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The Right Time to Reform Fuel Pricing

CAMBRIDGE – World oil prices, which have been highly volatile during the last decade, have fallen more than 50% over the past year. The economic effects have been negative overall for oil-exporting countries, and positive for oil-importing countries. But what about effects that are not directly economic? If we care about environmental and other externalities, should we want oil prices to go up, because that will discourage oil consumption, or down because that will discourage oil production?

The answer is that countries should seek to do both: Lower the price paid to oil producers and raise the price paid by oil consumers, by cutting subsidies for oil and refined products or raising taxes on them. Many emerging-market countries have taken advantage of falling oil prices to implement such reforms. The United States, which is now surprisingly close to energy self-sufficiency, so that the macroeconomic effects roughly balance, should follow suit.

Consider this: America’s roads and bridges are crumbling, and the national transportation infrastructure requires investment and maintenance. And yet the US Congress shamefully continues to evade its responsibility to fund the Federal Highway Trust Fund and put it on a sound long-term basis, owing to disagreement over how to pay for it. The obvious solution, which economists have long advocated, is an increase in America’s gasoline taxes. The federal gas tax has been stuck at 18.4 cents a gallon since 1993, the lowest among advanced countries. And yet, on July 30, Congress adopted only a three-month stopgap measure, kicking the gas can down the road for the 35th time since 2009.

Fossil-fuel pricing is a striking exception to the general rule that if the government has only one policy instrument, it can achieve only one policy objective. For starters, the money saved from a reduction in subsidies or an increase in taxes in the oil sector could be used either to reduce budget deficits or to fund desirable spending (such as US highway construction and maintenance). At the same time, lower oil consumption would reduce traffic congestion and accidents, limit local air pollution and its adverse health effects, and lower greenhouse-gas emissions, which lead to global climate change. Fuel taxes are a more efficient way to achieve these environmental goals than most of the alternatives.