Monday, August 29, 2005

Hoo-ray for marginal costs

Bradford Plumer, Andrew Samwick and Ezra Klein discuss CAFE standards and Gas taxes.

Gas taxes are preferred because they should allow for a more efficient reduction in gasoline consumption. However, gas taxes are politically difficult to impose, they harm low-income drivers, and it is estimated that to acheive the same reduction in gasoline use, the tax would have to be $1 per gallon. CAFE standards hide the costs of making more efficient cars in the purchase price.

I have two ideas.

=First, replace CAFE with a tax and credit system.

Instead of imposing a miles/gallon limit on cars, we should tax new cars (say, $100)for every 5% less efficient than average, and give a equal credit for new cars for every 5% more efficient than average. In the end the government should not have increased or decreased revenues and, therefore, the policy cannot be attacked as a tax the same way a gas tax would be. This policy is superior to CAFE standards because it would encourage all vehicles to become more efficient, no matter how efficient a vehicle currently is. For example, if CAFE requires 25mpg, and the Honda Accord gets 28mpg, Honda does not much incentive (other than consumer preference) to further increase fuel efficiency. Under a tax/credit system, Honda would have always have an incentive to create more efficient cars, because they would receive a credit for each sale. Also, this system would not require a CAFE battle every 5 or 10 years, the median gasoline level would adjust automatically as cars got more efficient. The tax/credit could be adjusted to the preferrable level.

=Second, fund half of car insurance through a gas tax.

In California, every driver must purchase insurance. Research indicates that in high-traffic states, such as California, "a typical additional driver increases the total of other people’s insurance costs by $2231 per year" due to accidents. This cost of placing additional cars on the road can be internalized by a gasoline tax. The more someone drives, the more they have to pay in gas tax.

Currently, insurance companies are not able to adjust rates very much for the amount of driving the insured does. The tax revenues received could be given to insurance companies in proportion to the number of drivers they have insured (up to one-half of the price the insured would pay, to discourage fraud). Car drivers would face the same costs on average -- so this is not a tax increase -- drivers would pay more for insurance at the pump and less in their monthly bill.

This system has several advantages.

First, it increases the marginal cost of driving, encouraging the use of public transportation, reducing traffic accidents, road wear, and congestion. Right now, I pay insurance every month no matter how little I drive my vehicle. When faced with the choice of taking the car or BART, I have already paid for part of the cost of driving, why not use the car? If the marginal cost of driving was higher because the insurance was built into gasoline prices, BART would be a more attractive alternative to go into San Francisco.

Second, to the extent that the system would overtax some drivers -- those with low gasoline millage – those drivers should be taxed for the externalities of air pollution, dependence of foreign oil, and more violent accidents (because the cars are larger they have greater momentum).

Third, the system would encourage the uninsured to purchase insurance because the cost of insurance will be much lower.

Fourth, the system could include a fund to pay for injuries caused by uninsured drivers. Because uninsured drivers are paying the tax but do not purchase insurance (and thus no credit is paid out), those extra funds could be used to pay off judgments against uninsured drivers (up to some limit).

Fifth, administrative costs would be minimal because (1) we already collect taxes on gas, (2) the insurance industry is already heavily regulated, and (3) the government can easily check fraud because every car should be registered with the state and the owner can confirm their insurance carrier.

Politically, implementing the system might be difficult because even though the gas tax would not actually be an increase in taxes, politicians are scared of anything that could be called "gas tax." And even though such as tax would actually create a more efficient market, most conservatives will have a knee-jerk reaction against government involvement in fixing a market failure.

=Other gas tax concerns

Some people have proposed tracking odometer readings rather than use a gas-tax to pay for road repairs because some drivers would have to pay more because they have a low gas millage vehicle. I don't think this is an intelligent proposal for several reasons. First, it would cost a lot to implement. Second, people are not completely rational and would not adequately internalize costs they do not see every week at the pump. Third, heavier cars -- those will low gas mileage – cause more wear on the roads. Fourth, there are externalities related to use of gasoline including air pollution and economic dependence on volatile oil supplies. Why not wrap it all up in a single gas tax?

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