How Much Should Highway Fuels Be Taxed?

This paper provides an updated assessment of economically efficient taxes on gasoline (used by light-duty vehicles) and diesel (used by heavy-duty trucks) to address various highway externalities in the United States. The (second-best) corrective fuel taxes are estimated, and we discuss the implications of fuel economy regulations and prospective (nationwide) controls on carbon emissions. We also examine how optimal fuel taxes depend on how they interact with the broader fiscal system. Our baseline estimates of the corrective taxes on gasoline and diesel are $1.23 and $1.15 per gallon, respectively. However, optimal fuel taxes can be substantially higher if extra revenues are used to reduce distortionary income taxes, or substantially lower if revenues are not used to enhance economic efficiency.

Gasoline consumption on the nation’s roads and highways account for one-fifth of U.S. carbon emissions. Meanwhile, traffic congestion continues to worsen and fatal vehicle accidents kill 40,000 people annually. Such conditions suggest that imposing higher taxes on highway fuels could have positive consequences – and would bring the United States more in line with policies of many European countries that tax gasoline more heavily.

In a new paper, “How Much Should Highway Fuels Be Taxed?” Ian W.H. Parry, the Allen Kneese Chair and RFF Senior Fellow, puts the economically efficient level of taxation at $1.23 per gallon for gasoline and $1.15 per gallon for  diesel fuel. However, the paper also warns that the case for higher taxes can be greatly undermined if revenues are not used to enhance economic efficiency.

Excerpts from the Paper

“There appears to be a strong efficiency case for substantially increasing taxes on highway fuels – to more than $1/gallon – at least for the foreseeable future, before other (more efficient) policies to largely internalize mileage-related externalities (e.g., peak-period road pricing) are widely implemented. This presumes efficient use of additional fuel tax revenues.”

 “Substantially higher fuel taxes appear to have little political traction at present, though it is not difficult to think of examples of policy reforms that, at some earlier date, seemed impossible to implement (e.g., industry deregulation or the use of market-based instruments for pollution control). At any rate, the economist’s role is to inform policymakers about the potential net benefits from overcoming obstacles to more efficient policy.”

In a recent RFF Weekly Policy Commentary, economist Kenneth Small also opines that current economic and political realities provide an opportune time to increase taxes on gasoline.