Professorial ‘Elite’ Blind to Problems in Gas Tax Proposal

Published October 1, 2007

The rise in world fuel prices since 2005 has made many motorists uneasy about proposals to increase gasoline taxes. But this has not stopped a handful of distinguished economists and pundits from calling for large gas tax hikes.

One is N. Gregory Mankiw, a Harvard University professor and former chairman of the Council of Economic Advisers, who recently wrote a piece for the Wall Street Journal outlining his reasons for imposing a $1 gasoline tax on American motorists, up from the current levy of 18.4 cents per gallon.

Depending on many factors–principally worldwide supply and demand–average gasoline prices fluctuate widely. Do we see traffic congestion magically disappearing since gasoline prices have increased nearly $1 since last winter? Is America’s national security strengthened by paying those elevated prices?

Of course not. So Mankiw’s plan to raise gasoline taxes by $1 over a decade would not accomplish his desired results.

Making ‘Pigouvians’ of Themselves

Mankiw says his proposal is “Pigouvian,” named for Arthur C. Pigou, an early twentieth century English economist who advocated taxes to correct what economists call “market failures” or “negative externalities” that impose spillover costs on society.

Mankiw is founder of the Pigou Club, which he describes as “an elite group of economists and pundits with the good sense to have publicly advocated higher Pigouvian taxes, such as gasoline taxes or carbon taxes.”

Mankiw has advocated phasing in a $1 per gallon increase in gasoline taxes over a decade to correct for social costs of gasoline consumption relating to national security, traffic congestion, and pollution.

Problem of Knowledge

In theory, using Pigouvian taxes is efficient and straightforward, but in practice, the Pigouvian solution is anything but simple. One important problem often ignored by advocates of Pigouvian taxes is what is typically referred to as the “knowledge problem.”

If gas taxes should be raised purely to offset the social costs of gasoline consumption, exactly how high are those social costs, how would policymakers quantify them on an ongoing basis, and how high a tax would be necessary to compensate for them?

Also, there are clear social benefits to the use of gasoline–greater mobility, quick delivery of goods and services, lives saved in emergencies, etc.–that should be factored in. Such an analysis could show social benefits outweighing the social costs.

Clearly, the practical difficulty of compiling data and estimating social costs is not trivial. Pigouvian taxes place enormously high information burdens on policymakers. Those looking for social cost estimates in the economic literature will find results that vary widely.

Additionally, what level of total social welfare loss would Americans experience if policymakers overestimated the costs of externalities and implemented an excessive Pigouvian tax? Those hit hardest would be the lower-income Americans who are already disproportionately harmed by the regressive nature of gasoline taxes.

On the other hand, what convinces proponents of Pigouvian taxes that $1 per gallon would be enough to solve the plethora of harms that “underpriced” gasoline is said to create?

Even if policymakers were able to solve the “knowledge problem” that plagues Pigouvian taxes, finding the optimal policy solution for environmental externalities from fossil fuels may require additional analysis.

For instance, even if a government-appointed central actor could somehow ascertain the “correct” tax rate that internalizes negative externalities from pollution, gasoline is probably the incorrect base for that tax.

Ending Gridlock?

The idea of applying a Pigouvian-style tax to relieve traffic congestion is also misguided from a public policy perspective. Overall gasoline usage is not the proximate cause of traffic congestion.

Raising the gasoline tax to help ease traffic congestion would be dreadfully inefficient, because it would tax a driver on a country road outside of Dodge City, Kansas at the same rate as a driver during rush hour in Washington, DC. Absent congestion-based pricing for road usage, Americans would still suffer high volumes of traffic during certain times on certain roads even if automobiles ran on water.

Improving National Security?

In his final Pigouvian justification for increasing gasoline taxes, Mankiw argues the gas tax is “an economic policy with positive spillovers to foreign affairs.” A common argument in support of this contention is that we should increase the gas tax to promote our “energy independence” from high-risk foreign sources of oil.

While well-intentioned, this argument neglects the important fact that the world market for oil is fully fungible. History has proven that even energy independent countries are harmed by worldwide supply disruptions. In addition, the latest report from the Energy Information Administration notes Canada and Mexico are the number one and three sources of U.S. oil imports, respectively, reducing any likelihood of major disruptions.

Disturbing the Economy

All told, raising gasoline taxes for Pigouvian purposes advances a dangerous view of tax policy, where government attempts to use the tax code as a tool for central planning of the economy. The fundamental purpose of taxes is to raise necessary revenue for government programs, not to micromanage a complex market economy by use of subsidies and penalties.

A central aim of the tax system should be to minimize distortions in the economy and to interfere as little as possible with the decisions of free people in the marketplace–not to disturb a mechanism that otherwise runs with impressive efficiency.

Jonathan Williams ([email protected]) is director of the Tax and Fiscal Policy Task Force at the American Legislative Exchange Council (ALEC).