Market equilibrium and welfare effects of a fuel tax in China: The impact of consumers' response through driving patterns

We investigate the market equilibrium and welfare effects of a fuel tax in China relative to an alternative policy instrument that rations the number of new automobile sales through auctioned quotas. Unlike those of previous studies, our modeling approach incorporates both household car purchase and utilization decisions, the latter of which have been ignored in previous studies on China's fuel tax. Ignoring this margin of choice will underestimate the fuel tax's ability to mitigate externalities. Using detailed household-level panel data and a fixed effects econometric specification, we estimate the fuel price elasticity of vehicle miles traveled is −0.59 on average. The results of the counterfactual analysis suggest that a 51% increase in tax-inclusive gasoline prices will reduce car sales by 24.9% but increase social welfare to a degree that depends on vehicles' lifetime. We find that compared to auctioned quotas, the fuel tax results in greater car sales but higher social welfare.     

Giving green to get green? Incentives and consumer adoption of hybrid vehicle technology

Federal, state, and local governments use a variety of incentives to induce consumer adoption of hybrid-electric vehicles. We study the relative efficacy of state sales tax waivers, income tax credits, and non-tax incentives and find that the type of tax incentive offered is as important as the generosity of the incentive. Conditional on value, sales tax waivers are associated with more than a ten-fold increase in hybrid sales relative to income tax credits. In addition, we examine how adoption varies with fuel prices. Rising gasoline prices are associated with greater hybrid vehicle sales, but this effect operates almost entirely through high fuel-economy vehicles. By comparing consumer response to sales tax waivers and estimated future fuel savings, we estimate an implicit discount rate of 14.6% on future fuel savings.     

Optimal policy instruments for externality-producing durable goods under present bias

When consumers exhibit present bias, the standard solution to market failures caused by externalities—Pigouvian pricing—is suboptimal. I investigate policies aimed at externalities for present-biased consumers. Optimal policy includes an instrument to correct the externality and an instrument to correct the present bias. Either instrument can be an incentive-based policy (e.g. a tax on fuel economy) or a command-and-control policy (e.g. a fuel economy mandate). Under consumer heterogeneity, a command-and-control policy may dominate an incentive-based policy. Calibrated to the US automobile market, simulation results suggest that the second-best gasoline tax is 3–30% higher than marginal external damages. The optimal price policy includes a gasoline tax set about equal to marginal external damages and a fuel economy tax that increases the price of an average non-hybrid car by about $550–$2200 relative to the price of an average hybrid car.     

Alternative transportation fuel standards: Welfare effects and climate benefits

This paper develops an integrated model of the fuel and agricultural sectors to analyze the welfare and greenhouse gas emission (GHG) effects of the existing Renewable Fuel Standard (RFS), a Low Carbon Fuel Standard (LCFS) and a carbon price policy. The conceptual framework shows that these policies differ in the incentives they create for the consumption and mix of different types of biofuels and in their effects on food and fuel prices and GHG emissions. We also simulate the welfare and GHG effects of these three policies which are normalized to achieve the same level of US GHG emissions. By promoting greater production of food-crop based biofuels, the RFS is found to lead to a larger reduction in fossil fuel use but also a larger increase in food prices and a smaller reduction in global GHG emissions compared to the LCFS and carbon tax. All three policies increase US social welfare compared to a no-biofuel baseline scenario due to improved terms-of-trade, even when environmental benefits are excluded; global social welfare increases with a carbon tax but decreases with the RFS and LCFS due to the efficiency costs imposed by these policies, even after including the benefits of mitigating GHG emissions.     

Salience of carbon taxes in the gasoline market

We demonstrate that the carbon tax imposed by the Canadian province of British Columbia caused a decline in short-run gasoline demand that is significantly greater than would be expected from an equivalent increase in the market price of gasoline. That the carbon tax is more salient, or yields a larger change in demand than equivalent market price movements, is robust to a range of specifications. As a result of the large consumer response to the tax, we calculate that during its first four years, the tax reduced carbon dioxide emissions from gasoline consumption by 2.4 million tonnes.     

Tax evasion and optimal environmental taxes

This paper introduces a new argument to the debate about the role of environmental taxes in modern tax systems. Some environmental taxes, particularly taxes on gasoline or electricity, are more difficult to evade than taxes on labor or income. When the tax base is shifted in a revenue-neutral manner toward these environmental taxes, the result is a net reduction in the amount of tax evasion. Using a carbon tax as a motivating example, the “tax evasion effect” is shown to sharply reduce the welfare cost of controlling emissions. A simple computable general equilibrium model suggests that the impact of considering tax evasion can be large: costs are lowered by 28% in the United States, by 89% in China, and by 97% in India. In countries with high levels of pre-existing tax evasion, a carbon tax will pay for itself through improvements in the efficiency of the tax system.     

Strategic climate policy with offsets and incomplete abatement: Carbon taxes versus cap-and-trade

This paper provides a first analysis of a “policy bloc” of fossil fuel importers which implements an optimal climate policy, faces a (non-policy) fringe of other fuel importers, and an exporter bloc, and purchases offset from the fringe. We compare a carbon tax and a cap-and-trade scheme for the policy bloc, in either case accompanied by an efficient offset mechanism for reducing emissions in the fringe. The policy bloc is shown to prefer a tax over a cap, since only a tax reduces the fuel export price and by more when the policy bloc is larger. Offsets are also more favorable to the policy bloc under a tax than under a cap. The optimal offset price under a carbon tax is below the tax rate, while under a cap and free quota trading the offset price must equal the quota price. The domestic carbon and offset prices are both higher under a tax than under a cap when the policy bloc is small. When the policy bloc is larger, the offset price can be higher under a cap. Fringe countries gain by mitigation in the policy bloc, more under a carbon tax since the fuel import price is lower.     

Fuel consumption and gasoline prices: The role of assortative matching between households and automobiles

Analyses of policies to reduce gasoline consumption have focused on two effects, a compositional effect on the fuel economy of the automotive fleet and a utilization effect on how much people drive. However, the literature has missed a third effect: a matching effect, in which policies change how high-utilization households are matched to fuel-efficient vehicles in equilibrium. We show that higher gas prices should lead to stronger assortative matching. Empirical estimates using US micro-level data are consistent with this hypothesis. We find a $0.50 increase in the gas tax would reduce US gas consumption by 0.8% through the matching effect alone, bringing annual environmental benefits of about $1.7 billion.     

Do renewable energy policies reduce carbon emissions? On caps and inter-industry leakage

In a parsimonious two-sector general equilibrium model, we challenge the widely-held tenet that within a cap-and-trade system renewable energy policies have no effect on carbon emissions. If the cap does not capture all sectors, we demonstrate that variations of a renewable energy subsidy change aggregate carbon emissions through an inter-industry leakage effect. We decompose this effect into intuitively intelligible components that depend in natural ways on measurable elasticity parameters. Raising the subsidy always reduces emissions if funded by a lump-sum tax, reinforcing recent findings that tightening environmental regulation can cause negative leakage. However, if the subsidy is funded by a levy on electricity, it can increase emissions. These results provide a valuable basis for an informed design of renewable energy policies and an accurate assessment of their effectiveness. We highlight how a state-of-the-art statistic used by governments to gauge such effectiveness, “virtual emission reductions”, is biased, because inter-industrial leakage effects are not captured.     

Clearing the air: The costs and consequences of higher CAFE standards and increased gasoline taxes

Concerns about energy security and climate change have sparked legislators’ interest in reducing gasoline consumption by increasing corporate average fuel-economy (CAFE) standards. Using an empirically rich simulation model and cost estimates for anticipated fuel-economy technologies, we estimate annual costs of reducing long-run gasoline consumption by 10% via a 3.8 miles per gallon increase in the standards, and the potential cost savings from allowing manufacturers to buy and sell fuel-economy credits. Maximum gasoline savings would be realized only after all existing vehicles were replaced, or 14 years in our model. A gasoline tax would produce greater immediate savings by encouraging people to drive less, and eventually to choose more-fuel-efficient vehicles. We demonstrate the advantage of a tax by comparing the cost of the higher CAFE standards over the first 14 years against the cost of a gasoline tax that would save the same amount of gasoline over that time.     

Is there really a green paradox?

In the absence of a CO₂ tax, the anticipation of a cheaper renewable backstop increases current emissions of CO₂. Since the date at which renewables are phased in is brought forward and more generally future emissions of CO₂ will decrease, the effect on global warming is unclear. Green welfare falls if the backstop is relatively expensive and full exhaustion of fossil fuels is optimal, but may increase if the backstop is sufficiently cheap relative to the cost of extracting the last drop of fossil fuels plus marginal global warming damages as then it is attractive to leave more fossil fuels unexploited and thus limit CO₂ emissions. We establish these results by analyzing depletion of non-renewable fossil fuels followed by a switch to a clean renewable backstop, paying attention to timing of the switch and the amount of fossil fuels remaining unexploited. We also discuss the potential for limit pricing when the non-renewable resource is owned by a monopolist. Finally, we show that if backstops are already used and more backstops become economically viable as the price of fossil fuels rises, a lower cost of the backstop will either postpone fossil fuel exhaustion or leave more fossil fuel in situ, thus boosting green welfare. However, if a market economy does not internalize global warming externalities and renewables have not kicked in yet, full exhaustion of fossil fuel will occur in finite time and a backstop subsidy always curbs green welfare.     

Biofuels and Biodiversity: Principles for Creating Better Policies for Biofuel Production

Abstract:  Biofuels are a new priority in efforts to reduce dependence on fossil fuels; nevertheless, the rapid increase in production of biofuel feedstock may threaten biodiversity. There are general principles that should be used in developing guidelines for certifying biodiversity-friendly biofuels. First, biofuel feedstocks should be grown with environmentally safe and biodiversity-friendly agricultural practices. The sustainability of any biofuel feedstock depends on good growing practices and sound environmental practices throughout the fuel-production life cycle. Second, the ecological footprint of a biofuel, in terms of the land area needed to grow sufficient quantities of the feedstock, should be minimized. The best alternatives appear to be fuels of the future, especially fuels derived from microalgae. Third, biofuels that can sequester carbon or that have a negative or zero carbon balance when viewed over the entire production life cycle should be given high priority. Corn-based ethanol is the worst among the alternatives that are available at present, although this is the biofuel that is most advanced for commercial production in the United States. We urge aggressive pursuit of alternatives to corn as a biofuel feedstock. Conservation biologists can significantly broaden and deepen efforts to develop sustainable fuels by playing active roles in pursuing research on biodiversity-friendly biofuel production practices and by helping define biodiversity-friendly biofuel certification standards.     

Estimates from a consumer demand system: implications for the incidence of environmental taxes

Most studies suggest that environmental taxes are regressive, making them less attractive policy options. We consider the distributional effects of a gasoline tax increase using four incidence measures and under three scenarios for gas tax revenue use. To incorporate behavioral responses we use Consumer Expenditure Survey data to estimate a consumer demand system that includes gasoline, other goods, and leisure. Our estimates confirm that when revenues are not recycled, a gasoline tax is regressive. Use of incidence measures that ignore demand responses, however, will substantially overstate this regressivity. In contrast, the differences between the equivalent variation and easier-to-implement consumer surplus measures are relatively small. In addition, our results suggest that using the additional gas tax revenue to fund labor tax cuts makes the policy substantially less regressive while using the revenue to fund lump-sum transfers actually makes it progressive.     

Reduction in global habitat loss from fossil-fuel-dependent increases in cropland productivity

Terrestrial biodiversity loss and climate change, driven mainly by loss of habitat to agriculture and fossil fuel (FF) use, respectively, are considered among the world's greatest environmental threats. However, FF-dependent technologies are currently essential for manufacturing synthetic nitrogen fertilizers (SNFs) and synthetic pesticides (SPs) critical to increasing agricultural productivity, which reduces habitat loss. Fossil fuel use increases CO₂ levels, further enhancing agricultural productivity. Based on estimates of global increases in yields from SNFs, SPs, and atmospheric CO₂ fertilization, I estimated that FF-dependent technologies are responsible for at least 62.5% of current global food production (GFP) from cropland. Thus, if FF use is eschewed in the future, maintaining current GFP means croplands would have to increase from 12.2% of global land area (GLA) excluding Antarctica to 32.7%. The additional 20.4% of GLA needed exceeds habitat lost currently to cropland (12.2% of GLA) and cumulative conservation areas globally (14.6% of GLA). Thus, although eliminating FF use could reduce climate change, its unintended consequences may be to significantly exacerbate biodiversity loss and indirectly increase food costs, reducing food security which, moreover, disproportionately affects the poor. Although it may be possible to replace SNFs and SPs with FF-free technologies, such substitutes have not yet been demonstrated to be sufficiently economical or efficient. In the interim, meeting global food demand and keeping food prices affordable would increase habitat conversion and food prices. These trade-offs should be considered in analyses of climate change policies.     

Biofuel Plantations on Forested Lands: Double Jeopardy for Biodiversity and Climate

Abstract: The growing demand for biofuels is promoting the expansion of a number of agricultural commodities, including oil palm (Elaeis guineensis). Oil‐palm plantations cover over 13 million ha, primarily in Southeast Asia, where they have directly or indirectly replaced tropical rainforest. We explored the impact of the spread of oil‐palm plantations on greenhouse gas emission and biodiversity. We assessed changes in carbon stocks with changing land use and compared this with the amount of fossil‐fuel carbon emission avoided through its replacement by biofuel carbon. We estimated it would take between 75 and 93 years for the carbon emissions saved through use of biofuel to compensate for the carbon lost through forest conversion, depending on how the forest was cleared. If the original habitat was peatland, carbon balance would take more than 600 years. Conversely, planting oil palms on degraded grassland would lead to a net removal of carbon within 10 years. These estimates have associated uncertainty, but their magnitude and relative proportions seem credible. We carried out a meta‐analysis of published faunal studies that compared forest with oil palm. We found that plantations supported species‐poor communities containing few forest species. Because no published data on flora were available, we present results from our sampling of plants in oil palm and forest plots in Indonesia. Although the species richness of pteridophytes was higher in plantations, they held few forest species. Trees, lianas, epiphytic orchids, and indigenous palms were wholly absent from oil‐palm plantations. The majority of individual plants and animals in oil‐palm plantations belonged to a small number of generalist species of low conservation concern. As countries strive to meet obligations to reduce carbon emissions under one international agreement (Kyoto Protocol), they may not only fail to meet their obligations under another (Convention on Biological Diversity) but may actually hasten global climate change. Reducing deforestation is likely to represent a more effective climate‐change mitigation strategy than converting forest for biofuel production, and it may help nations meet their international commitments to reduce biodiversity loss.     

Competing land uses and fossil fuel,and optimal energy conversion rates during the transition toward a green economy under a pollution stock constraint

We study the transition to a carbon-free economy in a model with a polluting non-renewable resource and a clean renewable resource. Transforming primary energy into ready-to-use energy services is costly and more efficient energy transformation rates are more costly to achieve. Renewable energy competes with food production for land and the food productivity of land can be improved at some cost. To avoid catastrophic climate damages, the pollution stock is mandated to stay below a given cap. When the economy is not constrained by the cap, the efficiency of energy transformation increases steadily until the transition toward the ultimate green economy; when renewable energy is exploited, its land use rises at the expense of food production; food productivity increases together with the land rent but food production drops; the food and energy prices increase and renewables substitute for non-renewable energy. During the constrained phase, the economy follows a constant path of prices, quantities, efficiency rates, food productivity and land rent, a phenomenon we call the ‘ceiling efficiency paradox’.     

Can pollution tax rebates protect low-wage earners?

Pollution taxes are believed to burden low-income households that spend a greater than average share of income on pollution-intensive goods. Some proposals offset that effect by returning revenue to low-income workers via reduced labor tax. We build analytical general equilibrium models with both high-skilled and low-skilled labor, and we solve for the change in real net wage of each group. Decomposition shows the separate effects of the tax rebate, higher product prices, and the changes in relative wage rates. We also include numerical examples. Even though the pollution tax injures both types of labor, in most cases we find that returning all of the revenue to low-skilled workers is still not enough to offset higher product prices. Changes in relative wage rates may further hurt low-skilled labor. Protecting low-income workers is possible in this model only if they are defined as those below a relatively low wage threshold, but we discuss many possible elaborations of this model that could affect those results.     

Emissions cap or emissions tax? A multi-sector business cycle analysis

We develop a multi-sector business cycle model to analyze stochastic implications of reducing CO₂ emissions with carbon permits or with carbon taxes in the presence of multiple sources of macroeconomic uncertainty. The model is calibrated to reflect the U.S. experience. As in previous studies, using a single-sector version of our model, we find that the cap regime generates lower volatility of real variables than the tax regime, but the latter may be preferable from the welfare perspective. Still, our multi-sector analysis points to the importance of the origin of the shocks in the ranking of the two instruments and to the desirability of going beyond a single-sector analysis in evaluating their merits. We find no significant difference between the cap and the tax regimes when shocks come from non-energy sectors. In contrast, the cap has lower volatility but higher welfare costs than the tax for the shocks to energy production.     

A ban on one is a boon for the other: Strict gasoline content rules and implicit ethanol blending mandates

Ethanol and methyl-tertiary butyl ether (MTBE) were close substitutes in the gasoline additives market until MTBE was banned due to the concerns about groundwater contamination, leading to a sudden and dramatic substitution toward ethanol as an alternative oxygenate and octane-booster. We use variation in the timing of MTBE bans across states to identify their effects on gasoline prices. We find that state bans increased reformulated gasoline prices by 3–6 cents in non-Midwestern states for which the bans were binding, with larger impacts during times of high ethanol prices relative to MTBE and crude oil. We find qualitatively similar, yet smaller effects for conventional gasoline. We argue on the basis of a simple conceptual model and supporting empirical evidence that these bans functioned as implicit ethanol blending mandates in areas that were previously using MTBE to comply with strict environmental constraints. Overall, our results are consistent with the theoretical prediction that mandating a minimum market share for a more costly alternative fuel—either directly, or implicitly through a ban on the preferred conventional fuel—will inevitably increase fuel prices in a competitive market.     

Time,affluence and pollution in the theory of consumer's behavior

This paper extends Becker's analysis on the allocation of time to provide a theoretical basis for the phrase “affluence breeds effluence.” Many environmentalists fear that a pollutant tax is merely a license to pollute. Their fears are well-founded if we consider the effect of increased affluence of the society on the pollutant stock. Assuming that relatively pollutant intensive “commodities” are also relatively less time intensive, an assumption applicable to most of the affluent societies, it is shown that the pollutant tax policy will be ineffective if the effect of increased wage rate on pollutant stock is ignored in spite of the efficiency of such a tax as a policy tool.