The Pigou Club and the Gas Tax
Prof. Mankiw has suggested an interesting policy, and I must say his arguments are pretty good.
With the midterm election around the corner, here’s a wacky idea you won’t often hear from our elected leaders: We should raise the tax on gasoline. Not quickly, but substantially. I would like to see Congress increase the gas tax by $1 per gallon, phased in gradually by 10 cents per year over the next decade. Campaign consultants aren’t fond of this kind of proposal, but policy wonks keep pushing for it.
He lists a number of reasons why people with disparate interests should find such a tax at least in some ways more palatable than other taxes.
First is the environment. A tax on anything will reduce the amount of that good that is produced/consumed by the economy. As such, less gasoline will mean less pollutants in the air and even less global warming. Such a tax will also reduce road congestion. With higher gasoline prices people will look to move closer to work, utilize public transportation more and/or car pool. We could also, reduce the number of regulations on the books. Instead of Congress wringing its hands over fuel economy standards, the problem would be at least partially solved by higher gasoline prices which would make more fuel efficient cars more desirable. The extra revenue certainly could help offset the budget deficit without raising income taxes. This would also be good for the economy in that money that is being borrowed by the government to pay for its spending could no be loaned out to people who do productive things like build homes, and other commodities. Then there is somewhat more esoteric point concering the incidence of the tax. Irrespective of who the tax is levied upon from a legal standpoint (i.e., where the legislation places the burden) the acutal incidence is borne by both producers and consumers. That is, as people reduce their consumption of gasoline here in the U.S. the price of oil would fall on world markets offsetting some of the price increase for consumers. Or as Prof. Mankiw put it: Venezuala and Saudi Arabia would pay part of the tax. Then there is economic growth. Since the gasoline tax is a consumption tax it also encourages savings and investment. One place we’d likely see some investment is in R&D looking for alternatives to gasoline. Finally, there is the issue of national security. U.S. foreign policy is undoubtedly influenced by oil and gasoline. The more dependent our economy is on oil and gasoline the more our foreign policy will be influenced by oil and gasoline. Where is most of the world’s oil? The Middle East. Hence a gasoline tax and the concomitant reduction on gasoline/oil consumption would reduce the the need to involve ourselves in the Middle East.
All of the above sound like good reasons to raise the gasoline tax. While I don’t like that idea, I agree that the alternatives are not pleasant either.
Update: There has been lots of disagreement in the comments so far. As such I thought I post a link to this reponse to opponents of Pigouvian taxes by Mankiw.
Here are 4 reasons that Mankiw put forward for not liking an increase in the gasoline tax,
1. You deny the existence of these externalities as a type of market failure. Perhaps you think you live in a Coasian fantasy world where people bargain without transaction costs to reach efficient allocations. (Note: I am not suggesting that Coase himself thought we lived in such a world—he considered it only a useful thought experiment.)
2. You recognize the externalities but you don’t think the government should try to respond to them. You are such a believer in small government that you are willing to live with inferior economic outcomes, such as pollution and congestion.
3. You recognize the externalities, think the government should try to correct them, but think the current low taxes we put on gasoline are sufficient. In this case, you have weighed and rejected the evidence, such as that of Parry and Small, that higher Pigovian would be optimal. (Parry and Small calculate an optimal tax of $1.01 for the United States in today’s dollars. After my proposed phase-in of a $1 hike, the U.S. tax would be $1.40. Assuming 10 years of 3 percent inflation, the tax in real terms would approach almost exactly what Parry and Small recommend. By the way, the published version of Parry and Small was in the American Economic Review, September 2005.)
4. You recognize the externalities but think the government should try to correct the market failure through regulations (such as CAFE standards) or through market-based solutions that do not raise government revenue (such as cap-and-trade systems). Perhaps you are concerned that government would waste the extra revenue on useless government programs.
He has a detailed response to number 4, which he thinks is perhaps the largest group. His basic argument is that he doesn’t worry about how the extra revenue will be spent because it has already been spent.
As for the rest, number 1 should have an obvious answer, we don’t live the perfect Coasian world were we can negotiate without transaction costs. If this were the case then there would be no corporations.
That leaves numbers 2 and 3. The area of externalities is one area that many libertarians and like minded people see as a potential area for government involvement. Externalities are called externalities because they are outside (external to) the market. As such, it results in a misallocation of resources and things can be improved. Such improvements can come via bargaining if property rights are well defined and transactions costs are not too high. In this case, we don’t need the government. However, when transactions costs are too high then negotiation will fail and that leaves the government. Still one can argue that even with an externality having the government intervene can be more costly than simply living with the externality and the sub-optimal outcome. I think this argument is fairly persuasive and is the primary reason we should pause before letting the government try to solve the problem.
Still despite these objections there are still cases where the government could improve on things. Most libertarian minded people think that there should be some level of government. Typically they limit it to things like national defense, police, the fire department, and courts. Maybe a few other things. However, the police and fire departments are, in my view, more accurately viewed as attempts to deal with externalities. High crime can impose economic losses indirectly. That is, even if you don’t suffer as a direct victim of crime, higher crime levels might lower your property values, or make you spend money on things you’d rather not spend it one (security systems, a firearm, etc.). So, many libertarians already acknowledge that addressing externalities via government coercion is legitimate.
So unless you are an anarcho-capitalist (i.e. you don’t want to see any government at all) you are left with number 3. But unless you have some data on which you are basing your rejection of an increase in the gasoline tax you really don’t have much reason at all for your position other than you just don’t like the idea of raising taxes. Well neither do I, but unfortunately I don’t think we can avoid raising taxes. Sorry, but with Bush increasing government liabilities and reducing tax revenues it just doesn’t bode well for keeping taxes low. As Mankiw notes, we’ve have basically spent whatever money the increase in the gasoline tax would raise. We spent on giving seniors a prescription drug benefit.