Energy Taxes: Traditional Efficiency Effects and Environmental Implications

This paper examines "traditional" (non-environmental) efficiency consequences and environmental effects of two energy tax policies: a tax on fossil and synthetic fuels based on BTU (or energy) content and a tax on consumer purchases of gasoline. It uses a model that uniquely combines attention to details of the US tax system with a consolidated treatment of US energy use and pollution emissions. On traditional efficiency grounds, each of the energy taxes emerges as more costly to the economy than increases in personal or corporate income taxes of equal revenue yield. The time profiles of GNP and consumption are significantly lower under the energy taxes than under the alternatives. We perform a number of simulation experiments designed to isolate key structural features of energy taxes and identify which features account for their "excess costs"—the nonenvironmental welfare costs over and above those of an equal-revenue increase in the personal income tax. For both energy taxes, the relative narrowness of the tax base accounts for most of the excess cost. Differences in costs also are attributable to differences in the stage of activity or type of commodity represented in the tax base. The BTU tax's application to gross output (as compared with net output under an income tax) serves to expand the excess costs. In contrast, the gasoline tax's focus on consumption (as opposed to income) tends to mitigate the excess costs. The finding that energy taxes generate larger gross costs than the income tax alternatives is robust to a range of specifications for values of key parameters. On the environmental side, we quantify the differences in the impacts of these tax alternatives for pollution emissions. For each of the eight major air pollutants considered, energy taxes induce emissions reductions that are at least nine times larger than the reductions under the income-tax alternatives. The differences in emissions impacts reflect the close connections between energy use and pollution generation. For the BTU tax, the largest percentage reductions in emissions are for CO₂ and NOₓ compounds. For the gasoline tax, the emissions reductions are spread somewhat more evenly across the eight major pollutants considered. Overall, this study indicates that the BTU and gasoline taxes considered are inferior to the alternatives on narrow efficiency grounds but superior on environmental grounds. It remains an open question whether the environmental attractions of these taxes are large enough to offset their relatively high nonenvironmental costs.