Fuel tax magic, part two
The following is part two of a guest essay from Charles Komanoff, an economist and environmental activist in New York City. For more on taxing carbon fuels, go to http://www.komanoff.net/fossil/.
For part one of this essay, go here.
Now another question arises: so what? At the end of the day, what’s the practical difference between the actual price-elasticity of 20% and the popular conception of zero elasticity if the effect of higher gas prices is only going to be offset by economic growth?
I offer two answers. Combined, they just might hold a solution to our era’s twin overriding crises: the oil-dependence crisis and the climate crisis.
The first answer is that as we extend our time horizon, gasoline’s price-elasticity, or price sensitivity to break free of the jargon, gets larger — a lot larger. Going out several years or more, individuals have greater scope to take actions that economize on gasoline. They can junk the gas-guzzler, or at least not replace it with another one when the old one gives out. They might calculate the dollar tradeoffs between density (high rents but less need to drive) and sprawl (the reverse) and pick up stakes for a less car-dependent area. They may gravitate toward job opportunities closer to home. And they can make more durable commitments to behavioral changes that reduce the need to drive, like forming a carpool or buying a roadworthy bicycle or selling the far-away vacation home.
The consensus of economists who have studied gasoline use is that the "long-term" price elasticity — the effect on demand eight or ten years hence — is between 50% and 70%, or roughly triple the 20% "short-term" elasticity I’m seeing in my spreadsheet. That is, over the long haul, rises in the price of gas are likely to dampen demand several times as much as the modest changes we’ve seen in the past year or two.
The second reason price-elasticity matters is that prices of gasoline and other fuels will probably climb in the future. Or, to be candid, fuel prices need to climb far and fast if America is to ever get off the oil spike and the world as a whole is to avoid disastrous climate change.
For all the promising antidotes to oil dependence, from ethanol and hybrid cars to rearranging living patterns so people and goods don’t have to move as much, there’s a growing awareness that the only surefire way to advance on all fronts is to create an irresistible and universal market pull by pricing gasoline at a very high level — perhaps in the $10 a gallon range. And now that the climate crisis is overtaking oil dependence as the ultimate energy nightmare, people are starting to face the fact that only vastly higher prices for all fossil fuels can reduce CO2 emissions across the board, through conservation, not just of gasoline but of all petroleum products as well as natural gas and coal.
Yes, I’m talking about a carbon tax — the only mechanism powerful and direct enough for the daunting task of phasing out fossil fuels. Conventional "market forces" would be too volatile in the short term and too weak in the long term to provide the needed incentives, and would ravage the poor and middle class besides. And sole reliance on market forces — say, rising crude oil prices due to shrinking supplies — would simply open the door to massive development of synthetic fuels such as tar sands, liquefied coal and oil shale, bringing environmental and climate consequences many times worse than the oil they would replace.
In contrast, carbon taxes could be predictable, sending unmistakable price signals to individuals, businesses, and government policymakers. Carbon taxes need not fall disproportionately on the poor — quite the reverse, if the tax revenues are redistributed in equal per-capita rebates or are dedicated to tax-shifting away from regressive taxes (social security checkoffs, for example). And if set at levels that truly "internalized" the damage costs of using fossil fuels, carbon taxes could create incentive enough to usher in full-scale deployment of every alternative, from wind farms and photovoltaics to non-sprawl cities and less driving and flying.
How high must we tax fossil fuels to accomplish, say, a halving of their use? As a thought-experiment, let’s extrapolate from gasoline and postulate that the long-term price elasticity of all U.S. fossil fuel use is 60%, the middle of the consensus range for gasoline over the long haul. It’s tempting to say that we only need an 80-85% increase in price (since an 83% price rise multiplied by 60% elasticity should give us the desired 50% drop in usage). But that would ignore the Law of Diminishing Returns, by which increasing increments to the price are required to keep sending usage lower, once we’ve picked the low-hanging fruit. And there’s also the need to offset the "natural" increases in fuel use due to future growth in the economy.
Reflecting these factors requires a bit of higher algebra — exponents and logarithms — so you’ll have to trust me on the numbers. Twenty years out, if we want to have cut fossil fuel use by half while our economy has kept growing at 3% a year, fuel prices will need to have increased — get ready — eight- or nine-fold from last year’s levels. Gasoline will sell in 2026 for $16 or $18 a gallon, home heating oil for close to that, and a kilowatt-hour of coal-fired electricity for 20 cents. You’ll probably pay a quarter for a plastic bag at the checkout line. And air travelers will be charged by the pound.
Sound awful? Only if we obsess over the empty part of the glass. Don’t forget, a heavy carbon tax means enormous revenues, enough to eliminate not just workers’ social security payments but, most likely, all federal income taxes on everyone’s first $100,000 of income, and state sales taxes to boot. Recycling the tax windfall through rebates or tax shifts will ensure that in the aggregate the nation’s hundred million households have as much money as now. Although energy will cost a lot more, families that now use less energy than average (that’s almost all poor families and many middle-class ones) will end up with more spending money than now.
Moreover, while carbon-taxing fuels to raise their prices nearly ten-fold in twenty years may sound outlandish, ramping up the tax in equal percentage installments could keep the increases manageable. Through the magic of compound growth, the necessary annual price increases would be only 10-12%. That’s a smaller real increase than has already occurred in each of the past three years — and not a penny of those increases, remember, has been rebated to consumers.
Most important, the carbon tax could revitalize our society. Picture the changes ten years out, just halfway to our 2026 target year: Wind farms have replaced coal-fired electricity as the mainstay of U.S. electricity supply. Road-hogging SUVs are out, trim sedans are back in. Energy-thrifty compact fluorescent lamps have made power-hungry incandescent and halogen bulbs collectors’ items. Costlier air and road travel has created the "market pull" for a 300-mph intercity rail network linking major American cities. Urban trips by bicycle are up 10-fold, to 10% of travel, making cycling safe and stress-free (through the "safety-in-numbers" phenomenon). Suburbs stop sprawling. Cities thrive. And, of course, oil dependence, like crack cocaine, is yesteryear’s problem, while the climate crisis is halfway toward solution.
Carbon taxes, carefully constructed, can do all this by providing the motivation to turn literally billions of individual and social decisions toward lower energy demand and carbon-free supply. That’s why it’s important for the media to get the story right on drivers’ adaptations so far to higher gasoline prices — the fate of our world may literally depend on the human propensity to rein in consumption when the price goes up.
What about those two California couples whose curtailed holidays were reported in the Times? We can imagine that in 2026 Pam and Matt Keith’s houseboat lives on in the family scrapbook. The Keiths now take the train and ride their bikes to their favorite kayaking spots (rentals are always available). And Celia and Michael Shane have turned their jet ski into a backyard fountain. The neighborhood kids frolic in it at the Shanes’ annual Memorial Day barbecue.
For part one of this essay, go here.