Since oil prices began their steady march back to three-digit levels, the cries for government intervention in gasoline markets has risen in tandem. These calls have reached a fever pitch this week with reports we will soon see a US-style dressing-down of the oil executives by federal MPs as well as calls from politicians including Ontario PC Leader Tim Hudak to consider tax relief at the pump.
Often, the case for government intervention in energy markets is premised on protecting low-income consumers from the effects of price increases. A quick look at Stats Can data suggests not only that this would be what Kevin Milligan has termed a “price solution to an income problem,” it would be an expensive and regressive policy change to say the least.
The Statistics Canada Survey of Household Expenditure compares transportation spending across income levels, and preliminary data analysis shows that the richest 20% of Canadian households spend over 6x as much on transportation as the poorest 20%. Kevin Milligan provides the breakdown of fuel expenditures, which show a similar although not quite as stark difference.
On average, about 22% of transportation dollars are spent on gasoline for private vehicles, and this number is higher among lower-income households as they tend to drive less expensive vehicles and take fewer (more expensive) trips by air than higher-income households. Higher-income households’ expenditure on gasoline and other fuels is $3621/yr on average, 4% or less of average annual expenditures. The lowest income households spend $662/yr, which is at least 2% of annual expenditure, but likely significantly more in many cases.
The impact of any broad-based tax change would benefit high income households as much as 6 times more than it benefits low income households. Based on the numbers above, if the Federal government were to exempt gasoline from GST, the 5% savings would amount to $180/yr for the country’s richest households, and would provide only about $33 to Canada lowest-income households. Yes, the $33 may make a larger difference to a lower-income household, but if we want to help lower income Canadians deal with high energy prices, a policy which provides significant cost savings to the highest income earners in the country is a poor place to start.
Before you argue for gas tax relief for the sake of those less fortunate, consider that higher income people tend to drive larger vehicles, drive greater distances, and drive more often than do lower income people. As such, higher income people use more gas than lower income people. They pay more tax, and so benefit more from any tax relief.
If we want to transfer money to lower income households, let’s do so, but let’s not for a second pretend that relief at the gas pumps is a good way to go about it.
MCould it not be argued that since lower income families spend 100
Percent of their income that they value 45$ more than higher income Canadians value 140$. Also, even though higher income people are more likely to fly, if they don’t fly then airlines lay people off. I’m not saying I disagree with your conclusion but more some aspects of your rationale. Eliminating the gst on fuel could help lower income people if coupled with a refundable energy tax credit of 100$ for those with low incomes. Then everyone gets the same benefit (if your numbers are precise).
My personal feelings are let those with higher incomes pay more for energy. On a global scale we already get a pretty good deal but I doubt the current gov’t agrees with
I really like your blog btw (and tweets).
Thanks for reading Willow. Yes, you could certainly make an argument that lower-income people have a higher value of incremental revenue or cost savings, and thus might benefit as much or more from this policy change in welfare terms. Conclusion still remains that it’s a pretty blunt instrument to protect lower income people, as you say. I think that we should let the market sort out the price for energy, and deal with income problems through income transfers.
Thanks again.
Andrew
The problem though, Andrew, is that the market is failing to sort out the price for energy. The wild fluctuations over short time spans despite no underlying conditions to justify them pretty much proves that.
I do agree though that lowering taxes on gasoline is an inefficient means of dealing with the problem. I think it needs to be dealt with by “regulating?” the commodities market which is the main source of the problem.
If you take a utility view of gasoline, then yes, the market is doing a poor job of ensuring that companies only earn a regulated rate of return. On the other hand, the “underlying conditions” exist at the gas pumps. As long as consumers are willing to buy gas at 1.40, this creates exactly the underlying conditions amenable to short run swings in prices. The only way you make money on speculating is if someone is short oil and willing to buy at the inflated prices. Looking to regulation to solve that problem is short-sighted IMO.
Is the “market will bear it” really an underlying justification for rising, volatile gas prices? Too me that seems to discard all economic theory.
Not at all…in fact I would argue the opposite. Arguing that the “fundamentals” don’t support the price in a physical commodity market with limited inventories discards economic theory altogether. The real question is the impact of the pecuniary externalities, i.e. does the short run inelasticity of demand allow for speculators to engage in activity which is harmful to the overall economic system. There is certainly something to that discussion. I think most people talking about these markets conveniently ignore that all of these transactions have two sides…a buyer and a seller, and so fundamentally, supply is equal to demand plus changes in inventories in the physical market, and that there are also buyers and sellers on both sides of all financial transactions. Sure, speculation amplifies short run fluctuations, but if the short run demand were more elastic, the potential for profitable short run speculation would dissipate.
If regulation would be so beneficial to consumers, why do we not see any retailers offering fixed-price gasoline contracts? They could fully hedge the contract price through the forward market and on average, consumers would pay a little more for gas but they would miss the quick swings.
Could it not be argued that since lower income families spend 100
Percent of their income that they value 45$ more than higher income Canadians value 140$. Also, even though higher income people are more likely to fly, if they don’t fly then airlines lay people off. I’m not saying I disagree with your conclusion but more some aspects of your rationale. Eliminating the gst on fuel could help lower income people if coupled with a refundable energy tax credit of 100$ for those with low incomes. Then everyone gets the same benefit (if your numbers are precise).
My personal feelings are let those with higher incomes pay more for energy. On a global scale we already get a pretty good deal but I doubt the current gov’t agrees with me.
I really like your blog btw (and tweets).
Boy, I hate typing on my phone:-)
Willow Balkwill (@chuckdawsongirl)
Sorry, my clumsy fingers made me send that twice.
If regulation would be so beneficial to consumers, why do we not see any retailers offering fixed-price gasoline contracts?
That’s a good question. There are fixed contracts for natural gas and home heating oil so why not gasoline. Could that be a solution to the volatility that angers consumers the most.
Hi Andrew, your blog has caught my interest. I am NOT an economist – more of a behavioral theorist trained in science and environmental resource management. So I’m keen to learn from you and your following.
Just wondering, what do you make of BCs broad based, revenue neutral carbon tax, which is now at $20/ tonne, and set to rise to $30 by 2012? http://www.fin.gov.bc.ca/tbs/tp/climate/carbon_tax.htm
Hi Heather,
Thanks for reading. I am very much in favor BC’s approach to carbon pricing, and to the idea of using the tax revenues to offset the need for income taxes. Revenue neutrality is hard to pin down in the long run, since the idea that income taxes have decreased by the amount of the carbon tax can only be judged against an estimate of what income taxes otherwise would have been. Overall, I like their policy and their price trajectory makes sense.
Andrew
[…] that the majority of the costs of a fuel cost increase are borne by the poor – that’s simply not true. If you increased fuel costs by 1%, it would cost the lowest 25% of income earners an average of $6 […]
Sirs,
I think we can solve our problems by moving to
Newfoundland, Nova Scotia, New Brunswick, or PEI.
Why, because gasoline prices are controlled by the
Government in those Provinces.
How, by taking the wholesale price which is
the New York Harbor price for unleaded gasoline,
that is traded on the Nymex Commodities Exchange
and adding a percentage for shipping, retail, and
profit. Check “down East” prices on Gasbuddy and see
how low they are!! Gasoline does have a wholesale
price and can be shipped between Canada and the US,
so prices on both sides of the border are the same,
except for taxes which vary by State or Province.
John,
You are correct that gasoline is freely tradeable, and so the NY Harbour price is a useful marker, at least on a spot price basis. Most gasoline distributors will be hedged in some way, so are not paying spot for all their gasoline at any one point, so that changes the price. The existence of a spot trading price does not mean there is no equivalent of a wholesale price, though – that price is the refinery rack price available in your area, or the price from your local gasoline distributor. As a gas station operator, in the same way as you can’t practically go direct to Kraft to buy your chocolate bars for retail sale, you can’t practically go to the NYMEX and buy your next week’s supply of gasoline.
You are, of course, correct with respect to prices in regulated markets being generally higher, although when adjusted for taxes, the differences are small.
Andrew