Who Pays the Gasoline Tax?

WHO PAYS THE GASOLINE TAX?

WHO PAYS THE GASOLINE TAX? HOWARD CHERNICK * & ANDREW RESCHOVSKY **

Abstract - The regressivity of the the United States is approximately one- gasoline tax and other consumption fifth of the average rate in Western taxes has been challenged on the Europe, any attempt to increase the tax grounds that the use of annual as rate is met with strong opposition. In opposed to lifetime income and 1993, a grueling political battle had to consumption data leads to a substantial be fought in order to raise the federal overestimate of regressivity. Rather than gasoline excise tax rate by four cents per rely on proxies for lifetime income, in gallon. this paper panel data on gasoline consumption and income are used to The fierce opposition to gas taxes exists measure incidence over an intermediate despite the view held by many econo- time period. When people are grouped mists and policy analysts that the into 11-year average income deciles, expanded use of gasoline excise taxes is average gasoline tax burdens are only an appropriate response to automobile slightly less regressive than annual congestion and a suitable tool for burdens. The main reason for the reducing air pollution and alleviating similarity of annual and intermediate- global warming attributable to vehicular run burdens is the limited degree of carbon emissions. The opposition to the income mobility over an 11-year period. gas tax on the part of politicians and the general public appears to arise from the widely held perception that the tax is unfair because it is regressive, imposing a greater economic burden on the poor INTRODUCTION than on higher-income families, and The taxation of gasoline is a highly horizontally inequitable, unduly penaliz- contentious issue in the United States. ing some regions of the country over Despite the fact that the combined others. federal and state tax rate on gasoline in The evidence for the regressivity of *Department of Economics, Hunter College and excise taxes comes primarily from cross- the Graduate Center, City University of New York, sectional surveys, which show that low- New York, NY 10021. income families spend a larger propor- **Robert M. La Follette Institute of Public Affairs and Department of Agricultural and Applied Economics, tion of their annual income on gasoline University of Wisconsin–Madison, Madison, WI 53706. than do high-income families. Recently,

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the regressivity of the gasoline tax has Caspersen and Metcalf, and Rogers, use been challenged by a number of consumption data for a single year to economists who have argued that it is calculate annual tax burdens relative to inappropriate to determine tax incidence lifetime income, for the value-added tax on the basis of income data from a and for gasoline, alcohol, and tobacco single year.1 Their argument, which is taxes, respectively. based on Friedman’s (1957) permanent income theory of consumption and the Yet another approach, taken by Poterba companion life-cycle model of saving (1989, 1991a), Metcalf (1994), and the (Ando and Modigliani, 1963), is that, if U.S. Congressional Budget Office most people with low incomes are only (1990), is based on the argument that, temporarily poor and if gasoline as long as consumption is a constant consumption decisions tend to be made fraction of lifetime income, annual on the basis of lifetime incomes, consumption expenditures provide a calculating tax burdens based on data good proxy for lifetime income. These from a single year will yield tax burdens studies, consequently, use total con- for low-income people that are substan- sumption data in a single year as a basis tially higher than burdens calculated on for their tax incidence calculations. the basis of lifetime or permanent Finally, Fullerton and Rogers (1991, income. 1993) calculate lifetime tax burdens by estimating lifetime income in the Although the argument that the context of a large overlapping-genera- regressivity of consumption taxes is tions computable general-equilibrium overstated when incidence calculations model. are based on annual income is widely accepted, until recently it has come A general conclusion that arises from under little empirical scrutiny. There these empirical studies is that consump- have been only a handful of studies that tion-based taxes are less regressive have employed alternative measures of when incidence calculations are based income in calculating the incidence of on lifetime as opposed to annual consumption taxes. Almost all of these income. In his studies of the gasoline studies have approached the question of tax, Poterba (1989, 1991a) concludes tax incidence from a lifetime perspec- that the gasoline tax is actually slightly tive, employing various approaches for progressive over the bottom half of the the calculation of lifetime income. income distribution. Rogers (1995) finds that relative to lifetime income, gasoline One approach, employed by Davies, tax burdens rise over the bottom three St.-Hilaire, and Whalley (1991), uses lifetime income quintiles and fall cross-sectional data and imposes thereafter. Finally, the U.S. Congres- assumptions about income mobility to sional Budget Office (1990) finds that a simulate lifetime income. A second tax on motor fuels, while regressive approach, exemplified by Lyon and relative to annual income, is generally Schwab (1995), Caspersen and Metcalf proportional relative to total expendi- (1994), and Rogers (1995), uses limited tures. We can thus summarize the panel data to estimate lifetime income. literature to date as concluding that the Lyon and Schwab combine these use of annual income in the calculation estimates with panel data on alcohol of gasoline tax burdens creates a and cigarette consumption, in order to substantial annual income bias in the calculate long-run excise tax burdens. direction of increased regressivity.

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While, on theoretical grounds, the use heads of households over 18- and 20- of lifetime incidence is highly appealing, year periods, respectively. By excluding there are a number of quite serious female-headed households, in the case practical and conceptual problems with of Lyon and Schwab, and maritally this approach to tax incidence. These unstable households, in the case of problems diminish the usefulness of the Fullerton and Rogers, these sample lifetime approach and suggest that selection rules result in samples that are policy conclusions based on the analysis not representative of the U.S. popula- of lifetime tax burdens should be tion. This is not a minor problem, treated with great caution. The basic because nearly 40 percent of the problem is that we cannot directly women in the first wave of the PSID observe an individual’s lifetime income. lived in a female-headed household in Any estimation of lifetime income is one or more years of the sample period, thus, by necessity, difficult to carry out and the average income of these and requires a large number of restric- women was about one-half of the tive assumptions. To illustrate, the income of the women who were in foundation for Fullerton and Rogers’ male-headed families. Moreover, divorce measure of lifetime income (Fullerton or separation is a primary route into and Rogers, 1993) is an estimated age- poverty2 for many women and children. earnings profile for a sample of house- Thus, this type of sample selection rule holds from the Panel Study of Income may bias estimates of lifetime income, Dynamics (PSID). One problem with this because2 individuals included in the approach is that forecasting lifetime sample are likely to have steeper age- income based on incomplete earnings earnings profiles than those who are experience can lead to substantial excluded. errors. As discussed by Moss (1978), any observed age-earnings profile represents The use of total annual expenditures as a combination of a cohort effect, an a proxy for lifetime income is also aggregate growth effect, and an seriously flawed. Like annual income, individual age-earnings profile. Forecast consumption expenditures vary over errors for any of these three compo- time for transitory reasons. Just as a nents can lead to a substantial error in negative transitory component of predicting lifetime income. For example, income could bias upward the measure Barthold1 (1993) points out that if age- of tax burdens relative to annual earning profiles had been based on data income, the presence of a positive from the 1960s, one would have transitory component of consumption projected rapidly rising real wages for could bias tax burdens downward. For young1 workers throughout the 1970s example, an unexpected illness that and 1980s, while in fact, real wages requires substantial out-of-pocket grew very slowly during this period. medical expenses will inappropriately be reflected in the measure of lifetime Another problem with existing estimates income, resulting in a downward bias in of lifetime income is that they tend to measured tax burdens. Liquidity rely on data from quite restricted sets of constraints are another factor that may households. For example, both Fullerton weaken the link between annual and Rogers (1991, 1993) and Lyon and consumption expenditures and lifetime Schwab (1995) base their income income. For those who are unable to estimates on a sample of individuals borrow against future income, changes from the PSID who were continuously in consumption are more likely to track

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changes in annual income than changes recognize that many taxpayers, especially in lifetime income. Zeldes (1989) those with low and moderate incomes, identifies those with low levels of liquid face substantial liquidity constraints, and assets as most likely to be liquidity thus find it impossible to use expected constrained, and finds that this group higher incomes as a basis for borrowing tends to consume more food in re- money to pay current taxes. sponse to increases in income than 3 would be predicted by the permanent Finally, the assertion that total consump- income–life-cycle model. Wilcox (1989) tion is a good proxy for lifetime income, presents aggregate evidence that even and hence a good measure of ability to well-publicized increases in social pay, is predicated on the assumption security benefits lead to greater in- that, over the course of a lifetime, all creases in consumption at the time they income is consumed. This assumption are received than one would expect will hold, however, only if individuals from the life-cycle model. Conceptually, make no bequests. Although research those with borrowing constraints could on bequests is limited, a careful study by still smooth consumption out of savings. Menchik and David (1982) provides However, the identification of liquidity- evidence that bequests are a rising share constrained consumption behavior with of lifetime income as income rises. Thus, the lack of fungible wealth suggests the failure to categorize bequests and that such individuals have been unable gifts as consumption expenditure will to save out of past income. If liquidity overstate the measured progressivity of constraints affected only a small portion consumption taxes. of the population, they might not be important to the consumption-lifetime In this paper, we propose an alternative income issue. However, the low level of measure of tax incidence that provides a wealth in at least the bottom two practical compromise between two quintiles of the income distribution extremes—the use of annual income suggests that substantial numbers of and lifetime income. Our approach people are likely to face such constraints recognizes both the potential problems (Wolff, 1994). In sum, for a substantial inherent in the use of data from a single fraction of the population, annual year and the difficulties in developing consumption is likely to be a poor proxy accurate estimates of lifetime income. for lifetime income. We calculate intermediate-run tax burdens based on 11 years of data on The use of lifetime income as a founda- both income and gasoline consumption. tion for tax incidence analysis implicitly The choice of 11, instead of an alterna- minimizes the difficulties some individu- tive number of years, is attributable als face in consumption smoothing. On primarily to the fact that 11 years is the the other hand, the use of annual maximum period over which high- income as the basis for tax incidence quality longitudinal data are available on calculations tends to overstate the tax both income and gasoline consumption. burdens faced by some taxpayers with Nevertheless, we shall argue that this low annual incomes, because it fails to intermediate-run period provides a account for the ability of many taxpay- practical compromise between annual ers to augment current income by and lifetime tax incidence measures. dissaving or by borrowing. One reason why policymakers may reject measures Individuals who have low incomes in of lifetime tax incidence is that they any given year fall into one of three

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groups: those with persistently low that growth occurring in the first decade incomes over a substantial number of (Levy, 1995). Thus, for an increasingly years; those who have temporarily low large number of individuals who have incomes for transitory reasons, such as relatively flat age-earnings profiles, 11 unemployment or illness; and those years of income data may well provide a who have temporarily low incomes for good estimate of their longer-run life-cycle reasons, for example, because income. they are students or retired elderly. As a consequence, classification on the basis However, for those with high lifetime of 11 years of income will provide a earnings, age-earnings trajectories have more accurate picture of long-term been rather steep (Fullerton and Rogers, income for some groups than for others. 1993). For some, especially those with graduate and professional degrees, the Only for the first group, the persistently slope of the age-income profile may poor, will tax burdens calculated using have actually increased. While a decade annual income and consumption data or so of income information will provide provide a reasonably accurate indicator an appropriate foundation for calculat- of longer-run burdens. For all those who ing intermediate-run tax burdens, for do not have persistently low incomes, these individuals, a longer period of in- tax burdens based on annual income come data would be required to provide and consumption data will be biased in an accurate estimate of lifetime income. the direction of regressivity. This discussion suggests that income Calculating intermediate-run tax mobility, broadly defined to include both burdens should eliminate any annual temporary changes in economic position income bias in the burden calculations and longer-run movements along age- for those who have low incomes income profiles, will be crucial to because of transitory variations in assessing the bias toward regressivity income. Whether the use of 11 years of occurring because of the use of annual data is sufficient to eliminate bias in the income data. calculation of tax burdens for individuals whose income varies over time for life- In this paper, we explore the relationship cycle reasons is open to question. between income mobility and tax Although 11 years will span about a incidence. We examine both the quarter of an individual’s working life, proportion of individuals who are this period may not be sufficient to fully economically mobile and the differences capture changes in economic status in tax burdens calculated using annual resulting from movements along some and 11-year income data, for both individuals’ age-earnings profiles. mobile and immobile individuals. The However, recent evidence on growing next section of the paper describes the wage inequality and stagnant real wage data and methodology used in this growth for many Americans suggests study. We then present the gasoline tax that, for many individuals, especially incidence results for alternate income those with a low level of education and measures and provide an interpretation training, age-earning profiles may be of the results, focusing on the impor- quite flat. For example, the median real tance of income mobility in determining earnings of all men who were 30 years tax incidence. We also briefly address old in 1972 rose by only 11 percent in the issue of compensating low-income the following 20 years, with most of families for gasoline tax increases.

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METHODOLOGY possible measure of longer-run ability to pay for a given annual distribution of The primary source of data for comput- income. Particularly for those individuals ing the intermediate-run burden of the who are liquidity constrained in their gasoline tax is the PSID. The PSID is a ability to consume, a measure of longer- large longitudinal survey that has run income based on expected (or followed the members of over 5,000 actual) future income does not provide families since 1968. The high quality of as good an estimate of the ability to pay the income data and the availability of taxes as a measure that combines past some longitudinal consumption data and future income. make the PSID the best available data set for examining long-term tax bur- Although tax burdens are calculated dens.2 Our sampling frame consists of over an entire income distribution, most all family heads and spouses who were political discussions of consumption in the PSID in 1982. For most of our taxes focus on the degree of regressivity analysis, the sample is an 11-year panel at the bottom end of the distribution. If constructed by following the 1982 a family is poor in the current year and sample backward to 1976 and forward in the midst of an extended spell of to 1986. The sample consists of 10,906 poverty, its economic well-being and its individuals. Making the individual the ability to pay taxes are presumed to be unit of analysis avoids severe sample lower than the well-being and tax- selection problems inherent in the paying ability of a family that has choice of a sample based on headship recently fallen into poverty. The litera- or on marital status. Because changes in ture on spells of poverty has emphasized family composition are major determi- the distinction between those who are nants of changes in income (Bane and poor at a given point in time and those Ellwood, 1986), it is important that who ever become poor (Bane and inclusion or exclusion from the sample Ellwood, 1986). While many of those not be conditional on such changes.3 who will ever become poor will experience only a short spell of poverty, of Our sampling strategy is designed to those in poverty in any given year, a make our results comparable to annual substantial fraction (over 50 percent in incidence studies based on cross- Bane and Ellwood’s work) are in the sectional data sets such as the Current midst of a long spell of poverty. Censor- Population Survey. It duplicates the ing of the sample, either from the left annual approach by choosing a sample (prior to the observation period) or the at a point in time, computing annual right, can give a misleading picture of incidence in that year, and then compar- the persistence of poverty. Thus, the ing the results to a measure of interme- permanence of low-income status will diate-run incidence by following the be understated if we look only at the sample backward and forward over length of time in poverty of those who time. This approach contrasts with the are currently poor, ignoring future strategy followed by a number of other income levels, or look only at poverty incidence studies, which compare status in the future, ignoring income individuals’ economic positions in an levels in previous years.5 initial period to their economic positions in some future year or years.4 We chose Because the public finance literature our approach because, from a tax- does not typically calculate tax burdens incidence perspective, we want the best according to arbitrary thresholds such as

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the poverty line, the results of research incidence results remain largely un- on spells of poverty cannot be applied changed when burden calculations are directly to quantile divisions (e.g., based on a subsample of individuals deciles) of the population. Nonetheless, with no missing data. the general point about sample truncation applies. The closer we come to Although the PSID provides considerable examining completed periods at any data on sources of income, it provides given income level, the more accurate only limited information on consump- the picture of long-run income status tion expenditures of individuals in the we will get for a given annual distribu- sample. In order to develop an estimate tion. Our approach is thus to compare of expenditures on gasoline, we rely on annual burdens for a centered year to data available on the PSID on the annual average burdens for periods surround- number of miles driven by the members ing that year. of each family.7 Indirect consumption of gasoline through public transportation The basic unit of analysis for intermedi- and reflected in the shipping cost of ate-term incidence is the individual.6 We goods is not considered in this analysis. assume that income and expenditures Gasoline expenditures are imputed to are pooled among all members of the the sample using a three-step proce- family unit. Therefore, at any point in dure. First, miles driven are divided by time, the resources available to an an imputed measure of the fuel individual equal the total resources of efficiency (miles per gallon) for each the family unit in which the individual family’s vehicles. Our miles-per-gallon resides, and consumption tax burdens estimates are based on methodology depend on family expenditures relative developed by Kayser (1994) that to family income. Our measure of combines data from the 1983 Survey of intermediate-run income is the average Consumer Finances on the make, income of the family (or families) in model, and year of cars owned by each which an individual lives over the 11- family with data on the average year period covered by our sample. If gasoline mileage of each type of car.8 the individual stays in the same family These data are used to estimate a unit over the sample period, then family regression of the assigned fuel efficiency and individual incidence are the same. If on a number of household-specific the individual passes through different socioeconomic and locational variables.9 family units, intermediate-run incidence The coefficients from this regression are is the average of family incidence at then used to calculate fuel efficiencies each point in time. for each individual in the PSID.

Due to missing data, it was not possible As the data needed to estimate the to calculate average incomes and tax regression were only available for 1983, burdens over the full 11-year period for we had to assume that the structural every individual in the 1982 sample. relationship that existed in 1983 However, the full 11 years of data are between individual characteristics available for a third of the sample, and (including income) and fuel efficiency data are available for eight or more also held true in the other ten years of years for fully 83 percent of the sample. our sample period. Miles-per-gallon data The implications of the missing data are for 1979, 1985, and 1988 from the discussed in a data appendix available Residential Energy Consumption Survey from the authors. On the whole, our tax (U.S. Energy Information Administration,

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various years) suggest, however, that however, prices at the beginning and the relationship between income and the end of our sample period were fuel efficiency was weaker in the approximately the same. Consumer period prior to 1980 than in the period responses to price changes can occur after 1980. Although this suggests that along two margins, adjustments in miles our use of the 1983 structural relation- driven and adjustments in the fuel ship between income and fuel efficien- efficiency of cars. The latter can be cy may be overestimating the accomplished by replacement of fuel- regressivity of gasoline expenditures, a inefficient cars, or, in multicar families, test of this proposition (described in the by substituting away from the less data appendix) indicates that the efficient car(s). In any given year, the magnitude of this overestimate is quite miles driven variable reflects the net small.10 effect of price adjustments along both of these margins. Miles driven declined The final step in estimating gasoline in 1980 and 1981 but started to expenditures is to multiply the number increase again in 1982. Meanwhile, of gallons consumed by each individual gallons of gasoline consumed by the price per gallon of gasoline. The decreased continuously until 1985 data on gasoline prices are inclusive of (Kayser, 1994). This suggests that both federal excise taxes and state excise and types of price responses did, in fact, sales taxes. The gasoline price data, occur. which were provided by the Bureau of Labor Statistics, are disaggregated by If the price elasticity of demand varies by region and for a number of major income level, then volatility in gasoline metropolitan areas. Individuals living prices may influence our tax incidence outside the major metropolitan areas results. The fact that, during the 11-year were assigned the average price for the period between 1976 and 1986, real region of the country and the size of the gasoline prices were highest in 1982, jurisdiction in which they lived. the base year of our study, suggests that, if gasoline consumption is at all The data indicate that poorer families responsive to the level of gasoline tend to drive older and less fuel efficient prices, our results may overstate the cars than families with higher incomes. regressivity of the gasoline tax. Al- This implies that an imputation of though we cannot precisely quantify the gasoline expenditures based on national magnitude of any overestimate of average fuel efficiency would result in a regressivity, we have used data from the less regressive pattern of gasoline U.S. Department of Energy on fuel expenditure burden than we observe efficiency by income class for the year using our more elaborate imputation 1979 to make a rough adjustment for procedure.11 any overestimate of fuel efficiency for high-income individuals. The results of There was a considerable amount of this adjustment to the data suggest that volatility in the price of gasoline during the methodology we employ for our sample period. The real price of estimating fuel efficiency does not result gasoline was stable from 1976 to 1979, in either a significant increase in the increased by 56 percent between 1980 regressivity of gasoline expenditures or a and 1982, and then fell steadily from substantial underestimate of the annual 1983 through 1986. In real terms, income bias.12

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TAX INCIDENCE RESULTS incidence of expenditure burdens, however, is similar to the pattern Gasoline Expenditures as a Percentage observed in 1982. We also averaged the of Income annual expenditure burdens for each To allow easier comparison to other decile over the 11 years and found the studies and because the incidence of resulting distribution of burdens to be gasoline taxes is quite similar to the similar to, although slightly more incidence of gasoline expenditures, most regressive than, the annual incidence of our analysis will focus on gasoline pattern in 1982. expenditures rather than gasoline taxes. We begin with the traditional approach Our finding that gasoline expenditures used in tax incidence analysis, namely, are regressive when measured using comparing gasoline consumption in a annual data on income and expendi- single year with income in that year. In tures is consistent with the findings of the left panel of Table 1, we order our other recent studies. Poterba (1991a) sample of individuals by deciles of 1982 reports a similar regressive pattern for income 13 and calculate average gasoline gasoline and motor oil expenditures expenditure burdens by decile (defined relative to annual income. Using 1985 as gasoline expenditures by 1982 annual expenditure and income data from the income). The data indicate that, as Consumer Expenditure Survey, he finds expected, annual gasoline expenditure that the average burden falls from 6.5 burdens are regressive, with burdens percent in decile 2 to 2.4 percent in falling from 7.3 percent of income in decile 10. The U.S. Congressional the second decile of 1982 annual Budget Office (1990) reports that income to 3.1 percent in the top decile. gasoline expenditures as a percent of To be sure that 1982 was not an atypical “post-tax family income” decline from year, we also computed annual gasoline 6.9 percent in the bottom annual expenditure burdens for each year income quintile to 1.5 percent in the top between 1976 and 1986. Average quintile. Rogers (1995) finds an even burdens are lower in nine of the ten more highly regressive pattern of annual other years, reflecting lower real prices gasoline expenditure burdens. Her of gasoline relative to 1982. The measure of annual burden falls from

TABLE 1 GASOLINE EXPENDITURE BURDENS Gasoline Expenditures Average Family Gasoline Expenditures as a Percentage of 1976–86 During the Period from 1976 to 1986 as 1982 Family Annual Income: Average Family a Percentage of Average Family Income Income Decile 1982 Data from PSID Income Decile During the Period from 1976 to 1986 1 (lowest) 6.4 % 1 (lowest) 3.9 % 2 7.3 2 5.3 3 6.7 3 5.1 4 5.8 4 5.0 5 5.7 5 4.6 6 5.2 6 4.3 7 5.0 7 4.0 8 4.6 8 3.8 9 3.9 9 3.4 10 (highest) 3.1 10 (highest) 2.5 Source: Authors’ tablulations based on data from the PSID.

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0.19 in the bottom annual income lifetime). Because measured annual quintile to 0.02 in the top quintile. income contains a transitory component that by assumption, is weakly correlated Calculating average burdens for the with total consumption, the elasticity of bottom decile is complicated by the fact gasoline consumption with respect to that a number of individuals report annual income should also be smaller negative, zero, or very small incomes. than the elasticity with respect to The standard response to this problem is longer-run income. Since the fraction of to exclude individuals with very low measured income, which is transitory, incomes from the analysis. In their well- should decline as the time period is known study of the distribution of tax lengthened, expenditures on any given burdens, Pechman and Okner (1974) item, in this case, gasoline, should be excluded those in the bottom five less regressive when compared to long- percent of the income distribution from run income than when compared to the bottom decile. In this paper, we annual income. have excluded all individuals in the lowest one percent of the income Consumption as well as income has a distribution from the average burden long-run component and a transitory calculations for the lowest decile. component. Therefore, basing calcula- Although we have excluded as few tions of gasoline tax burdens on data individuals as possible, any exclusion from a single year of gasoline consump- rule is, by definition, arbitrary. A close tion may give a misleading picture of look at the pattern of income over time the long-run burden of the gasoline tax. of the excluded individuals shows very Assuming that the ratio of transitory to large year-to-year income swings, long-run consumption declines as the suggesting that many excluded indi- measurement period increases, average viduals are self-employed and comfort- gasoline expenditures over 11 years will ably middle class, yet suffer occasional provide a better approximation of long- business losses. Similar conclusions are run expenditure patterns. Therefore, a reached by Slemrod (1992), who, more precise measure of the interme- drawing on a panel of tax return data, diate-run burden of gasoline taxes is reports that those with negative given by comparing the average amount adjusted gross incomes in a given year of money spent on gasoline during each have relatively high seven-year average year of the 1976 to1986 period with incomes. The numbers reported in the the average amount of real income tables for the lowest decile also reflect earned during each year of that same the fact that a substantial portion of the period. individuals in the lowest decile do not have access to a car and, hence, have a The right panel of Table 1 presents our zero burden. If we exclude nondrivers intermediate-run incidence results. As from our calculations, the distribution of we believe that intermediate-run income burdens is regressive starting with the provides a better measure of taxpayer lowest decile. ability to pay than annual income, we rank individuals by their 11-year average We expect that the use of annual income and assign them to average- income in calculating expenditure or tax income deciles. Expenditure burdens are burdens will result in a more regressive defined as average family gasoline pattern of burdens than if income is expenditures over the 11-year period measured over a period of years (up to a from 1976 to 1986 divided by average

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family income over the same 11-year five-year average income and expendi- period.11 ture is –0.165. As a percentage of the one-year Suits index, the difference The results indicate that intermediate- between the one-year and the 11-year run burdens decline monotonically from index represents an 11.5 percent decline 5.3 percent in the second decile to 2.5 in the regressivity of gasoline expendi- percent in the highest decile. If we ture burdens. The decline in regressivity characterize individuals in the lowest is fairly uniform over the 11-year several deciles as “persistently” poor, observation period, with a 4.6 percent where persistence is defined as low change in the first five years. average income over an 11-year period, then an ad valorem tax on gasoline The incidence pattern indicated by the would impose an economic burden on Suits indexes is illustrated in Figure 1, the persistently poor that is nearly twice which plots one-year, five-year, and 11- as high as the burden placed on the year gasoline expenditure burdens by persistently rich. decile of income. For comparability, individuals are ranked according to their Although intermediate-run burdens income position over the relevant remain regressive, they appear to be less accounting period. Thus, for 11-year regressive than annual burdens. To burdens, individuals are ranked by 11- summarize and compare progressivity year average income position, while for under different measures of income and the five-year period, they are ranked by consumption, we use the Suits index of five-year income deciles. Figure 1 shows tax progressivity, which ranges from –1 that, although the average burden falls (most regressive) to +1 (most progres- as the accounting period is lengthened sive).15 The Suits index for gasoline and regressivity is somewhat reduced by expenditures using annual data is not relying on annual income and –0.173. The index drops to –0.153 consumption data, the overall regressive when 11-year average income and pattern of the gasoline tax remains expenditure data are used. A criticism regardless of time period. sometimes levied against the Suits index is that it is sensitive to the distribution of Lyon and Schwab (1995), in a study of income (Kiefer, 1984). For our purposes, alcohol and cigarette tax incidence, however, the fact that the income arrive at results that are similar to our distribution tends to become more results for gasoline consumption. They equal when income is measured over find that taxes on cigarette and alcohol longer periods of time is an important consumption are only slightly less factor in explaining the annual income regressive when incidence is measured bias. It is, thus, appropriate that the with respect to both five-year and Suits index indicates decreased regres- lifetime incomes than when it is sivity as we move to longer time measured with respect to annual periods. income.

To examine the relationship between the Our results, however, contrast with length of the accounting period and those of several other recent studies of measured incidence, we also calculate gasoline expenditure incidence. Poterba average gasoline expenditure burdens (1991a) calculates expenditure burdens for the five-year period from 1980 to by dividing 1985 gasoline and motor oil 1984. The value of the Suits index for expenditures by total 1985 expenditures

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FIGURE 1. Three Measures of Gasoline Expenditure Burdens as a Percentage of Income: Single Year, Five-Year Averages, and 11-Year Averages

for families ranked by expenditure lifetime income to calculate gasoline deciles. He finds that the pattern of expenditure burdens. Ranking individu- expenditure burdens is progressive als by her lifetime income measure, she through the bottom four deciles before finds that gasoline expenditure burdens turning regressive over higher deciles.16 follow a hump-shaped pattern, with the The U.S. Congressional Budget Office highest burdens in the middle lifetime (1990) also uses total expenditures as a income quintile. measure of ability to pay. They calculate motor fuel expenditures relative to total Gasoline Tax Burdens expenditures using annual data, but rank families by their post-tax annual If the only tax on gasoline was in the income.17 They find that spending on form of a national ad valorem excise motor fuels is proportional to total tax, then the gasoline expenditure expenditures over the bottom four incidence displayed in Table 1 would be income quintiles and regressive over the proportional to the incidence of the top income quintile. gasoline tax. In fact, about two-thirds of the total gasoline excise tax rate faced Rogers (1995) uses gasoline expendi- by the average American consumer is tures in a single year and a proxy for composed of state excise taxes. In 1982,

244 WHO PAYS THE GASOLINE TAX?

these state taxes ranged from 8 to 22 to the differences between these two cents per gallon. In addition, nine states measures of incidence as annual income included gasoline consumption in their bias. The bias from using annual data to sales tax base during some or all of the conduct tax incidence analysis occurs 11-year period between 1976 and for two reasons. First, annual income 1986. bias will be larger to the extent that annual income differs from longer-run To determine whether the incidence of income. If, over time, most individuals the gasoline tax is identical to that of experience limited changes in their real gasoline expenditures, we calculated income (for either transitory or life-cycle gasoline tax burdens by assuming that reasons), the measurement of tax gasoline taxes are shifted fully forward incidence will be quite insensitive to to consumers and by applying state- the length of time over which income specific total gasoline excise tax rates to is measured. Second, given that annual gasoline consumption (in gallons) and, income differs from longer-run income, where appropriate, state sales tax rates the annual income bias will be larger to gasoline expenditures. The results to the extent that individuals’ gasoline show that the incidence of tax burdens consumption depends on their is very similar to the incidence of longer-run rather than their annual gasoline expenditure burdens displayed income. in Table 1. The average intermediate-run gasoline tax burden is 0.90 percent in To help us analyze the annual income the second average income decile, 0.77 bias, it is useful to write out a simple percent in the fifth decile, and 0.43 model of gasoline consumption percent in the top decile. behavior. Let us assume that annual gasoline expenditures in year t (G ) To determine whether the variation t depend on longer-run income (Y ) and among states in excise tax burdens l on the difference (Y d ) between annual contributes to the overall regressivity of t income in year t (Y ) and longer-run the tax, we simulated a revenue-neutral t income.18 This relationship can be uniform national gasoline excise tax expressed as rate. The results of the simulation indicate that the variation in rates across the states actually contributes to a slight reduction in regressivity. This 1 occurs because states with a high d concentration of residents with rela- G = a + a Y + a Y . t 0 1 l 2 t tively low intermediate-run incomes tend to have below-average gasoline tax rates. If a 2 = 0, then annual gasoline expenditures depend only on longer-run income. In that case, the consumption INTERPRETATION OF THE RESULTS model in equation 1 is in the spirit of

The purpose of this section is to explore the permanent income model. If a 2 > 0, the reasons why the intermediate-run then positive deviations of annual incidence of gasoline expenditures (and income from longer-run income would taxation) is quite similar to the annual lead to an increase in annual gasoline incidence. Following Poterba, we refer expenditures. Defining Yl as equal to Yt

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d minus Y t , substituting into equation 1, ing the calculation of intermediate-run and dividing by annual income, we incidence into two parts. The first is the obtain the following expression for the calculation of annual, five-year average,

annual gasoline expenditure burden (Bt): and 11-year average expenditure burdens for each individual. The second is the ranking of individuals by alterna- 2 tive measures of their ability to pay taxes, namely, annual, five-year, and 11- G a + a Y Y d t 0 1 t t year average incomes. Bt = = + (a 2 – a 1) . Yt Yt Yt Summary statistics generated from this d two-step procedure are presented in If Y t equals zero, annual income equals longer-run income in year t, and the Table 2, which displays two measures of annual burden (the first term in equa- the incidence of gasoline expenditure tion 2) is equal to the longer-run burdens using three alternative mea- d sures of burden and three alternative burden. If Y t is not equal to zero, then the first term represents the longer-run income rankings. For each expenditure component of the measured annual burden measure, horizontal movements in Table 2 represent alternative rankings burden. Labeling this term Bl, we can define the annual income bias in year of individuals by annual, five-year, and 11-year average incomes. Vertical t (bt) as movements (down the columns) represent the use of different burden 3 measures under a constant income ranking. Y d b = B – B = (a – a ) t . The Suits indexes presented in the t t l 2 1 Y t previous section of the paper are From equation 3, we can see that the displayed in the upper-left to lower-right annual income bias depends on the re- diagonal cells of Table 2. Thus, in the sponsiveness of gasoline consumption upper-left cell (which we will call cell

to changes in both annual and longer- a11), burdens are calculated using 1982 run income and to income mobility, where annual income and gasoline expenditure mobility is measured as the difference data and individuals are ranked by their between annual and longer-run income 1982 annual incomes. In the bottom- d right cell (cell a ), burdens are calcu- relative to annual income (Y t /Yt). 33 lated using 11-year average gasoline In this section, we analyze the roles expenditures and income and individuals income mobility and gasoline consump- are ranked by their 11-year average tion behavior play in determining the incomes. As discussed previously, the incidence of gasoline expenditures. The observed decline in the Suits index from discussion will help explain our inci- –0.173 to –0.153 indicates a modest dence results and will explore the reduction in regressivity as we move reasons our results differ from those of from annual to intermediate-run other studies. As will be explained incidence. below, our ability to look separately at the impact of income mobility and As Suits indexes can only be calculated gasoline consumption behavior on tax when expenditures (or taxes) and incidence will be enhanced by separat- income are ranked according to the

246 WHO PAYS THE GASOLINE TAX?

TABLE 2 DISTRIBUTIONAL INDICES FOR GASOLINE TAX INCIDENCE: SUITS INDEX (IN BOLD) AND RATIO PROGRESSIVITY INDEX* (IN SQUARE BRACKETS) Ranking of Individuals by Alternate Ability to Pay Measures (1) (2) (3) Five-Year 11-Year Annual Average Average Income Income Income Alternative gasoline (1) –0.173 expenditure burdens annual [0.68] [0.72] [0.76]

(2) Five-year –0.165 average [0.75] [0.72] [0.73]

(3) 11-year –0.153 average [0.78] [0.73] [0.73] *The ratio progressivity index is defined as the average burden in deciles 7 through 9, divided by the average burden in deciles 2 through 4. Source: Authors’ calculations.

same criterion, we must use an alterna- faceted one, and any attempt to devise tive summary measure to determine a measure that aims to incorporate all incidence in the off-diagonal cells of aspects of income mobility is therefore Table 2. As an alternative incidence destined for failure” (p. 4). Results may measure, we take the ratio of the differ depending on whether economic average burden in the top part of the movement is defined in relative or income distribution (deciles 7 through 9) absolute terms and depending on the to the average burden in the bottom time frame for measurement. part (deciles 2 through 4). For conve- nience, we will call this measure the ratio index of tax progressivity.19 The Defining Mobility larger the value of the index, the greater For any given year t, we define income the progressivity of the underlying mobility in terms of the difference distribution. A value of one indicates between an individual’s annual income proportionality. decile and his or her 11-year average income decile. Average income is defined in terms of an income period The Role of Economic Mobility centered on year t. As discussed We consider first the role of economic previously, defining average income in mobility in explaining the magnitude of this way, rather than as average income the annual income bias. At the outset, it in a period starting in year t, provides a is important to emphasize that income better measure of ability to pay because mobility is a particularly elusive concept, it considers both past and future income and any conclusions about the extent of levels and tends to reduce the impact of mobility are highly sensitive to the way sample truncation. We refer to individu- in which it is measured. As Fields and als whose annual income position in a Ok (1996) point out, “...the very notion given year is close to their intermediate- of income mobility is rather a multi- run income position as economically

247 NATIONAL TAX JOURNAL VOL. L NO. 2

immobile and individuals whose annual as a whole.22 The second is that, for the position differs substantially from their reasons articulated earlier, we use a intermediate-run position economically centered measure of mobility, whereas mobile. This definition of mobility most other studies use a prospective emphasizes changes in relative income measure of mobility—comparing income position and makes no distinction in year t to income in a period following between mobility that occurs for year t. Furthermore, other studies tend to transitory reasons and that which takes estimate income over a longer time pe- place for life-cycle reasons. riod, generally a lifetime. For those individuals whose real income follows a To calculate the number of individuals in linear time trend over the observation pe- our PSID sample whose relative income riod, the interior year will be a better pre- position remain unchanged over a period dictor of average income than the initial of 11 years, we calculate the proportion year. Hence, centered measures of mo- of individuals who are in the same or an bility are more likely to reflect transitory adjacent decile of 1982 annual income changes in income while minimizing the and 11-year average income.20 A U- impact of life-cycle changes (movements shaped pattern that is characteristic of along an age-earnings profile).23 transition matrix measures of income mobility emerges, with a higher propor- We are now ready to use the ratio tion immobile in the tails of the distribu- progressivity indices presented in Table 2 tion than in the middle (Atkinson, to help us look more closely at the Bourguignon, and Morrisson, 1992). question of why annual gasoline Overall, nearly 85 percent of individuals expenditure incidence differs from remained in the same or an adjacent intermediate-run incidence. We start by average-income decile and, thus, are asking what happens to the distribution classified as immobile. Among house- of annual expenditure burdens if holds whose incomes are in the bottom individuals are ranked by their average two deciles in 1982, 87 percent had low income. The answer to this question can 11-year average incomes.21 And even in be seen by looking at the first row of the middle-income deciles, where Table 2 and comparing the value of the economic mobility is greatest, we classify ratio progressivity index in cell a11 (0.68) over 75 percent of households as to the value of the index in cell a31 economically immobile. (0.76). As burden measures remain unchanged for all horizontal moves It should be pointed out that other within Table 2, any changes in the value studies that have reported larger annual of the index must be due entirely to income biases than we do, for example, changes in relative income. The change Fullerton and Rogers (1993), Caspersen in the ratio index from 0.68 to 0.76 and Metcalf (1994), and Davies, indicates that income reranking reduces St.-Hilaire, and Whalley (1991), also regressivity. Recall that reranking of tend to find a substantial amount of individuals from their annual to their 11- income mobility. These differences in year average income position results in reported income mobility stem from two little change in the relative income sources. The first is that most other positions for most individuals. Thus, the studies rely on restricted samples, reduction in regressivity indicated by a generally household heads. These move from cell a11 to a13 reflects the individuals tend to experience more income mobility of a relatively small economic mobility than the population number of individuals. Many of these

248 WHO PAYS THE GASOLINE TAX?

individuals have high annual gasoline sure of ability to pay, will overstate the expenditure burdens. The income magnitude of the annual income reranking moves them up the average- bias. income distribution. The movement of individuals with high burdens from the The Role of Gasoline Consumption bottom of the annual income distribu- Behavior tion to a higher position in the average- income distribution results in the The importance of intermediate-run observed reduction in measured income as opposed to annual income in regressivity. determining annual gasoline expendi-

tures depends on the magnitude of a 1

A different story can be told by looking relative to a 2 (see equation 3). The at horizontal movements in the third annual income bias will be larger to the row of Table 2. Again, we are isolating extent that gasoline consumption the impact of income mobility, but here decisions are made on the basis of we look at the distribution of average longer-run income rather than on the expenditure burdens as individuals move basis of annual income. To help isolate from a ranking by annual income to a the relationship between income and gasoline expenditures from the impacts ranking by average income. In cell a31, average expenditure burdens are of income mobility, we move down arrayed by 1982 annual incomes.24 By column 1 of Table 2. The movement reranking these individuals by their from cell a11 (annual burdens ranked by average incomes, the ratio progressivity 1982 annual income) to cell a31 (11- index is reduced from 0.78 to 0.73, year average burdens for individuals indicating an increase in regressivity or, ranked by 1982 annual income) alternatively stated, a reduction in the indicates a substantial reduction in magnitude of the annual income bias. regressivity, with the ratio index going To understand this change, remember from 0.68 to 0.78. In terms of the ratio that the very process of calculating index of progressivity, this reduction in intermediate-run burdens has tended to regressivity is twice as large as the reduce burdens for those with unusually reduction in regressivity that we observe high annual burdens (and low annual when we calculate intermediate-run incomes) and increase burdens for those burdens and rank individuals by their with unusually low annual burdens (and intermediate-run incomes. The conclu- high annual incomes). The reordering sion we draw is that the annual income from annual to intermediate-run income bias is substantially overstated if we position (represented by the move from calculate average expenditure burdens but continue to rank individuals by their cell a31 to a33) takes mobile individuals with low annual incomes and what are annual incomes. now relatively low average burdens and moves them up the income distribution. To help us understand the reasons for Conversely, mobile individuals with high this reduction in regressivity, we divide annual incomes and moderate or high our sample into three groups according average burdens tend to move down to their magnitude and direction of the income distribution. The result is an income mobility. Individuals are defined increase in measured regressivity. This as upwardly mobile if their 11-year suggests that using measures of long- average income decile is more than one run tax burdens, but failing to rank decile higher than their 1982 annual individuals by the corresponding mea- income decile, downwardly mobile if

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their average income decile is more than ate-run burdens, leading to greater one decile lower than their annual regressivity. income decile, and immobile if they remain in the same or an adjacent To summarize the results of this section, average and annual income decile. For we argue that the magnitude of the each of these three groups, we calculate annual income bias depends on the annual and 11-year average gasoline extent of economic mobility and the expenditure burdens. Figure 2 illustrates difference in consumption behavior with the results of these calculations for regard to longer-run income and annual individuals in each group ranked by their income. When we compare annual to 1982 annual incomes.25 11-year incidence for gasoline expenditures, we find that the annual income The top panel of Figure 2 demonstrates bias is relatively modest. Looking first at that, for those who are upwardly mobility, we find limited economic mobile, the use of annual data in mobility in our 11-year sample. Only a calculating gasoline tax burdens will small proportion of the sample have substantially overestimate the regres- more than one decile difference sivity of the gasoline tax. For the lowest between their annual and intermediate- three deciles of the 1982 annual income income positions. Comparing gasoline distribution, annual burdens are about expenditure burdens for those who are eight percentage points higher than mobile and those who are not shows average burdens. The annual income that the annual income bias is substan- bias is especially high in the lowest tial only for the small percentage of the annual income decile, equalling almost sample who are upwardly mobile. ten percent of income. By contrast, for those who are classified as immobile or Though mobility in our sample is downwardly mobile, the annual income limited, the annual income bias is still bias appears to be negligible. These overstated if we take into account only results suggest that, for the relatively economic mobility. The bias is similarly small number of individuals who are overstated if we take into account only upwardly mobile, gasoline consumption the difference between annual and decisions are primarily influenced by intermediate-run burdens. The bias is intermediate-run incomes rather than by correctly measured by comparing (temporarily) low annual incomes. intermediate-run incidence to annual incidence, in other words, by substitut- Just as income mobility reduces the ing intermediate-run for annual expen- annual income bias (increases diture burdens and reranking individ- regressivity) once we have replaced uals according to longer-run ability to annual by intermediate-run burdens pay. (represented by horizontal movement in

Table 2 from a31 to a33), so replacing The discussion in this section should annual by intermediate-run burdens, help clarify why a number of other after we have taken into account studies of the incidence of the con- economic mobility (represented by sumption-based taxes conclude that the vertical movement from a13 to a33), also use of annual data leads to a substantial decreases the annual income bias. In overestimate of regressivity. As pointed this case, some high intermediate-run out previously, the U.S. Congressional income individuals with high annual Budget Office (1990) study of excise burdens are assigned lower intermedi- taxes calculated expenditure burdens

250 WHO PAYS THE GASOLINE TAX?

FIGURE 2. Annual and 11-Year Average Gasoline Expenditure Burdens for Individuals Classified by Income Mobility

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using a single year of consumption data tures would indeed be a good proxy for and used total consumption expendi- lifetime income. It seems unlikely, tures in the same year as a measure of however, that annual expenditures are ability to pay. We have argued in the devoid of both transitory and life-cycle Introduction that annual expenditures effects. Annual consumption almost are likely to be a poor proxy for the certainly has a transitory component long-run ability to pay taxes. In addition, and a permanent component. As sug- the Congressional Budget Office draws gested by Caspersen and Metcalf (1994), conclusions about long-run incidence to the extent that transitory consump- based on the distribution of expenditure tion expenditures are constant across burdens for individuals ranked by their income classes, the use of annual annual income. As demonstrated above, expenditure data will lead to a down- the failure to rank individuals by a ward bias in tax (or expenditures) bur- measure of long-run ability to pay dens at lower income levels. In terms of results in an overestimate of the annual life-cycle measurement, because annual income bias. expenditures exclude bequests, and bequests are a larger proportion of lifetime In his study of gasoline tax incidence, income for individuals with higher Poterba (1991a) also uses annual lifetime incomes, the use of annual expenditures as a proxy for lifetime expenditures as a measure of ability to income. He uses annual gasoline pay will bias tax burdens upward at the expenditures to calculate burdens, and top of the income distribution. then ranks individuals by decile on the basis of their total annual expenditures. Davies, St.-Hilaire, and Whalley (1991) We calculated that Poterba’s results report that the lifetime incidence of imply a ratio progressivity index for sales and excise taxes, while remaining gasoline expenditure burdens of 0.84. regressive over the entire income This number compares with the ratio distribution, is substantially less regres- index values for annual burdens of 0.68 sive than the annual incidence. The ratio and for 11-year average burdens of index of progressivity for sales and 0.73, and, hence, indicates that the use excise taxes, calculated from their Table of total expenditure data as a measure 2, increases from 0.78 for annual of lifetime income results in a substan- incidence to 0.94 for lifetime inci- tially larger annual income bias than the dence—an increase of 22 percent. This bias relative to intermediate-run income. contrasts with our results, which indicate that the ratio index increases by The difference between Poterba and our only seven percent as we move from gasoline incidence results demonstrates annual to intermediate-run incidence. In that total annual expenditures provide a their study, Davies, St.-Hilaire, and poor proxy for intermediate-run income. Whalley use Lillard’s (1977) results on One possible explanation for this result earnings mobility to construct their is that, while the 11 years over which estimates of lifetime income. By intermediate-run income is measured is parameterizing a mobility probability long enough to eliminate the bias from that is greater than that for the entire transitory income variations, the use of population, and that does not reflect annual expenditures may serve to differences in mobility across the annual remove the annual income bias attribut- income distribution, Davies, St.-Hilaire, able to both transitory and life-cycle and Whalley impose unrepresentative effects. If this were so, annual expendi- mobility on the sample. Our longitudinal

252 WHO PAYS THE GASOLINE TAX?

data from the PSID indicate that The cost of any compensation scheme substantial income mobility, at least over rises and its effectiveness declines to the an 11-year period, tends to be limited to extent that “undeserving” individuals a relatively small proportion of the receive payments or “deserving” population. This result suggests that the individuals are not compensated. The earnings mobility assumptions used by use of annual income instead of Davies, St.-Hilaire, and Whalley may intermediate-run income in a compen- result in an overestimate of the bias sation scheme would result in some created by using annual data for tax degree of “mispayment.” In any given incidence analyses. year, some middle-income families would qualify for compensation, because their incomes are temporarily COMPENSATION FOR EXCISE TAX low, and some persistently low-income INCREASES families would not be eligible for As a way of countering claims that compensation, because their income increases in regressive consumption this year is too high. taxes will create hardships for individuals with low incomes, economists fre- To illustrate the consequences of quently propose coupling a tax increase designing a compensation scheme using with an offsetting compensation annual income instead of some measure scheme designed to neutralize any of longer-run income, we consider a adverse distributional impacts of the $100 per ton carbon tax analyzed by initial tax increase. An important issue in Poterba (1991b). Based on projected the design of such schemes is to target retail energy prices in the United States, compensatory payments as effectively as Poterba estimates that a fully forward- possible to those most in need of shifted tax of this magnitude would assistance. If one of the reasons for cause a 25 percent increase in the retail increasing gasoline taxes is to dis- price of gasoline. We adopt the follow- courage the consumption of gasoline, ing simple compensation scheme: compensatory payments should be targeted as closely as possible to those Compensatory payments are restricted to facing increased burdens, yet be those in the lowest three deciles of the independent of individual gasoline annual income distribution, and the amount of compensation is determined consumption decisions. A sensible by using a “circuit breaker” type of for- strategy would be to limit eligibility for mula that limits the average eligible compensation to those in the weakest person’s increase in gasoline tax burden economic position. In principle, to one-half of one percent of annual compensation payments could be paid income. only to those with persistently low incomes, defined, for example, as Our discussion in the last section individuals in the bottom of the inter- suggests that if a large portion of low- mediate-income distribution. In practice, income individuals in any given year are it would be almost impossible to only temporarily poor, any compensa- implement any scheme based on tion scheme will be characterized by average incomes. Practical consider- substantial mispayments. Given the ations would probably require that any relatively low level of income mobility compensation scheme be based on an reported in the Interpretation of the easily observable characteristic, such as Results section it is not surprising that a annual income. simulation of the compensation scheme

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outlined above reveals that only about addressing a number of major problems: 18 percent of those in the lowest three the threat of global warming, our annual income deciles (based on their congested highways, and the large 1982 income) would be ineligible for federal budget deficit. A frequently compensation if compensation were heard political objection to increasing based on 11-year average income. the gasoline tax is its alleged regressivity. Conversely, about six percent of those Empirical support for the view that the ineligible for compensation because tax imposes a much higher burden on their 1982 income places them above the poor than on the affluent comes the third income decile would be eligible primarily from studies that utilize annual if compensation had been based on data on gasoline consumption and average income. income. Recently, however, the regressivity of the gasoline tax, as well Under the assumption of a long-run as other consumption taxes, has been gasoline price elasticity of -0.5, we challenged by a number of economists. calculate that a $100 per ton carbon tax They argue, primarily on the basis of would have raised $9.8 billion in 1982.26 Milton Friedman’s permanent income The implementation of the compensa- hypothesis, that the use of annual data tion scheme outlined above would have as opposed to lifetime income and cost $692 million, which equals seven consumption data leads to a substantial percent of the tax revenue raised. overestimate of the regressivity of the Furthermore, we estimate that signifi- tax. cantly less than 18 percent of total compensation would have been paid In this paper, we argue that, while a “incorrectly” to persons who were lifetime perspective is conceptually above the third average income decile. attractive, a series of problems with the The amount of misallocated compensa- approach, including the difficult task of tion is relatively small, because most of measuring lifetime income and the families with intermediate-run consumption and explaining the results incomes above the third decile, but to policymakers, preclude the wide- annual incomes in the lowest three spread use of the approach in analyzing deciles, have incomes in the third annual consumption tax incidence. To address income decile and, therefore, would tend the issue of the bias toward regressivity to receive lower payments than those in when annual data are used in distribu- the first two annual income deciles. We tional analyses, we propose an alterna- conclude that, although there is no way tive to both the annual and the lifetime to design a completely target effective approaches that is based on data for an scheme to compensate low-income intermediate time period. individuals for increases in consumption tax burdens, schemes that rely on annual Using longitudinal data on income and income to determine eligibility and gasoline expenditures, we show that, payment levels would be quite effective when people are grouped into 11-year in targeting payments to the most average income deciles, intermediate- economically vulnerable individuals. run average gasoline tax burdens are only slightly less regressive than annual Conclusions burdens. The main reason for the similarity of annual and intermediate- Attention has focused on the gasoline run burdens is the limited degree of tax as an efficient way of simultaneously income mobility over an 11-year period.

254 WHO PAYS THE GASOLINE TAX?

We find that most persons who were concerns about the burdens placed on poor (or rich) in 1982 were in a similar those with low incomes cannot be relative income position over the period dismissed. Persons in the bottom half of from 1976 to 1986. This lack of income the income distribution face 11-year mobility means that, for most people, average gasoline tax burdens that annual spending patterns are replicated average 0.85 percent of income. Our over a longer time period. The special mobility findings indicate that, of those strength of our analysis is that we with low incomes in a given year, a large combine income and expenditure data majority are in the midst of an extended in a single panel. We exploit this data to period of low incomes. For people with examine directly the proportion of the low incomes, burdens of this magnitude sample for whom the annual income and duration can create substantial bias is important. We find that, in a economic hardships. Nevertheless, we given year, substantial overestimates of believe that the magnitude of the tax the regressivity of gas expenditures burdens (especially when compared to occur only among the small proportion other taxes) is moderate enough so of individuals who were only temporarily that, when combined with a reasonably poor in 1982. simple compensation scheme, gasoline tax increases could be implemented that One criticism of our approach is that, by would generate substantial revenues defining intermediate-run income as and provide efficiency benefits, yet average income over 11 years, we protect the poor from undue hardship. substantially underestimate the degree of income mobility that occurs as ENDNOTES individuals move up their age-earnings profile. Lack of data availability pre- We would like to thank the seminar participants at vented us from testing this proposition Northwestern University, Hunter College, and the directly with linked expenditure and University of Wisconsin–Madison and Greg Duncan, James Poterba, Cordelia Reimers, John income data. However, we note that Karl Scholz, and three anonymous referees for very Lyon and Schwab (1995) find no change helpful comments on a previous draft. We are in the incidence of cigarette consump- indebted to Dietrich Earnhart, Hilke Kayser, and tion when cigarette burdens are John Pepper for exceptionally able research assistance. Financial support was provided by the calculated using income over a five-year Russell Sage Foundation and the Robert M. La period and lifetime income. A similar Follette Institute of Public Affairs at the University comparison for alcohol consumption of Wisconsin–Madison. indicates only a relatively small decrease 1 See Poterba (1989, 1991a), U.S. Congressional in regressivity when lifetime burdens are Budget Office (1990), and Charles River Associates (1991). compared to five-year burdens. The 2 Duncan and Hill (1989) report that total income Lyon and Schwab results taken together reported by the PSID accounts for about 95 with ours suggest that, while the annual percent of income as measured by aggregate income bias is a real phenomenon, its national statistics, and Duncan, Smeeding, and magnitude is insufficient to overturn the Rodgers (1991) find that family income trends found in the PSID are exceedingly close to those general proposition that consumption found in the Current Population Survey. By taxes are regressive. contrast, Clayton-Matthews and Kazarosian (1988) report that income measured by the Consumer With regard to the gasoline tax itself, Expenditure Survey, is lower than income as reported on the Current Population Survey. we conclude that, in assessing the Furthermore, even after accounting for differences advantages and disadvantages of in definition, they find total consumption increased reliance on gasoline taxation, expenditures as reported on the Consumer

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Expenditure Survey are considerably lower than distance to the city center, and state dummies. The aggregate estimates of consumption from the sample for the regression includes only the heads National Income and Product Accounts. In previous of family units. work, we have found that estimates of sales and 8 Data on fuel efficiency come from gasoline mileage excise tax revenues made using consumption data guides published annually by the U.S. Environ- from the Consumer Expenditure Survey are mental Protection Agency (various years). generally substantially below actual tax collections, 9 To impute fuel efficiency for years other than 1983, even after subtracting taxes paid on interfirm we simply adjust the constant term of the miles- transactions (Chernick and Reschovsky, 1990). per-gallon regression to reflect increasing fuel 3 Considerable uncertainty exists with respect to the efficiency over the sample period. The imputation reported household income when the head of the equation is household changes. A family member leaving a

household to become head of a new family unit mpgt = mpgt + b 83,SCF [Xt,PSID – Xt,PSID] . may, for example, report zero income for the previous year that was spent mainly as part of the According to this equation, each household’s fuel original family unit. The original family’s income efficiency differs from the national average by the may be a more accurate measure of the individual’s way in which the household’s characteristics differ financial situation. The PSID deals with the from the average values for the characteristics in allocation issue by prorating the mover’s income to the sample. the family of origin and attributing the income to 10 It is interesting to note that recent data indicate that family. The entire calendar year income is also that the fuel efficiency to income relationship is attributed to the new family. This technique now weaker than it was during our sample period. produces some double counting in the aggregate. Increases in the number of vans and light trucks To avoid any incorrect assignment that may result purchased by households have actually inverted from the proration method, in calculating average the relationship, with higher-income families more incomes, we excluded reported income for each likely to drive less fuel efficient vehicles than lower- year in which a change in the head of the family income families. These changes in vehicle unit occurred. This is equivalent to assuming that purchasing habits clearly have the effect of the income in the year a family change occurred somewhat reducing the regressivity of the gasoline was equal to the average income over the rest of tax. the 11-year period. For the reference year 1982, 11 Earlier studies of gasoline demand using data from average income from the remaining years is used the PSID by Holmes (1976) and Hill (1980) to replace the self-reported income. assumed that all drivers experienced the same fuel 4 For examples, see Fullerton and Rogers (1993) or efficiency. Davies, St.-Hilaire, and Whalley (1991). 12 Details about the procedure we followed to 5 For example, Bane and Ellwood (1986) show that determine the magnitude of any underestimate of only a quarter of those who are poor in a given the annual income bias attributable to our fuel year have been poor for more than nine years. By efficiency imputations are provided in a data not following those who are currently poor into appendix available from the authors. the future, 25 percent of the sample are incorrectly 13 For expositional clarity, we refer to the income of assigned a long-term poverty status of less than individuals interviewed in 1982 as 1982 annual nine years. income. It should be understood, however, that in 6 Each adult is assigned the weight of the family of the PSID, as in most sample surveys, individuals are which he or she is a member in 1982. However, asked to provide income in the previous year. Thus, because family weights in the PSID do not vary references in this paper to “1982 annual income” with family size, the weight will be the same actually represent income in 1981. regardless of the number of children in a family. 14 This is equivalent to a weighted average of annual 7 Each year about 3.2 percent of the automobile burdens, where the weights represent annual owners in our PSID sample responded to the income relative to average income. question asking for the number of miles driven by 15 The Suits index is similar to the well-known Gini answering “do not know.” Because the number of coefficient, except that it compares a cumulative miles driven is a crucial variable in the analysis, we frequency distribution of tax liabilities with a have used an ordinary least-squares regression to similar distribution of household income. For a impute miles for individuals with missing data. regressive tax, the resulting Lorenz curve lies above Included in the regression as explanatory variables the diagonal, and the Suits index takes on negative for miles driven are family income, number of values. adults in the family unit, number of children, 16 Poterba’s (1991a) results are taken from column 3 number of cars, average miles driven over the of his Table 2. previous three years (or the previous two years for 17 In the next section, we argue that it is inappropri- 1976 because miles were not reported in 1973), ate to make normative judgments about long-run

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tax incidence on the basis of a ranking of tax estimate of the magnitude of the annual income burdens by annual income. bias. 18 Annual income can differ from longer-run income 25 This is equivalent to a movement down the first for both transitory and life-cycle reasons. column of Table 2 for three subsamples. 19 It should be noted that the ratio progressivity index 26 Our choice of gas price elasticity reflects an assigns identical weights to, for example, the average of estimated price elasticities in studies of second and the fourth decile of income. An gasoline demand surveyed in Dahl (1986). increase in the burden in the second decile coupled with an equal-value decrease in the fourth decile would leave the index unchanged. We recognize REFERENCES that this is not acceptable as a social welfare index. 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