas is the desire of oil companies to have more profit so they will keep on increasing from time to time if there is no enough supply of gas. People may not need payday loans to afford gas anymore, but a lot of the trends that started because of high gas prices have continued, even though prices are lower again. Many people who started using public transportation to save money are still using it. I guess they just got used to it. I know it would be tough for me to go from taking the bus back to sitting in traffic and spending hours looking for parking. Americans are driving less and less, even with the lower prices, so the transportation commission is considering a hike in gas taxes. The money from gas taxes is needed to fund road construction and repair, and the current amount being collected from gas taxes is apparently not enough.