ENERGY ECONOMICS

Energy Economics: Governmental Fiscal Policy and Taxation - Effects on Oil Supply and Demand

Energy Economics: Governmental Fiscal Policy and Taxation - Effects on Oil Supply and Demand

Introduction

This study shows that fuel taxes serve a very important role for the environment and that we risk a backlash of increased emissions if they are abolished. Fuel taxes have restrained growth in fuel demand and associated carbon emissions. Although fuel demand is large and growing, our analysis shows that it would have been much higher in the absence of domestic fuel taxes. People often assert that fuel demand is inelastic but there is strong research evidence showing the opposite. The price elasticity is in fact quite high but only in the long-run: in the short run it may be quite inelastic which has important implications for policy makers.

Taxation and Kyoto Protocol

Lately there has been some interest in including transport into carbon permit trading. This is natural since people now expect that permit trading implies generous allocation of free permits and if a firm needs to buy more they are inexpensive (at least compared to fuel tax levels)! Agents in the transport sector presumably hope that joining a trading scheme will act as an argument for abolished or lower taxation. We must however be very careful otherwise this will lead to a rapid escalation in transport fuel use. Analyses by climate scientists show that since atmospheric carbon absorption is slow it acts virtually like a stock pollutant and we will need eventually to reduce emissions drastically. The exact reduction depends on what risks we are willing to take but for instance Azar (2005) shows that 50% reductions relative today's level would be needed this century in order to meet a target of 450 ppm. The Kyoto Protocol only aims for a reduction that was intentionally made very small in order to get all countries on board. However not even Kyoto was acceptable to all parties and one of the reasons for this is the belief that there are no acceptable and yet sufficiently effective policy instruments available. As evidence some observers point to the carbon tax that was tested politically in the EU during the 1990s and (prematurely) discarded as impossible. Relatively little is said about fuel taxes which have a long and reliable track record of reducing emissions in the countries that set them sufficiently high.

On both ends of the political spectrum, there are people who lack faith in fuel taxes as environmental instruments. There are some who do believe in market mechanisms but who do not fully grasp the importance of the environmental issues at stake and therefore dislike fuel taxes. On the other side, there are those who are concerned for the atmosphere but who believe capitalism cannot survive without satisfying a 'constantly growing thirst for oil'. They therefore think there is no point in arguing for economic instruments. But both are wrong! Economic instruments can and do work well! The evidence is already here because—by some irony—the policies have been ...