Why high fuel prices may be good

by Spectator

At an academic and specialist level there is a considerable body of literature and views that makes the general case for high domestic taxes on fuel as being in the public interest. There are two strands to the argument.

First, unbridled fuel usage has a damaging effect on the environment. It is self evident that usage from fuel guzzling motor cars, power stations, buildings, appliances is much more when energy taxes and prices are low than high.

Indeed it is an everyday experience, especially in countries where fuel prices are low, to witness fuel wasteful bumper to bumper traffic at rush hours, and for pedestrians to walk through pervasive, unhealthy gusts of vehicular smoke on the roads made even more hazardous by congested motor traffic. The worst affected from these features of everyday life are the least affluent in society.

There is little dispute that high taxes (and high prices) of fuel by deterring consumption of fuel would improve the quality of life of the population in so far as it reduces traffic congestion, air pollution and making the roads safer. High taxes (and retail prices) provide more than such “negative” benefits, valuable as they are, to improve the life style particularly of the poorest.

Innovation

They encourage technological innovation in the development of alternative fuel efficient inexpensive substitutes including those based on renewable resources e.g. fuel efficient motor vehicles, wood burning stoves, wind power.

None of these can take-off profitably without incentives. The incentive would be provided by low taxes on alternative fuels and high taxes on oil.

The second strand springs from the fact that fuel consumption is so large in most countries that for any given tax levied on fuel the revenue collected is huge. It constitutes an important component of government revenue. Moreover it is easy to collect.

For example, in major industrial countries (United States, Canada, Germany, France, Italy and United Kingdom) fuel tax revenues averaged 470 billion dollars (470,000 million dollars) a year from 2002-2006. Moreover the tax as a percentage of c.i.f. oil prices between 2003 and 2007 was higher than 100 per cent in most if not all the Western European countries. In 2003 the tax as a percentage of c.i.f. oil prices was Japan 118 per cent, France 229 per cent, Germany 213 per cent, Italy 226 per cent, United Kingdom 326 per cent.

Subsequently, world market prices of oil rose every year until 2007. However, domestic taxes in all these countries remained above 100 per cent in every year except Japan (from 2004) and Germany ( in 2007). For 2007, when c.i.f. prices had risen significantly, the tax rate was 62 per cent in Japan, France 124 per cent, Germany 97 per cent, Italy 122 per cent and United Kingdom 201 per cent.

Although tax rates fell with high oil prices, the overall tax revenue did not fall simultaneously as lower tax rates were based on rapidly increasing oil prices. Likewise for tax revenue when oil prices were low and tax rates high.

Fuel tax rates

The fuel tax rates in other Western European countries are similar to those mentioned above. In the United States fuel tax rates are much lower than in Europe, about 30 per cent-55 per cent of the c.i.f. prices in the 2003-2007 period.

However, there has been a vigorous public policy debate on the need to raise fuel taxes and prices. The arguments advanced include: to reduce global warming, to develop alternative fuels, to spur fuel thrifty hybrid cars, to prompt consumer demand for more fuel efficient vehicles, to depress imports from politically unstable countries, and to reduce the huge budget deficit of the US Government.

Some have even gone to the extent of advocating a wartime special fuel tax to pay for the cost of fighting in Iraq and Afghanistan. What is evident from the figures in developed countries is that when oil prices are low the tax rate rises because government’s wish to maintain revenue, and vice versa always with a revenue target in view.

If any of the above mentioned governments had a maximum oil price tax rate, total revenue from oil taxes of governments would be low when oil prices are low and high when oil prices are high assuming the maximum tax rate is imposed throughout.

The size of fuel tax revenues suggests that governments do not look at taxation of fuel in isolation, or what the limits of fuel tax rates should be in the public interest. Taxes are imposed in a broader context of revenue collection in order to achieve the economic, military and other objectives of governments.

Public interest

Most governments of oil importing countries view public interest of the distribution of oil tax revenue in a national context, rather than in terms of the interests of oil consumers. Indeed, fuel taxes are generally central to improve the revenue and spending balance sheets of governments.

Without relative stability of revenues from fuel taxes something would have to give, in other words reducing expenditures of Governments in the social sectors, the military or other areas of government expenditure.

Of course, if revenue from fuel taxes fall because of tax rate ceilings and declining oil prices, governments have the option of keeping expenditures unchanged, and raising other taxes or indulging in greater deficit financing. Both of these options have economic consequences affecting the public interest.

In some countries, revenues from fuel taxes are ring-fenced for specific purposes. In Switzerland, revenues from fuel taxes can be used primarily to improve transportation. In several other countries, there are differential tax rates for different uses of fuel and for different types of fuel. Retail oil prices for industry and agriculture are generally much less than for motor cars.

All increases, reductions, ceilings of tax rates, including on fuel, are political acts in the sense that there are always gainers and losers, either directly or indirectly, from tax changes and limits. For example when c.i.f. fuel prices fall fast, governments could pass on all, or a proportion, of the fall in fuel prices to the consumers. That is widely followed to a greater or lesser extent in developed countries.

A free market approach is to pass oil price falls to all consumers without discrimination. It goes without saying that some consumers benefit more than others. For example, the monetary benefit of across the board lower fuel prices is far greater for the individual motor car owner than the bus traveller.

Should governments offset the loss in oil tax revenue because of reductions in retail prices (say following declines in world market prices and fuel tax ceilings) by cutting subsidies and other government expenditure on public transport, such transport may deteriorate to the detriment of the bus traveller.

On the other hand, an interventionist or managed option when oil prices fall fast, is for governments to maintain retail prices, and allocate the unexpected windfall profit (over and above budgeted profits) with or without a special fund in a targeted manner.

This sum could then be used transparently to fund alternative energy sources than imported oil, improve public transport and transportation in general, or give reduced retail prices only for the functioning of special categories such as three-wheel vehicles and public buses. Or, for example, the windfall profit could be used to reduce the budget deficit and thereby reduce inflation.