Rethinking Rethinking the Gas Tax

Adam Ozimek argues that we shouldn't jump to conclusions about the ineffectiveness of a gas tax, saying that the elasticities I blogged about yesterday were from IMF estimates that are substantially lower than other estimates.  You should read the whole thing, but I think there are two points worth highlighting.

The first is that elasticities of demand for oil seem to be falling; they were much higher in the seventies than they are now, especially here.  This makes perfect sense: when prices spike, people invest in making their lives more efficient, and when prices fall, they don't suddenly rip out the insulation and sell the Prius.  (Though anecdotally, when I bought my Mini in mid-2008, oil prices were very high, and so were prices for small cars--dealers couldn't keep small cars on the lots.  A year later, oil prices had fallen, and I'm told the market for small cars had evaporated--those who were buying, were buying big, and dealers couldn't move little cars even at a loss).

When you're very inefficient, small changes in efficiency mean big reductions in fuel usage--and spending.  But as your products become more efficient, the potential gains get smaller and smaller:

fuel for improvment.png

This graph is really important, and I think underappreciated by those who write about things like CAFE standards.  What it tells you is that for both consumers, and consumption, the difference between 10 mpg and 20 mpg is larger than the difference between 20 mpg and 40 mpg.

And what about changing driving habits?  The effect persists.  All else equal, you can think of increasing fuel efficiency from 10 to 20 mpg as cutting someone's driving in half.  Just as with MPG, the effect is largest if they're already very efficient.  I use about 12 tanks of gas a year in my Mini-Cooper.  Cutting my fuel usage in half--either by reducing my driving, or increasing my fuel efficiency--just won't save much energy, or money.

So it makes sense that in 1973, when prices spiked, people reacted by buying smaller, more efficient cars.  It also makes sense that nowadays, people are slower to switch; unless gas runs up to $10 a gallon or above, we're already getting past the point where increasing fuel efficiency delivers giant annual cost savings for a typical family driving 8-10,000 miles a year per car.

But not all is lost for supporters of a gas tax.  Ozimek also points out that price elasticity of demand may not be the same as tax elasticity of demand:

As Killian and Davis point out, another serious problem with these estimates is that they estimate the price elasticity of demand, and not the tax elasticity of demand. They argue:

"...the response of gasoline consumption to a change in tax is likely to differ from its response to an average change in price. Price changes induced by tax changes are more persistent than other price changes and thus may induce larger behavioral changes. In addition, gasoline tax increases are often accompanied by media coverage that may have an effect of its own."

To overcome these issues, they look at U.S. state level demand for gasoline. Their results shed some interesting light on how the econometric mispecifications affect elasticity estimates. Using a single equation model they estimate an elasticity of -0.10. Using a panel data method, as done in the IMF study, the elasticity increases to -0.19. And finally using changes in state level gas taxes as an instrument they find an elasticity of -0.46, which more than four times larger than the single equation model.

So a gas tax might well be effective after all.  Whether it is politically possible is, of course, an entirely different question.