Raise the Gas Tax Now

Three months ago, gas taxes were untouchable. Now, with oil prices down, they're having a moment. Public voices ranging from Larry Summers to Charles Krauthammer are calling for hikes. (Summers argues for a carbon tax; Krauthammer says the tax should be raised "a lot.")

More important, serious lawmakers from both sides of the aisle have gotten in on the game. The general thrust of the arguments on offer is that with oil prices falling, it's now possible to raise the gas tax and still leave consumers better off than they were half a year ago.

That's right, but I think there's an even stronger argument to be made.

The standard argument is basically a political case about what voters will tolerate. (The theory is that they'll tolerate a higher gas tax if they're still better off than before.) It's then paired with preexisting economic logic (a higher gasoline tax made economic sense when oil prices were higher too).

This is essentially the pattern I flagged in a Financial Times column in November, when I argued that falling oil prices were creating an opportunity for leaders in developing countries to curb gasoline and diesel subsidies.

But there is an economic case that's peculiar to the current situation to be made too. Whenever you impose a new and unanticipated tax, some part of the existing capital stock becomes less valuable than it was before. (Some other part typically becomes more valuable, but if market participants were rational before, this downside should be smaller than the upside.)

Adding, say, 50 cents to a gallon of gasoline makes preexisting gas guzzlers, homes in the suburbs and oil-based home heating systems worth less than before. Normally, that would reduce the net benefits of any new gasoline tax, particularly one phased in quickly.

Conversely, when oil prices fall, fuel-efficient cars, homes in city centers and public transit investments all drop in value. This can lead to economic waste: under-used automobiles, unrented homes and empty subways.

A particularly glaring example came on Wednesday when President Barack Obama visited a Ford plant that makes fuel-efficient vehicles. Because of the drop in oil prices, that plant was closed, wasting both the factory and the skills of the workers that it would have employed.

In this world, a newly higher gasoline tax would actually avoid economic waste rather than creating it. Ford and others that invested money on the expectation that oil prices would remain relatively high (and, if options prices on oil futures as recently as six months ago are any indication, that means most businesses) would see their investments hold more value.

The same goes for drivers who, facing higher oil prices, already spent their money on ever more fuel-efficient cars. (They'd still pay more at the pump, but the resale value of their cars would rise.) One can go down the list of oil-sensitive consumers and find more examples like this.

Similar logic underpinned proposals several years ago from Robert Lawrence and from Jason Bordoff and Gilbert Metcalf for a variable gas tax that smoothed consumer prices (up when oil prices fell; down when they rose). It would allow consumers to better prepare for the future and would thus avoid economic waste.

No one is talking about a variable tax now, but by hiking gas taxes while oil prices have fallen, lawmakers would be manually mimicking the mechanisms that these analysts proposed be made automatic.

To be certain, there would still be losers as well as winners from raising the gasoline tax now. But almost everyone would come out ahead, compared with where we were a year ago, and many would be even better off than they were with low gas prices but without the gas tax.

Not everyone fits in one of those two categories. In particular, there is nothing here that's good for oil companies, which would face less demand for their product over time. (Although combined oil and gas companies could make money on the other side from buildings that switch from oil to gas heating.) But that was always the case with any gasoline tax, and less important than many other policy decisions to the oil companies' bottom lines.

It has always made economic sense to make consumers pay for the full costs of the gasoline they use. Also, there have always been legitimate worries about the impact of higher gas taxes on vulnerable consumers, but those can be addressed by using the proceeds of a tax effectively. The fall in oil prices just adds to the reasons for getting U.S. energy prices right.

Michael A. Levi is the David M. Rubenstein Senior Fellow for Energy and the Environment at the Council on Foreign Relations. This article first appeared on the Council on Foreign Relations website.