Are Gasoline Taxes in Britain Too High?

Challenge, July, 2001 by Ian Parry

It may make sense to reduce gasoline taxes in Britain and substitute higher income taxes to raise revenue. But this must be weighed against other benefits of high gasoline taxes in reduced pollution and traffic congestion.

BRITAIN witnessed extraordinary scenes in September 2000 as its people, particularly truck drivers and farmers, spontaneously took to the streets to protest high gasoline prices. Throughout the country, oil refineries and depots were blockaded, disrupting the movement of fuel to gas stations. Panic buying by motorists compounded the situation to such an extent that by the middle of the month, nearly all of the country's gas stations had run dry. The protesters were no doubt encouraged by the earlier success of demonstrations in France that led to the government's agreeing to tax concessions. [1] Similar protests spread across Europe, with truck drivers blockad- ing Brussels, snarling up motorways around Dutch cities, and staging wildcat action in Germany.

The immediate cause of the rise in fuel prices is the dramatic increase in the world price of oil, which has jumped from below $10 per barrel in December 1998 to more than $30 per barrel in September 2000 (Figure 1). The main reason for this price increase is the rapid expansion of the world economy, following recovery from the Asian financial crisis. Consequently, the demand for oil has leapt up, while supply has been restrained, deliberately, by the quarrelsome but at times effective OPEC cartel and by capacity constraints in non-OPEC countries.

However, gasoline prices are high in Britain also because the government now imposes a higher rate of excise tax on gasoline than any other country does. The current excise tax per liter is 50 pence ($2.80 per American gallon), and, even with adjustment for inflation, this tax is 75 percent higher than the 1990 level (Figure 2). [2] The tax constitutes 60 percent of the price of fuel, which now stands at about 83 pence per liter ($4.70 per gallon). [3] Gasoline tax rates in other countries are well below those in the United Kingdom (Figure 3), particularly in the United States, where the gasoline tax is about 40 cents per gallon (7 pence per liter).

Protest leaders demanded an immediate cut in the gasoline tax to provide some relief for trucking companies, farmers, taxi drivers, and other motorists. In his November 2000 mini-budget, the Chancellor of the Exchequer, Gordon Brown, responded with a package of measures to reduce road taxes. These measures include a pledge not to increase the gasoline tax in line with inflation in the next budget, a reduction in vehicle taxes for trucks and small-engine cars, and a cut of 3 pence in the tax on low-sulfur gasoline. But at the moment, the government has no plans to substantially reduce the general excise tax on gasoline.

The Labour government has defended high gasoline taxes on three grounds. First, taxes reduce pollution and emissions of greenhouse gases by penalizing driving and by encouraging people to purchase more fuel-efficient cars. Second, they also reduce traffic congestion by discouraging driving. Third, gasoline taxes provide revenues that will help pay for the substantial increases in public spending that were recently announced by Gordon Brown. Leaving aside whether these spending increases are justifiable, the issue is this: Given that the government needs extra revenue, should this funding be financed by raising the gasoline tax above the rate that might be justified on grounds of pollution or congestion, or should the revenue be financed by other means, such as by increasing the personal income tax?

The rest of this article discusses what economics has to say about the extent to which government spending should be financed through gasoline taxes versus other taxes, taking into account benefits from reducing pollution and congestion. The focus is purely on economic efficiency. Distributional effects and political feasibility also are relevant to the politics of tax reform, but these issues are not addressed here.

The Environmental Costs of Gasoline Combustion

Gasoline combustion causes both local air pollution and emissions of carbon, a greenhouse gas that might affect the future global climate. Local air pollutants include volatile organic compounds, nitrogen oxides, carbon monoxide, and particulates. These emissions can reduce visibility but their main harm is to human health. For example, poor air quality can exacerbate respiratory problems and cause premature mortality.

Economists have attempted to estimate, in monetary terms, the damages caused by these pollutants. In making these estimates, they use the epidemiological evidence on the link between air quality and human health, as well as studies that attempt to assess how much people would be willing to pay to reduce the risk of adverse health effects. Most studies have focused on the United States, although we might expect the results to be broadly similar for other developed countries. Not surprisingly, the studies have produced a wide range of possible damage estimates. However, more recent studies point to damage estimates of around 10 pence per liter (60 cents per gallon) or less. [4]