BOX 7.1
The Case for Fuel Pricing

The case for fuel pricing policies is based on economic theory as well as experience: for most goods, raising the price reduces the quantity demanded. One way to reduce petroleum use or greenhouse gas (GHG) emissions is to tax them. GHG emissions are environmental externalities, and their full societal costs are not reflected in market prices. As discussed in Box 5.5 in Chapter 5, a range of estimates exist for the damage that may be caused by GHG emissions. The committee chose a value at the high end of the range, $136.20 per metric ton of CO2, because that is most consistent with the 80 percent GHG mitigation goal. There are excess social costs of oil dependence, as well, caused by the use of market power by oil producers, as well as increased public expenditures on defense (Greene and Leiby, 1993). As discussed in Box 5.6 in Chapter 5, a tax on the order of $10.50 to $38 per barrel with a midpoint of $24 in 2009 dollars would be needed to reflect the full social costs of oil dependence.

Fuel prices affect producer and consumer behavior with respect to the three parameters that affect petroleum use and GHG emissions: fuels, vehicles, and vehicle miles traveled. Experience both here and abroad indicates that producers and consumers indeed respond to fuel prices (Sterner, 2007; Dahl, 2012) but that fuel demand is relatively inelastic. For example, estimates of the elasticity of demand for gasoline range from only 0.1 over short periods when it is difficult to modify use, to about 0.3 to 0.5 over longer periods when there are more opportunities to change behavior. One study finds that a tax on gasoline that increases to about $2.00 a gallon by 2030 results in decreased gasoline use of about 25 percent over that same period (Krupnick et al., 2010). There is little experience with GHG pricing of transportation fuels and their supply chains, and so the overall GHG emissions response to including such pricing could be greater than the demand response alone.

There are also reasons why a fuel or GHG tax may need to be combined with other policies. Pricing gasoline to reflect its full costs will still not induce consumers to make optimal choices about fuel-efficient vehicles if they undervalue fuel economy (Greene, 2010). This point is discussed more fully in Chapter 5, but to the extent it is true, then a combination of pricing and vehicle standards will be important. The committee’s scenario analyses suggest that significant ongoing fuel economy improvement is likely to play a very large role in meeting both the petroleum reduction and GHG emissions reduction goals (Greene, 2011; Allcott et al., 2012). That is why one of the committee’s high-priority suggestions is to continue to strengthen vehicle standards for fuel economy and GHG emissions.

There are other reasons why pricing energy will be helpful in conjunction with such vehicle standards:

  • Reducing VMT, including countering the rebound effect. Because fuel economy standards reduce the variable cost of driving, they encourage more driving, partially offsetting the fuel-use-reducing benefits of the standards. This phenomenon is called the rebound effect. Raising fuel prices counters the rebound effect and reduces the demand for fuel-consuming travel generally.
  • Increasing demand for fuel-efficient vehicles. Higher fuel prices increase consumers’ demand for fuel-efficient vehicles, thereby aligning the requirements faced by automakers under vehicle standards with the demands of consumers.

Any of these behavioral rationales for higher fuel taxation would represent a significant departure in U.S. fiscal policy. Traditionally, federal, state, and local fuel taxes have been justified only as a way to raise revenue for transportation infrastructure and maintenance. Federal U.S. gasoline taxes have not increased in nominal terms in almost 20 years; in real terms, they have declined dramatically, leading to crumbling roads, bridges, and tunnels. Other studies have documented a justification for higher fuel taxes in order to make up for this substantial shortfall in transportation funding (National Surface Transportation Policy and Revenue Study Commission, 2007). Thus, taxing fuels to reduce oil use and GHG emissions could have the important co-benefit of raising needed revenue for our transportation system. Although this behavioral rationale for fuel pricing is not traditional in U.S. policy, it has been used in Western Europe and other countries and is one reason for the higher levels of vehicle fuel economy and lower levels of per capita demand for automobile travel observed in those countries relative to the United States.

  • By counterbalancing the end-use (vehicular) CO2 emissions from carbon-based fuels with sufficient net CO2 uptake elsewhere. Because this CO2 uptake and the emissions associated with feedstock growth and processing (e.g., for biofuels) occur outside the transportation sector, the optimal policies are not those directed at the transportation sector per se, but rather measures to address net GHG emissions in fossil fuel extraction and refining, biorefining, agriculture, forestry, and related land-use management sectors involved in supplying carbon-based fuels. (See also Chapter 6.) In the future, counterbalancing also might occur through geologic storage or biological sequestration techniques.
  • By using physically carbon-free fuels such as electricity or hydrogen, which avoid release of CO2 from vehicles themselves. These energy carriers must then be supplied from low-GHG emitting-production sectors. Therefore, optimal policies are not those directed at the transportation sector per se, but rather measures addressing electric power generation and other industrial sectors that produce carbon-free fuel.

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