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About the Commentary

Series Editor: Joshua Linn
Managing Editor: Felicia Day
Assistant Editors: John Anderson and Adrienne Foerster

Welcome to the RFF Policy Commentary, which is meant to provide an easy way to learn about important policy issues related to environmental, natural resource, energy, urban, and public health problems.

Views expressed are those of the author. RFF does not take institutional positions on legislative or policy questions.

To receive the RFF Policy Commentary by email, or to submit comments and feedback, contact comments@rff.org.

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Ian W.H. Parry and
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June 22, 2009
Series Editor: Ian Parry
Managing Editor: Felicia Day
Assistant Editors: John Anderson and Adrienne Foerster

Welcome to the RFF Weekly Policy Commentary, which is meant to provide an easy way to learn about important policy issues related to environmental, natural resource, energy, urban, and public health problems.

Gasoline taxes are easily the most efficient policy to reduce gasoline use. However, the federal gasoline tax has not been increased since 1993, and inflation has eroded its real value over time. One common argument against raising fuel taxes is that they might impose a disproportionate burden on low-income families. In this week's commentary, Sarah West takes a careful look at the validity of this argument.

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Should Distributional Considerations Hold Up Higher Gasoline Taxes?
By Sarah E. West

Cars in traffic

Increasing federal or state gasoline taxes would offer clear advantages: consumers would tend to buy less gasoline, thereby reducing greenhouse gas emissions and dependency on foreign oil. Households would have an incentive to drive fewer miles, reducing congestion, accidents, and emissions of local pollutants. Because households do not currently account for all of these costs of driving, gasoline tax rates (now 44 cents per gallon on average) are inefficiently low.

Someone would bear the burden of an increase in gasoline taxes—but who? Policymakers frequently argue that the gasoline tax is regressive by definition—poor households pay a higher proportion of their income in tax than do wealthy households. But is this a valid argument?

Assessing the approximate distributional burden of a gasoline tax is fairly straightforward. Nearly all gasoline is purchased directly by households, so if the gasoline tax is fully passed forward into pump prices its distributional effect can be assessed by comparing gasoline consumption (relative to income) across different household groupings. At least in the short run, before households make major changes in the kinds of vehicles they drive or in the location of their residence, consumers seem to bear the bulk, if not the entirety, of any increase in the gasoline tax. Over the longer run, the effect might be more complicated as consumers switch between fuel-efficient and fuel-inefficient vehicles and some of the tax burden might be borne by fuel refiners and gas-station owners.

Among those households that consume gasoline, the gas tax is clearly regressive. Gasoline-buying households with the highest annual income (in the top 20 percent) pay less than half of what poor households (in the bottom 20 percent) pay, as a proportion of annual income. One reason for this is that lower-income households are more likely to drive older, used vehicles, with relatively higher fuel consumption rates. Another is that vehicles miles driven tend to rise by less than in proportion to household income.

But annual income is probably not the best measure of household well-being, as poorer households tend to have expenditures greater than their annual income, while other low-income people, like MBA students, are clearly not poor when account is taken of their future earnings potential. For these reasons, economists often prefer to proxy household well-being by the total amount they spend or consume each year, rather than their annual income. It's also important to account for the fact that many poor households neither own nor lease a vehicle, and therefore do not pay gasoline taxes at all.

When the amount of gasoline taxes paid is divided by total expenditures, rather than income, and when households that do not own vehicles are taken into account, highest-income households still spend less in gasoline taxes as a proportion of total expenditures (half a percent) than the lowest-income households (0.7 percent), but the poorest households actually spend less than middle-income households, providing a murkier picture of just how regressive the gasoline tax actually is.

 

 Sarah E. West
Sarah E. West is an associate professor of economics at Macalester College in Saint Paul, Minnesota. Her research analyzes optimal tax policy, with a focus on estimating behavioral responses to policies that reduce gasoline consumption, including taxes on gasoline, subsidies for clean vehicles, and Corporate Average Fuel Economy standards.

Another relationship between income distribution and gasoline consumption further mitigates the regressive nature of the gasoline tax: poorer households are more responsive to gasoline price changes than are wealthy households. This may be because gasoline price increases have greater relative impacts on poor households’ budgets, or because the poor have greater access or less aversion to public transportation. Whatever the reason, when gasoline prices rise, we can expect poorer households to reduce gasoline consumption up to twice as much as wealthy households, thereby escaping a greater proportion of the gasoline price increase. Care must be taken to account for the fact that gasoline price increases can make it disproportionately more difficult for poor households to get to work, but failing to account for flexible price-responsiveness can overstate regressivity.

Rebates Can Counter Regressivity

Even accounting for the above factors, the gasoline tax still places a disproportionate burden on poor households. But careful recycling of the gasoline tax revenues back to households can mitigate or even completely overcome its regressive nature.

By using the revenues from the gasoline tax to reduce taxes on work hours, the policy can be made significantly less regressive. The overall effect of the tax rate increase and revenue rebate could be made more progressive by targeting these tax rate reductions toward the poor, or by increasing the earned-income tax credit (EITC). If the revenues are used to give rebates of the same amount to all households, the policy could be made progressive. With such a rebate scheme, the poorest households could actually be made better off. These lump-sum rebates are analogous to those in "cap-and-dividend" proposals for climate change policy.

While it might seem natural to use gasoline tax revenues to counter regressive impacts, this need not be the case. Public finance economists generally would recommend that policymakers set the gasoline tax at the efficient level, so that motorists face the full costs of driving, regardless of the distributional implications. Then, if they think that the gasoline tax places too much burden on poor and working-class households, policymakers can use the most efficient redistributive tools to attain equity goals, be they lump-sum rebates of gas tax revenue or modifications to the broader income tax and benefit system.

Further Reading:

Burtraw, Dallas, Richard Sweeney, and Margaret Walls. 2009. The Incidence of Climate Change Policy: Alternative Uses of Revenues from a Cap-and-Trade Auction. Discussion paper 09-17. Washington, DC: Resources for the Future.

Parry, Ian W.H., Margaret Walls, and Winston Harrington. 2007. Automobile Externalities and Policies. Journal of Economic Literature XLV: 374–400.

West, Sarah. 2004. Distributional Effects of Alternative Vehicle Pollution Control Policies. Journal of Public Economics 88: 735–757.

West, Sarah E. and Roberton C. Williams III. 2004. Estimates from a Consumer Demand System: Implications for the Incidence of Environmental Taxes. Journal of Environmental Economics and Management 47: 535–558.

West, Sarah E. and Roberton C. Williams III 2007. Optimal Taxation and Cross-Price Effects on Labor Supply: Estimates of the Optimal Gas Tax. Journal of Public Economics, 91: 593–617.

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Views expressed are those of the author.
RFF does not take institutional positions on legislative or policy questions.

To receive the Weekly Policy Commentary by email, or to submit comments and feedback, contact comments@rff.org.

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