Policy commentary

Triple Convergence toward a Higher Gasoline Tax

Nov 20, 2009 | Kenneth A. Small

The United States taxes highway fuels at very low rates compared with many other countries—in fact, federal taxes have been fixed in nominal terms since 1993, despite inflation. Has the time come for a large increase in gasoline and diesel taxes?

It’s rare that a single policy instrument can solve several problems at once. Rarer still that the political and economic motivations to address these problems converge; and almost unheard of that lessons of history lead to the same conclusion. We are in such a situation today with respect to taxes on motor vehicle fuels. It is time for a dramatic, permanent increase in these taxes.


Problem #1: infrastructure needs. It is clear that state and federal governments, private investors, local authorities, and others have trouble keeping up with legitimate needs for spending on roads, mass transit, flood control, and other public assets. These needs include maintenance of aging capital, upgrades to accommodate newer standards for earthquakes and extreme weather, and expansion to handle continued population and economic growth. Taxes on gasoline and diesel fuel are the long-standing bedrock of funding for the surface transportation component of this infrastructure. But this bedrock has been eroded by a combination of a shrinking tax base (more fuel-efficient vehicles) and lower real tax rates (rates rising more slowly than inflation). The shrinking tax base cannot be reversed, but there is no reason why tax rates cannot be maintained and indeed drastically increased. Numerous countries already have rates several times higher than in the United States, without stifling their economies.


Problem #2: petroleum dependence and climate change. The United States is poised to embark on new programs to reduce dependence on foreign oil and emissions of carbon dioxide. This effort cannot possibly succeed if it ignores the underlying economic motivation for people to use petroleum: quite simply, it is cheaper than alternatives. Higher fuel prices could bring about significant reductions in petroleum use through reduced driving and by harnessing consumer self-interest to the cause of improving vehicle fuel efficiency. Other policies, such as higher fuel-efficiency standards or promoting green technologies, will work more effectively if there is pressure from customers to encourage rather than evade such measures.


Problem #3: federal and state deficits. Governments at all levels in this country face a fiscal climate in which revenues lag at just the time when increased spending is needed—both for programmatic goals and to kick-start a weak economy. The massive federal stimulus program relies heavily on public debt, giving pause to many thoughtful observers.


Raising fuel taxes can go a long way toward closing the financing gap without more debt. While tax-financed government spending is less stimulating than debt-financed spending, the well-known Keynesian “balanced-budget multiplier” shows that it remains a potent tool. Put simply, what government spends goes directly into the hands of producers, who mostly spend it on labor or intermediate goods; whereas the tax bite that finances it does not reduce people’s spending dollar for dollar. Furthermore, the timing of a tax increase now fits nicely with the expected gradual decline in the desired role of fiscal stimulus as the economy recovers.


Convergence with History and Current Events

Most of the current decade witnessed an apparently relentless increase in gasoline and diesel fuel prices, hitting about $4.00 per gallon in mid-2008. Expecting the rise to be permanent, many consumers, motor vehicle manufacturers, real estate developers, energy technology companies, and others had begun investments for a more fuel-scarce future: sales of large SUVs plummeted, development of battery and hybrid car technologies flourished, truckers invested in more aerodynamic designs, home-buyers sought to shorten commutes. However, these efforts are now being undercut by the subsequent collapse in fuel prices. What better time to assure such decisionmakers of the long-term economic wisdom of fuel parsimony by raising fuel taxes?



History supports this analysis by revealing a lost similar opportunity. From 1973 through 1985, fuel prices rose sharply, instigating a 30 percent rise in the average fuel efficiency of the entire U.S. fleet of passenger cars, new and old. Some of this rise can be attributed to the Corporate Average Fuel Economy (CAFE) standards that were instituted in 1978; high fuel prices made those standards easier to meet because manufacturers did not have to fight consumer preferences. When petroleum prices collapsed in 1985, it did not take long for the market to respond with an unprecedented shift to large, low-efficiency vehicles (aided by a huge loophole in CAFE that treated SUVs and pickup trucks separately from and much less stringently than cars). With no end in sight to low fuel prices, the “big three” U.S. automakers bet heavily that the trend would last—a bet that has now cost U.S. taxpayers and workers dearly.  


Kenneth Small


But the story is even more perverse. Since SUVs and pickup trucks caught on, several factors have maintained their popularity. First, manufacturers committed their designs, assembly lines, and dealership networks in ways not easy to reverse. Second, marketing efforts gave consumers a long-lasting positive image of large vehicles. Third, travelers learned that small cars fare poorly in collisions with large ones, and so turned to “upsizing” out of fear. So even if everyone would be better off with a fleet of mostly small cars, we became stuck with large ones; it will take a sustained policy change to get us out of this rut.


In addition to these factors, it is well established that drivers do not pay for various costs they impose on others, especially congestion, air pollution, and a substantial portion of accident costs. These costs amount to about 10 cents per mile on average throughout the United States. With motor vehicles now traveling more than three trillion miles per year, even small reductions add up to big cost savings. For example, raising fuel prices from $3.00 to $5.00 per gallon through a tax increase could be expected to reduce driving long-term by about 6.7 percent according to a conservative estimate; at 10 cents per mile, this reduction would produce $20 billion a year in less congestion, air pollution, and accidents.


Right Tool for the Job?

There are many policies better than fuel taxes for specific problems. An oil tax would do more for energy security by motivating conservation in industrial as well as transportation uses. A cap-and-trade system or broader tax would achieve greater coverage of greenhouse gases. For motor vehicle externalities, direct policies such as congestion pricing, mileage taxes (including on heavy trucks), and tighter pollution-control measures are probably more effective. Private tolling initiatives can ease public fiscal stress. But it’s hard to think of a single policy that covers all of these problems so well with a tool already familiar to the public, with administrative mechanisms already in place, and with experience abroad to assure us that an apparently draconian policy will not end life as we know it. At least until broader policies are comprehensively implemented, which may be a long way off, there is an overwhelming case for a large increase in federal fuel taxes.

Kenneth Small is research professor and professor emeritus of economics at the University of California at Irvine. He specializes in urban, transportation, and environmental economics.


Further Readings: 

Parry, Ian W.H. and Kenneth A. Small. 2005. Does Britain or The United States Have the Right Gasoline Tax? American Economic Review 95: 1276–1289. 

Transportation Research Board (TRB). 2006. The Fuel Tax and Alternatives for Transportation Funding. TRB Special Report 285. Washington, DC: National Academy of Sciences.

Wachs, Martin. 2003. Improving Efficiency and Equity in Transportation Finance. Transportation Reform Series. Washington, DC: The Brookings Institution.