Friday, August 28, 2009

Believe it or not: What we need now is higher gas prices.

“We are swilling oil faster than new fields are being discovered.” “Is oil at the tipping point?” Jane Bryant Quinn and Robert J. Samuelson ask these two questions in the latest issues of Newsweek. With gasoline prices hovering around three dollars a gallon the American public and press are rightly concerned and preoccupied with the effects of high gas prices – but they are missing the point. Yes – we do need comprehensive energy policy, but we do not need lower gas prices or to worry about the impending end of oil. In fact, running out of oil is not a problem. The real problem (as Joe Stiglitz was kind enough to point out in the last volume) is the pollution that comes from burning fossil fuels – mainly CO2.

The concerns about the price of gasoline are straightforward. Uncertainty in the Middle East is fueling fears of a reduction in the supply of crude oil. This potential supply constraint will have the effect of raising the price of gasoline (and all energy) in the United States. The fear is that rising energy costs will eventually burden the US economy and lead to recession. These may, in fact, be concerns and anyone who drives to work each day certainly feels the pain of $3.00 a gallon gasoline. So you may find my next statement a little strange – we need higher gas prices. In order to internalize the externalities associated with burning gasoline, the price of gas should be much higher than it currently is and in the end – higher gas prices will benefit not only the environment but also the US economy.

The argument for higher gas prices is not new. In fact, Gary Becker and others have made the argument many times in the past decade that what we really need are some steep increases in gas taxes. Increasing the price of gas will have several effects including (1) conservation of oil reserves, (2) increasing investment in alternative energy, (3) the transfer of wealth from oil exporting nations to the treasury department of the United States of America and (4) the reduction of greenhouse gases and other air and water polluting emissions. The first effect is straightforward in that when prices increase the quantity demanded falls. The recent rise in gas prices to over $3.00 per gallon has not had much of an impact on the amount of gas consumed. But, if we were to move from $3 to $5, I’ll bet we see a change in the amount of gasoline consumed. The second effect will take time, but it is one that needs to be told – that is – higher gas prices will eventually be good for the US economy. Alternative energy in the form of hydrogen, solar, wind, hydro, etc will all benefit from higher gas prices. Businesses will grow. Investment will increase. Jobs will be created and national security improved all through the development of the alternative energy sector. As for number 3, the current dollars flowing to Saudi Arabia, Canada, Venezuela, Mexico, Iraq, and Nigeria will begin to flow to Washington D.C. Lastly, the fourth effect comes directly from the first. If people drive less there will be less pollution in the form of reduced CO2, NOx, SO2, and O3.

The importance of number four cannot be overstated. The release of CO2 is the primary greenhouse gas responsible for climate change. Recent estimates from the impacts associated with increasing concentrations of CO2 in the atmosphere range from (Tol, 2005)…. NOx is the primary pollutant in the formation of smog and SO2 is the precursor pollutant for acid precipitation. Although we have made tremendous strides to reduce NOx and SO2 emissions, there is still more that can be done. The last pollutant O3 – low level ozone – forms when NOx from automobiles interacts with sunlight and the recent epidemiological literature is powerfully suggestive of the ability of low level ozone to not only exacerbate asthma and other bronchial ailments but to cause increases in the incidence of these breathing disorders. In order to reduce these costs – we need to increase the price of gasoline.

When are we going to recognize the full costs of our addiction to oil? To argue that the high price of gasoline will hurt the US economy is to ignore the true costs associated with “cheap” fuel. Global climate change, and the health of our children are at stake. Why are we willing to sacrifice the health of the planet and of our children in order to keep gas prices low? Clearly these are enormous costs and when we are willing to recognize these costs we will also be willing to see higher gas prices. But how?

My idea is to implement a $3.00 per gallon federal gas tax in phases over the next six years (50 cents a year). This will give firms and households time to change behavior. Additionally, in order to offset the financial burden to poorer households there will be an income tax refund available during the same time period. In order to be fair let’s set the income threshold for those eligible to receive the rebate at two times the median household income. So, any household with an annual income of less than 85k will be eligible. The refund will work in the opposite direction of the tax. In the first year households will be eligible for a 50% refund on fuel expenditures. In year two it falls to 40%, year three 30%, until it is fully phased out in year six. Any households falling below the poverty line would be eligible for full refunds for all six years. Households between the poverty line and 45k would be eligible for double the refunds proposed with the same phase out as the households between 45k and 85k. Now is the time to act and raise gas taxes in order to protect our children and the planet they will inherit.