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Defying Conventional Wisdom: Distributional Impacts of Fuel Taxes

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Defying Conventional Wisdom: Distributional Impacts of Fuel Taxes Mistra Indigo Policy Paper Defying Conventional Wisdom: Distributional Impacts of Fuel Taxes Daniel F. Morris and Thomas Sterner1 Abstract Fuel taxes for transportation represent one of the most potent and readily available policies to address increasing global greenhouse gas emissions. Yet, they are pilloried by politicians because of their supposedly regressive impacts to the poorest populations. Research from both OECD and non-OECD countries, how- ever, suggests such arguments are disingenuous and that fuel taxes are often neutral or even progressive in their impacts. Transport fuel taxes function like luxury goods in many countries, particularly low income countries, so tax burdens fall on wealthier individuals rather than poorer ones. This paper summarizes the findings of a recent book with more than twenty empirical case studies of the effects of fuel taxes for different nations. According to the studies, fuel taxes are strongly progressive throughout Africa and the big Asian countries. In middle income countries in Latin America and in Europe they are often neutral. Tax regres- sivity in the United States can be corrected with effective revenue use. Mistra Indigo Policy Paper 3 June 2013 Authors: Daniel F. Morris and Thomas Sterner © Mistra Indigo (2013) Box 53021 400 14 Gothenburg Sweden http://indigo.ivl.se Editing, production: Helena Davidsson, IVL Swedish Environmental Research Institute 1 Daniel F. Morris is a center fellow at the Center for Climate and Electricity Policy at Resources for the Future. Thomas Sterner is a Professor of Environmental Economics at University of Gothenburg, Visiting Chief Economist for the Environmental Defense Fund, and a University Fellow at Resources for the Future. We thank Susanna Olai for research assistance and Mistra Indigo for generously funding this work. Contents About the Authors............................................................................4 Introduction............................................................................................5 Effects of Fuel Taxes........................................................................6 Understanding Fuel Tax Incidence........................................7 Finding Progressivity in South Africa...................................8 Fuel Taxes Around the World.......................................................9 Progressivity Across the Developing World......................9 The Indian Experience.................................................................9 Tax Neutrality in Europe............................................................10 Revenue Use Matters in the US............................................10 Conclusion.............................................................................................11 References...........................................................................................12 About the authors Daniel F. Morris is a Center Fellow in the Center for Climate Thomas Sterner is Visiting Chief Economist of the and Electricity Policy at Resources for the Future. Environmental Defense Fund in New York and professor of environmental economics in Gothenburg, Sweden. In his five years at RFF, he has focused on the policy and economic implications of a broad swath of climate change issue. He has built up the Unit for Environmental Economics a prominent European centre that gives a unique PhD Topics he has researched include design and dynamics program in climate economics for students from developing of environmental amenity pricing, including carbon and countries. Around 30 researchers have graduated and energy taxes, cap-and-trade systems and carbon markets, returned to further build capacity. Almost 200 have taken federal policy options for adaptation in the US, the nexus of shorter courses. water supply and energy production, international climate negotiations, international REDD+ efforts, domestic offsets, Sterner has published more than a dozen book and 80 articles, international adaptation finance, and EPA regulations. mainly on environmental policy instruments with applications to energy and climate, industry, transport economics and He has a Masters of Environmental Science and Management resource management in developing countries. from the Bren School at University of California, Santa Barbara. Sterner is the recipient of the Myrdal Prize, past president for the European Association of Environmental and Resource Economists, Coordinating Lead Author for the IPCC and Associate Editor of Environmental and Resource Economics. He is also a Fellow or researcher at Resources for the Future, The Beijer Institute and Statistics Norway. With Gunnar Köhlin, he has founded the Environment for Development Initiative and is a member of the research board of several developing country networks such as CEEPA (Africa) and SANDEE (in South Asia) and the Board of Academic advisors to the Center for Chinese Agricultural Policy, CCAP of the Chinese Academy of Sciences. 4 Introduction Climate change policy as it stands in 2013 has made se- on whether they have higher or lower budget shares for verely insufficient progress since the signing of the Kyoto fuel than the rich. Protocol in 1997. Instead of nations signing on to a single comprehensive climate agreement, individual countries Research on the economic effects of fuel taxes from are searching for elements and ideas with which to start around the world suggests that fears about their regres- pursuing their own policies. sivity may be overstated and that the poor may not suffer unduly from their use. In this paper, we summarize how As a result, many national governments and inter-govern- people in different income categories are affected and mental groups are looking for different types of climate how they react to fuel taxes, how their behavior changes solutions. One policy that has long been recognized as use- over time can lead to significant CO2 reductions, and how ful for reducing greenhouse gases is to increase the cost low-income communities may be sheltered from regres- of transport fuel, first through removing subsidies, then by sive impacts. For the purposes of this discussion, we focus instituting taxes on the carbon content of those fuels. Emis- only on transport fuels used in motor vehicles, though we sions from transport fuel are a major contributor to climate survey both Organisation for Economic Co-operation and change; all transport accounted for 22 percent, and road Development (OECD) and non-OECD countries. transport specifically accounted for over 16 percent of car- bon dioxide emissions in 2010 (IEA 2012). Fuel taxes are among the most common forms of indirect carbon taxation. They are, however, unpopular policy choic- es in many parts of the world because they raise the price of gasoline, and gasoline prices can be a potent trigger for civil unrest. In 2012, Nigeria and Indonesia saw widespread and at times violent protests against government plans to reduce subsidies for petrol. Protesters often claimed the price increases would disproportionately impact the poor. Concerns about negative impacts of higher gasoline pric- es on poor populations, especially in developing coun- tries, are an oft-recurring part of the discussion about the effectiveness of fuel taxes as regulatory instruments. It is an empirical question whether the poor stand to lose or Fuel price increases often lead to civil unrest due to concerns about benefit from taxation of fuels. The results depend largely their impacts to the poor. 5 Effects of Fuel Taxes Taxing automobile fuel will have both economic and They have, in fact, already had a substantial impact on environmental effects, but to understand how fuel taxes GHG emissions. Research conducted by Sterner (2007) may impact people in different countries, it is first helpful suggests that if all OECD countries had fuel taxes as low to understand how people react to changes in the price of as those in the United States, consumption of gasoline fuel generally. Demand for fuel in any country is determined would be 30 percent higher than current use; in contrast, by income, price at the time of purchase, and historical if all OECD countries had gas prices that correspond factors that contribute to the amount of fuel used, such with those in high fuel tax countries, such as the United as type and number of cars on the road, available public Kingdom or the Netherlands, fuel consumption would be transportation options, and the extent and condition of reduced by 35 percent and carbon emissions from the the country’s roads. When prices change, it takes time for transportation sector would be 36 to 44 percent lower consumers to adjust their behavior because there are not within the range of long-term elasticities. many viable substitutes for transport fuel consumption, especially in car-dependent societies, meaning that fuel is generally an inelastic good in the short term. Research suggests that short-term elasticities fall between –0.2 and –0.3, meaning that consumers will consume similar amounts of fuel within a year of a price increase (Sterner 2012). Over the long term, consumers discover transportation alternatives, such as using more public transit or swapping out older, gas-guzzling cars for newer, more efficient ones. In fact, not accounting for demand responses can overstate regressivity significantly (West and Williams 2012). Long- term price elasticities are about three times greater than in the short term, falling between –0.6 and –0.8 (Sterner 2007). It is important to
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