Chapter

V U.S. Energy Policy: Role of Taxation

Author(s):
Martin Mühleisen, and Christopher Towe
Published Date:
January 2004
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Author(s)
Prust Jim and Simard Dominique 

Following the release of the administration’s National Energy Policy in 2001, far-reaching energy legislation is being considered in Congress.1 The legislation seems to be mainly driven by two issues: the security-related and macroeconomic risks stemming from U.S. dependence on oil imports and a recognition of the environmental consequences, including greenhouse gas emissions, of the energy intensity of the U.S. economy.

None of the initiatives has emphasized taxes as a means of discouraging energy consumption. The focus, instead, has been on measures geared toward boosting domestic energy supply and developing new technologies to increase the efficiency of energy use. Tax proposals have been limited to providing tax subsidies for domestic energy production as well as developing energy-efficient production processes, at a substantial fiscal cost. This section suggests that there may be a case for considering consumption-based energy taxes to meet both energy and fiscal policy objectives.

Energy Use in the United States

Although declining, the energy intensity of GDP in the United States remains well above that in most other industrial countries (Figure 5.1). As in many other industrialized countries, the energy intensity of GDP in the United States has fallen steadily during the last half century. The drop in energy intensity, measured in British thermal units (Btu) per real dollar of GDP, was particularly rapid from the 1970s through the mid-1980s, when real energy prices were above their historical average (Figure 5.2). More recently, the decline has accelerated again, partly reflecting a structural shift away from manufacturing and toward a more information technology–intensive economy (EIA, 2003). Nevertheless, U.S. consumption remains 30–50 percent higher per unit of GDP than in Europe.2

Figure 5.1.Energy Intensity of GDP: International Comparison

(In thousands of Btus per unit of GDP at 1995 dollars)

Sources: IMF, World Economic Outlook; United States, Energy Information Administration: http://www.eia.doe.gov.

Figure 5.2Energy Intensity of GDP and Real Motor Gasoline Price

(In dollars per million Btu)

Sources: IMF, World Economic Outlook; OECD, IEA Statistics; and United States, Energy Information Administration: http://www.eia.doe.gov.

The higher energy intensity of the United States partly reflects geographic and tax-related factors. To a significant degree, energy usage in both the United States and Canada has reflected the need to cope with low population densities and relatively severe and variable climate conditions compared with Europe.3 However, energy prices in the United States are also significantly lower than in most other industrial countries. For example, average U.S. gasoline prices in 2001 were more than 50 percent below European prices and 10–15 percent lower than Canadian prices (Figure 5.3), with the difference mostly accounted for by taxation (Figure 5.4). The prices of most other energy products—for example, electricity and natural gas—display similar cross-country variation.4

Figure 5.3.Real Prices of Premium Unleaded Gasoline

(Gasoline price, in 1996 U.S. dollars per liter)

Sources: IMF, World Economic Outlook, Western Hemisphere Department databases; OECD, IEA Statistics; and United States, Energy Information Administration: http://www.eia.doe.gov.

Figure 5.4.Prices and Taxes of Premium Unleaded Gasoline

(In U.S. dollars per liter, 2001)

Source: OECD, IEA Statistics.

High U.S. energy intensity has been associated with greenhouse gas (GHG) emissions that are among the highest per unit of GDP of major industrialized countries (Figure 5.5). International rankings of emissions of carbon dioxide (CO2)—the principal GHG—are broadly consistent with the energy intensity of GDP, notwithstanding differences in countries’ reliance on fossil fuels, and differences in the carbon content of different fuels.

Figure 5.5.Carbon Dioxide Emissions per GDP

(In metric tons equivalent per thousand 1995 U.S. dollars)

Hydrocarbons represent the principal source of U.S. energy (Figure 5.6). The share of energy consumption from petroleum fell from a peak of nearly 50 percent in the mid-1970s to around 40 percent by the end of the 1990s. The share of natural gas peaked at 32 percent in 1970 and now stands at around 25 percent—roughly the same share as coal, which remains the main source of fuel for electricity generation. Although the share of energy produced from nuclear, hydroelectric, and other nonfossil fuel sources has increased since 1973, it remains at just under 15 percent of total consumption.

Figure 5.6.Shares of Energy Consumption by Type of Fuel

(In percent)

Petroleum imports have been rising steadily since the mid-1980s (Figure 5.7). Net imports of petroleum are projected by the U.S. Department of Energy to continue to grow strongly for the next quarter century, and the share of net imports in total U.S. petroleum consumption is expected to increase from 55 percent in 2001 to 68 percent in 2025.

Figure 5.7.Net Petroleum Imports

(Thousands of barrels per day, yearly average)

Source: EIA, Monthly Energy Review (May 2003).

Energy Policy

The U.S. administration’s National Energy Policy (NEP) was released in May 2001. The NEP’s principal focus is on addressing the “fundamental imbalance between supply and demand” and the projected increase in U.S. dependence on energy imports (NEPDG, 2001). Specific policy measures focused on promoting “dependable, affordable, and environ-mentally sound production and distribution of energy” and include

  • subsidies to promote conservation by households;
  • funding for research and development into alternative energy sources;
  • establishing a new regulatory structure for the electricity sector, including the extension of the tradable emissions permit system on sulphur dioxide and introducing similar systems for emissions of nitrogen oxides (NOx) and mercury;
  • revising emissions standards for autos and household appliances;
  • tax credits to encourage the use of fuel-efficient vehicles, new landfill methane projects, electricity produced from wind and biomass, residential solar energy property, and the purchase of new hybrid or fuel-cell vehicles; and
  • opening the Arctic National Wildlife Reserve (ANWR) for oil exploration and pipelines, and earmarking associated royalties for conservation.

The NEP has helped shape energy legislation subsequently debated by Congress. Its major provisions include loan guarantees and tax credits for pipeline development; tax breaks for oil, gas, and coal industries; tax incentives for improving energy of homes and appliances, and for encouraging development and use of renewable energy sources, including biomass and waste; and a mandated increase of the use of ethanol in gasoline.

The administration’s environmental policy proposals have potentially important implications for the energy sector. In 2001, the administration rejected the Kyoto Protocol, which would bind countries to targets for reducing GH G emissions. The decision reflected the administration’s view that its goals were unrealistic and had potentially harmful implications for U.S. economic growth.5 Instead, the administration proposed its Clear Skies Initiative in 2002. The centerpiece of the Initiative is a commitment to reducing, by 2012, the emission intensity—defined as GH G emissions relative to real output—in the United States by 18 percent.6 This objective is to be met primarily through the combined effect of measures proposed by the administration, including an extension of existing cap-and-trade programs.

Significant cap-and-trade programs are already in place in the United States to reduce air pollutants. For example, under the Clean Ai r Act, electric utilities were allocated sulphur dioxide (SO2) emissions allowances beginning in 1995 and allowed to buy and sell unused portions of these allowances as they saw fit. A tradable permits program also exists for nitrogen oxide emissions in the eastern United States.

Taxation and Other Instruments to Reduce Energy Consumption

Many analysts have argued that energy taxes can play an important role in achieving conservation and environmental goals. Taxes are widely viewed as an effective instrument for restraining demand and encouraging efficient resource use, as well as for aligning private and social costs in the presence of externalities (Sandmo, 1976). Indeed, a range of tax instruments is already in place in the United States to address environmental, conservation, and fiscal objectives on both the federal and state levels (Box 5.1).

Alternative approaches to increasing energy efficiency—including direct regulation of energy use and subsidization of new technologies—have important drawbacks:

  • For example, a study by the Congressional Budget Office—which compared the relative merits of Corporate Average Fuel Economy (CAFE) standards and similar regulatory approaches with gasoline taxes—found that taxes were considerably less costly from an economic efficiency perspective (CBO, 2002). Since CAFE standards did not directly target fuel-saving activities by the consumer, any given decrease in targeted gasoline consumption could be made at a lower cost through a gasoline tax (CBO, 2002).
  • A similar point was made by Goulder and Schneider (1999), whose simulations illustrate that achieving a 10 percent reduction in carbon dioxide emissions would be 10 times more costly if technology subsidies were employed as a stand-alone measure, relative to a broader approach that combined technology subsidies with policies to raise the cost of carbon, such as tradable carbon permits or carbon taxes.
  • Questions have also been raised regarding the efficiency of subsidizing both the development and introduction of new, fuel-efficient technologies, given the uncertainty inherent in choosing the technology that will yield significant payoffs (Sutherland, 1999).

What would be the optimal level of energy taxation in the United States? As emphasized by Bovenberg and Goulder (2002), economic theory suggests that optimal tax rates would be expected to vary across countries, based on the different costs that countries face regarding environmental degradation and remediation of environmental harm, opportunity cost of public funds, and political and administrative considerations. Similarly, two studies based on a representative agent model calibrated to the U.S. and U.K. economies have identified the key factors determining an optimal fuel tax (Parry, 2002; Parry and Small, 2002). These include, in decreasing order of importance, the social cost of automotive congestion, the capacity of the tax to raise revenue, and the extent to which fuel consumption imposes environ-mental externalities.

Box 5.1.U.S. Energy Excise Taxes

Federal Government

A large number of federal excises are levied on energy by the federal government. Fuel taxes average $0,184 per gallon, and estimates by the Joint Committee on Taxation and Internal Revenue Service indicate that federal fuel taxes yielded $29.6 billion (0.3 percent of GDP) in FY2003. The yield on other excises was smaller: for example, the excise tax on coal yielded $550 million, and the excise tax on the sale of automobiles with low fuel economy ratings yielded $78 million. The specific excises include

  • Energy excise taxes for general revenue. These include
    • —Tax of $0.43 per gallon rail diesel fuel and inland waterways fuel; $0,068 per gallon motorboat fuel, small engine gasoline, and special fuels.
  • Excise taxes dedicated to environmental trust funds or designated funds. These include
    • —Abandoned Mine Reclamation Fund: tax of $0.35 per ton of surface coal, $0.15 per ton of coal mined underground, $0.10 per ton of lignite (average tax estimated about $0.26 per ton in 1999).
    • —Aquatic Resources Trust Fund: tax levied on motorboat gasoline and other fuel.
    • —Highway Trust Fund: tax of $0,043 per gallon motor fuel.
    • —Leaking Underground Storage Tank Trust Fund: tax of $0,001 per gallon motor fuel.
    • —Nuclear Waste Fund: tax estimated to impose a 1.45 percent cost increment for power provided from nuclear energy in 1999.
    • —Pipeline Safety Fund: user fees collected from pipeline operators.
    • —Uranium Enrichment Decontamination and Decommissioning Fund: contributions from commercial utilities based on historical enrichment services.
  • Excise taxes dedicated to health-related trust funds. These include
    • —Black Lung Disability Trust Fund: minimum of $0.55 per ton of coal or 4.4 percent of sales revenue if selling price is less than $25 per ton from surface mines or $12.50 per ton for surface coal.
  • Excise tax on the sale of automobiles with relatively low fuel economy ratings. This includes
    • —Tax ranging from $1,000 for an automobile rated between 21.5 and 22.5 miles per gallon (mpg) to $7,700 for an automobile rated at less than 12.5 mpg.

State Governments

All state and many local governments levy specific excise and sales taxes on fuel and other energy commodities. In 2002, excise taxes on motor fuel represented 6 percent of total taxes collected by states. Total state and local taxes on fuel varied from $0.08 per gallon in Alaska to $0.35 per gallon in New York. Many states also levy severance taxes—a tax on a portion of the value of the natural resource extracted—on oil, gas, and coal production. State energy severance taxes accounted for less than 0.8 percent of total state tax revenue in 2002.

Sources: EIA (1999); Lazzari (2003); U.S. Census Bureau (2003); and CBO (2002).

Although it is difficult to define the optimal level of energy taxation in practice, some studies suggest that energy taxes in the United States may be too low. Both the United States and Canada would be expected to impose relatively low taxes on diesel and gasoline, given their low population densities and congestion externalities relative to western European countries. Nonetheless, even adjusting for these considerations, Parry (2002) and Parry and Small (2002) conclude that gasoline taxes in the United States may be only half their optimal level. In an earlier study, the OECD had not only suggested that an increase in fuel taxes of 40 cents per gallon could be justified given the range of externalities associated with road use, but also noted that roughly three-fourths of U.S. carbon emissions are not taxed at all (OECD, 2001a).

Recent U.S. and international experience has shown that tax measures can be usefully complemented by market-oriented regulatory approaches. For example, the cap-and-trade emissions permit system already in effect for SO2 emissions has generally been viewed as a success (CBO, 2000). By limiting the quantity of permits, these systems can directly affect the level of emissions. However, a drawback of these approaches is that there is no upper limit to the costs that polluters may be obliged to incur to achieve given quantitative targets. Approaches to deal with this problem include the facility to issue additional permits if permit prices exceed some ceiling and to grant a percentage of free permits instead of auctioning them (Goulder, 2002).

Macroeconomic Effects of Energy Taxation

The impact of energy taxation on demand and fiscal revenue depends importantly on the price elasticity of demand. Most studies suggest that energy demand is considerably more price elastic in the long run than in the short run. For example, short-run elasticities for energy and fuel demand are estimated in the range between −0.13 and −0.26, compared with long-run elasticities in the range between −0.37 and −0.46 (OECD, 2001b). A detailed survey of 97 econometric studies of the elasticity of demand for gasoline found that the short-run elasticity averaged -0.26, compared with an average long-run elasticity of-0.86 (Dahl and Sterner, 1991).

These findings suggest that taxes could have a substantial impact on consumption while, at the same time, raising significant government revenues. For example, the CBO estimates that a 15 cent per gallon hike in gasoline taxes could have raised $16 billion in additional budget revenue in 2003, more than doubling existing revenues (CBO, 2002). According to the OECD (2001a), a carbon tax of $100 per ton—equivalent in its effect on gasoline prices to a tax of about 30 cents per gallon—would have yielded $110 billion in 1999.

Concerns have been raised about the potential adverse impact of energy taxes on prices, real wages, and income distribution, but most studies show that the effects depend importantly on the use that is made of the additional tax revenue. For example, the adverse effects on output can be alleviated if the revenue is used to lower taxes on labor or investment (Bovenberg and Goulder, 1996;Nordhaus, 1993). Similarly, there is scope for addressing the impact on income distribution if revenues are used to compensate the population segments most vulnerable to tax increases, such as rural versus urban households (CBO, 2002).

Model Simulations

IMF staff simulations suggest that the output effects of higher energy taxes, which are redistributed to consumers, may be modest. A version of the IMF’s Global Economy Model (GEM), calibrated to the U.S. economy, suggests that a 10 percentage point increase in taxes on petroleum products used as intermediate production inputs would reduce longrun U.S. GDP by 0.03 percent (Table 5.1).7 A larger output loss—0.11 percent—would occur if the tax was also levied on the final consumption of petroleum products, reflecting the broader scope of the tax and the lower elasticity of substitution that applies to energy consumption.

Table 5.1.Simulated Impact of Energy Taxes on the Economy(Percent deviation from baseline)
After One YearAfter Five YearsLong Run
10 Percent Tax on Energy Used in Consumption
Real GDP−0.03−0.02−0.08
Consumption−0.030.01−0.04
Investment−0.3−0.3−0.22
Consumption price of energy7.698.339.38
Goods producers’ price of energy−2.09−1.51−0.56
Oil producers’ price of energy−2.59−1.87−0.67
Real exchange rate0.160.230.22
10 Percent Tax on Energy Used in Production
Real GDP0.020.02−0.03
Consumption0.030.050
Investment0−0.01−0.13
Consumption price of energy−0.3−1−2.23
Goods producers’ price of energy9.678.917.62
Oil producers’ price of energy−0.38−1.26−2.79
Real exchange rate0.120.1 10.26
10 Percent Tax on All Energy
Real GDP−0.01−0.01−0.11
Consumption0.040.06−0.04
Investment−0.3−0.32−0.35
Consumption price of energy7.397.277.02
Goods producers’ price of energy7.397.277.02
Oil producers’ price of energy−2.95−3.09−3.45
Real exchange rate0.370.340.47
Source: IMF staff estimates.
Source: IMF staff estimates.

These simulations take into account that the large size of the U.S. market influences the output effects of energy taxes. Part of the burden of higher U.S. taxes is shifted to the rest of the world through lower prices and an appreciated U.S. dollar because U.S. petroleum imports represent almost 20 percent of the world market. The simulations suggest that the short-run effects of a U.S. tax on energy used in production could even be positive because of different adjustment speeds of producer and consumer prices. The simulations also illustrate the importance of the elasticity of substitution—the higher the degree of substitutability between petroleum products and other goods and services, the more likely the domestic tax will cause world prices to fall and mitigate U.S. output declines. This exercise, however, does not take into account possible responses by world energy producers to the change in market conditions.

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1Benjamin Hunt prepared the simulations presented in this section.
2Japan was omitted from the group of comparable countries because of its vastly different geography and land use patterns.
3The main user of energy in the United States in 2001 was the industrial sector (33 percent of total Btu consumption), followed by the transportation sector (28 percent), the residential sector (21 percent), and the commercial sector (18 percent). Canada’s high level of energy intensity also reflects the preponderance of energy-intensive industry.
4According to International Energy Agency statistics, this observation is robust across different years (IEA, 2003). Products with homogeneous net-of-tax prices across countries, such as gasoline and diesel, display a wide cross-country variation of end-user prices because of different tax policy choices. Other products, which are less easily traded internationally, such as electricity and natural gas, display a wider international variation in their net-of tax prices. For example, Canadian prices of natural gas and electricity have in the past tended to be lower than in the United States, reflecting their relatively abundant supply in Canada, including from hydroelectric generation. However, taxes on these products also differ across countries.
5The United States, for example, would have to cut its GHG emissions by 7 percent, compared with 1990 levels, during 2008–12. Estimates have placed the cost of achieving this reduction as high as 2 percent of GDP.
6Goulder (2002) suggests that the administration’s target would leave emissions roughly 10 percent higher than at the beginning of the decade and nearly 30 percent above the Kyoto Protocol target.
7The theoretical structure and derivation of the GEM can be found in Pesenti (2003), and an extension of the model fully incorporating the oil market is explained in Hunt (2003).

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