The Oil Drum | Fun with Fuel Subsidies and Taxes

26 comments on Fun with Fuel Subsidies and Taxes

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drewster on June 1, 2008 - 9:46pm

In high tax countries like Britain and Germany, a 100% increase in the price of oil translates to only a 40% increase in the pump price. Demand destruction doesn't happen but, over time, the balance of payments is ruined. That means the currencies of high fuel-tax countries should depreciate relative to the currencies of low fuel-tax countries, as the latter cuts consumption faster in response to higher prices. Unthinkable as it may seem, the dollar may regain some weight against the euro.

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DaveMart on June 1, 2008 - 10:25pm

In the high tax countries it is a percentage of the price, and so goes up proportionately.
Governments there are dependent on petrol tax, and if demand dropped would still need to raise just as much money or go bankrupt.

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drewster on June 1, 2008 - 11:19pm

The tax is not a percentage, it's a fixed levy. In Britain/Germany/Netherlands, fuel duty is fixed at £0.50/€0.68/€0.65 per litre of petrol. A proportional value added tax (17.5%/19%/19%) is added on top, so this part is variable; but business users generally don't have to pay this part (it's a bit like Sales Tax in the US). Large users like the logistics industry are therefore excluded from the variable portion of the tax.

To take a simple example: in Britain, if the price of a litre of untaxed petrol increases 100% from £0.24 to £0.48, then the final cost to the consumer rises from £0.87 to £1.16 - only a 33% increase. This is the increase we have actually seen between Feb '07 and May '08; a 33% increase in pump price for a ~100% increase in oil price.

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DaveMart on June 2, 2008 - 5:51am

Thanks for the correction - my bad.
This does raise an interesting issue though.
Demand for petrol has so far been inelastic, and some here have made the point, persuasively IMO, that demand destruction will only really take off when a recession/depression hits.
In Europe Government finances are heavily dependent on petrol tax.
So far to the limited extent that demand has dropped Government revenues have been protected by the VAT component.
If demand seriously drops, as it must in a world with decreasing oil available, and in my view this is likely to occur shortly with recession, then a horse and cart will have been driven through Government revenues.
Either Government spending would have to be savagely slashed, revenues would have to be greatly increased - in economic terms the best way would be to increase the price of fuel still more as this would restrain demand, but in any case taxes would have to go up a great deal, or Government deficits would spiral out of control leading to hyper-inflation.
Under those circumstances it would seem that after a tipping point the high petroleum tax countries would be in an even worse position than the countries which had traditionally had a low tax on petrol.

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drewster on June 2, 2008 - 11:27am

There are several other "green" taxes, all of which are supposedly intended to reduce consumption of fossil fuels. Excluding VAT, these account for 7.3% of all taxation in Britain. When Peak Oil really hits home revenue from green taxes is bound to fall. So DaveMart, you are right to say that either spending will be slashed or taxes will be hiked, and that the loss of revenue will be worse in high-tax countries.

The rising price of oil will act as a green tax in itself; so presumably the government should reduce taxes as the price rises. A gradual reduction in the tax will allow the government to wean itself off green taxes over time. Fuel taxes should be set like all other taxes - to pluck the maximum of feathers with the minimum of hissing.

_{(I'm deliberately ignoring the more general issue of decreased revenues and increased expenditure which was discussed at length in the recent article on Local Government.)}

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DaveMart on June 2, 2008 - 12:12pm

I'd disagree with that and say that economically the correct response would be to put all the increase on to fuel.
This would further restrict demand and lower the amount oil exporting countries could get for the oil, so effectively keeping the excess money in the oil consuming nations.
I have my doubts that that will be politically possible though, and even more doubt that in a recession when payments for unemployment benefit etc rise that the result will be other than large increases in direct taxation.

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drewster on June 3, 2008 - 9:25am

You're right, that does make more sense. As you point out though, it could be politically untenable. Governments can only force down the bitter medicine if their electorate recognize the disease; this requires a well-educated workforce.

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dadco on June 2, 2008 - 12:45am

hello,
As a consumer who anually consumes energy in both US & France ( a high tax country) I hafta say that my actual experience corresponds to what Drewster is saying. I even noticed this effect last June '07..... that the prices for gas/petrol/essence were going up very-noticably faster ( d$/dt > ) in Vermont than in France.

d$/dt > d(euro)/dt

not a theory, an observation.

sa

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enemy of state on June 1, 2008 - 10:42pm

That sounds precisely backwards. In high tax countries, especially those with taxes that rise proportionately to the price of oil, consumers acutely feel the oil price, and should consume less. A relatively smaller chunk of the consumer fuel dollar goes to the exporter. A low tax country like the US has a serious balance of payments problem, because consumers consume a lot of oil. High tax economies are forced to become more oil efficient, while those with low taxes, or subsidizes will lag behind on efficiency.

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FrankRichards on June 2, 2008 - 10:39am

As pointed out above, few if any countries have taxes fully proportional to price. There's usually a fixed whack and then a percentage too.

Second, the folks in high tax countries are already using less. If you're already paying $8/gal, the rise to $9 is going to squeeze relatively less hard than a rise from $3 to $4 per gal here in the states.

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garyp on June 2, 2008 - 3:39am

In high fuel tax countries the economy has an opportunity to adjust to higher oil prices since the effect is 'damped' by fixed tax rates.

In low fuel tax countries the full rate of rise is passed through, increasing costs swiftly and leading to 'breaks' rather than adaptation.

In both situations the balance of payments tends to go to hell, but at least in the high fuel tax countries they still have working industry to produce export goods to sell to the producers. A country that's industry has gone bankrupt has nothing to sell apart from its assets.

You do point up one thing that is likely though. Countries will impose import restrictions to try to fix their balance of payments.

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26 comments on Fun with Fuel Subsidies and Taxes

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