Thursday, May 05, 2011

Weighing in on the Gas Tax Debate

By Jesse Jenkins and Sara Mansur

Kevin Drum's recent post on the low price elasticity of demand for oil has reignited an old debate over gas taxes and energy innovation.

Drum draws our attention to some "eye popping" figures for price elasticity of demand for oil from the IMF. According to Drum, these elasticities mean that, in the short term, a 50 percent increase in price leads to a 1.2 percent decrease in consumption. In the long term, it leads to a 4.7 percent decrease.

Conservative blogger Jim Manzi rightly points out that, with elasticities as low as these, a gas tax at any politically realistic level is not going to reduce our dependence on fossil fuels.

Specifically, to the extent that we continue to progress in making non-fossil-fuels technology cheaper and more effective for an ever wider array of applications, we can accelerate the ongoing de-carbonization of our economy. The idea of economists to use artificial scarcity pricing to do this is aggressively marketed in blogs, magazines and TV shows, but is extremely unlikely to work, because the current price elasticity of oil is so low. The work of engineers and physical scientists, however, is likely to be determinative.
In response, several bloggers have argued that these elasticities are underestimated, pointing to the unreliability of estimates of long-run price elasticity of oil demand in general and to other literature with higher estimates than the IMF study. While the IMF estimates are low, revised estimates certainly aren't so high as to penalize consumption, particularly in the absence of viable, and cheap alternatives to fossil-fuel based technologies.


This brings us to a second, crucial reason that a gas tax won't solve our dependence on foreign oil. As Matt Hourihan of the Information Technology and Innovation Foundation argues on Andrew Sullivan's blog, price hikes alone won't do much to spur clean energy innovation, mostly because of the risks inherent with nascent, early-stage technologies, risks that private companies aren't willing to bear on their own.

The problem is that just as price changes have to be severe to manifest any impacts on gas consumption, price changes on their own also tend not to do much to inspire the development of radical new tech solutions, unless prices are through the roof. This is mainly due to the high levels of risk and uncertainty that come with new tech: private firms would generally rather seek out low-risk, low-cost alternatives (i.e. more efficient internal processes or capital goods) than to invest time and effort into developing high-risk, initially-high cost alternatives (i.e. hydrogen fuel cells). It takes a real, permanent shock to get any real effects, and suffice to say the American political system is unlikely to ever pass a gas tax high enough to drive these kinds of changes.
Hourihan points to the European example, where, despite significantly higher gas prices than in the US, the population is still dependent on fossil fuels, and high gas prices haven't led to the widespread uptake of electric cars.

But this doesn't mean that a gas tax doesn't have a place in a smart model for a clean energy infrastructure. As Ryan Avent noted last summer, a $5 per barrel oil tax could raise about $40 billion annually. That's the equivalent of about 12 cents per gallon of gasoline -- certainly not enough to seriously alter consumer behavior, but $40 billion in revenues is enough to fund the development and construction of an improved clean energy infrastructure.

As the Breakthrough Institute has previously argued, a low and politically sustainable carbon tax or gas tax or other fee on today's energy consumption, coupled with direct federal investments in innovation, will go a long way towards developing the clean energy infrastructure of the future. In fact, the revenues raised by a carbon or gas tax could be used to fund the public-private partnerships that have so successfully spurred private sector innovation in the past.

The mental model for this effort shouldn't be the high gas taxes of Europe - designed as they are to penalize consumption (and relatively ineffective at doing so). Rather the right precedent is the relatively low gas taxes of the United States, which raise revenues dedicated to the Highway Trust Fund.

The reasons for developing a cleaner, safer, more secure energy system are well known. What we need is a user fee charged for the enjoyment of today's affordable and efficient energy infrastructure, used to generate revenues set aside and specifically tasked with building the affordable, efficient, and improved energy infrastructure of tomorrow.

Whether imposed on oil or gasoline or electricity or on all carbon fuels, such a user fee would amount to pennies on the gallon for consumers. But it would ensure that we dedicate the tens of billions needed nationally to develop and deploy the clean, reliable, and affordable energy sources of tomorrow.

In sum, carbon pricing or gas taxes alone won't lead to breakthrough energy innovations. What will lead us there are directed government investments in energy innovation, in which a smart user fee on energy consumption or carbon emissions can play an important, but fundamentally different (and less central role) as envisioned by conventional cap and trade, carbon tax, and gas tax proponents.

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