Friday, January 13, 2012

More On Dropping The Petrol Subsidy

There is, as one commentator put it, more than one way to kill [sic] a cat. I’ve been open about my support for dropping petrol subsidies in favour of taxes which cover the overall costs to society imposed by fossil fuel use i.e. a Pigovian tax.

There’s actually some method to my madness.

While a petrol tax would cause hardship to some segments of the population, the savings from abolishing petrol subsidies can be used to offset the loss in purchasing power among the low income groups – in fact would do so more efficiently, as the funds will go to those who actually need them, rather than the everyone-benefits-and-everyone-loses scenario under subsidies.

But there are of course alternatives to Pigovian taxes, which this new paper at the NBER discusses (abstract):

Reducing Petroleum Consumption from Transportation
Christopher R. Knittel

The United States consumed more petroleum-based liquid fuel per capita than any other OECD-high-income country – 30 percent more than the second-highest country (Canada) and 40 percent more than the third-highest (Luxemburg). This paper examines the main channels through which reductions in U.S. oil consumption might take place: (a) increased fuel economy of existing vehicles, (b) increased use of non-petroleum-based low-carbon fuels, (c) alternatives to the internal combustion engine, and (d) reduced vehicles miles travelled. I then discuss how the policies for reducing petroleum consumption used in the US compare with the standard economics prescription for using a Pigouvian tax to deal with externalities. Taking into account that energy taxes are a political hot button in the United States, and also considering some evidence that consumers may not correctly value fuel economy, I offer some thoughts about the margins on which policy aimed at reducing petroleum consumption would have the largest impact on economic efficiency.

It’s a nice overall look at all the possible policy alternatives, with references to other research covering each question in detail. But the bottom line is that most of these alternatives are either still too far in the future (new technologies such as fuel cells), don’t offer much advantage in terms of life time emissions over petrol (bio-fuels), or have perverse results (fuel economy measures). That last one has to be explained – by forcing manufacturers to increase fuel efficiency, drivers actually drive more not less, and has actually raised per capita fuel consumption. Overall social welfare has dropped, not increased.

But Mr Knittel doesn’t dismiss all these alternatives entirely – the search for alternatives to the internal combustion engine is gathering pace, and might in time fulfil the promise of clean energy use. And the other alternatives can be effective, but only as complements to a Pigovian Tax, not as a substitute.

But that still leaves taxation of fuel consumption as the first, best option.

Technical Notes

Knittel, Christopher R., "Reducing Petroleum Consumption from Transportation", NBER Working Paper No. 17724, January 2012


  1. If remove fuel subsidy.. then introduce fuel tax.. followed by removal of taxes for cars.. then I'm all for it.

    However, I don't think any politician PM wannabes dare to do that ;p The transition will be too painful.

    Imagine.. you bought a car for RM150k. Loan for 5 years. In year 3, new policy took effect. Fuel price goes up. New car price goes down by 50%. You still need to pay bank loan of RM150k (eventho market price of your 2nd hand car now probably already sunk to RM20k) AND the high fuel price. Double whammy!

    Can probably do it in stages.. but still painful I think and requires stadium loads of political courage which unfortunately no current leaders have (be it in BN or PR or NGO).

  2. Yes, agreed.

    To be fair, subsidy rationalisation was already ongoing, with incremental cuts, until it was suspended early last year. I suspect we'll see a resumption (assuming BN wins) after GE13. I don't see PR doing it.