How to Do a Pigovian Oil Tax
Economists have been advocating a tax on oil and/or gasoline for as long as I have been an economist. More recently, Greg Mankiw has even started a Pigou Club on his blog . I agree with it myself but the problem is that in the current political climate ANY kind of tax increase is unlikely and even if it werent, a tax big enough to offset the externalities of our huge oil demand would be extremely damaging in the short run – enough so to make it a bad idea from a short run economic as well as political point of view.
I will go out on a limb and say it will be a cold day in hell when President Bush proposes such a tax. Not only is it against his religion (no taxes, none, not ever, not for any reason) but it is also against the interests of his oil industry friends. He has yet to go against either of these and I don’t expect him to change in tonight’s State of the
But what OUGHT we to want even if our benighted leader cant bring himself to propose it? Other commentators (See for example, knzn here ) have discussed whether oil demand elasticities are high enough to “work” and beyond that the developing world (especially China and India) is the place where demand growth is likely to be the highest, but there are several considerations that make a Pigovian tax a good idea and a simple implementation plan that would make it both more feasible and more effective.
Though demand growth is projected to be huge in China and India it is undeniable that the US consumes a disproportionate share – more than a quarter – of world oil demand at the present time ( See here ) The
Though short run oil demand elasticities may be low, long run ones are without a doubt much higher. But even this understates the importance of raising the price of oil. The main goal is NOT to encourage more conservation within our current technological base though that is a good idea and the experience of the past year shows that the effects can be significant. Rather it is to encourage development of new non-oil technologies to replace our foreign dependence altogether. New technologies will only become economically feasible if/when oil becomes more expensive and is widely perceived as certain to remain so.
And there is perhaps the biggest problem – If we in the
The answer to this is to phase it in gradually over a long period. An oil tax that added a dollar a barrel each year for the next two or three decades would not only provide the long run certainty that would be needed to risk development of new technologies but it would also be gradual enough not to cause any short run disruptions. It would be at least two or three years before it even brought
Politically, this idea would be a lot easier to sell than a single large tax increase would be. No politician would be forced to do something massively unpleasant in any single year or election cycle, while appeals to the need for energy independence would go far in convincing voters of the need for sacrifice. Indeed, is there anybody left in the country who doesn’t think it would be a good idea not to need to worry about foreign oil supplies?