Oil Taxes Are a Step Backward : Increases Hurt Consumers Without Raising Promised Revenue

The price of oil is at its lowest level in six years and it may fall even further.

This is good news for the economy--falling oil prices translate into lower inflation, lower interest rates and more jobs. The bad news is that many politicians are calling for new taxes on oil.

Tax advocates argue that only a new oil tax--either an oil import fee or an increase in the federal gasoline tax--can prevent us from reliving the energy crisis of the 1970s. Lower oil prices, they contend, will allow myopic consumers to return to the days of carefree energy consumption. This increased consumption will cause foreign oil imports to rise and make our nation more vulnerable to disruptions in those supplies. The result: lower oil prices now mean higher prices later.

On the other hand, they argue, an oil tax would raise a considerable amount of revenue that would help relieve the federal budget deficit.

Both arguments are flawed. Importing oil is no longer a problem. Our dependence on foreign oil supplies in the 1970s was dangerous only because our nation was unable to respond effectively to supply disruptions and higher prices.

While it is possible, though far from certain, that oil consumption could increase so much that the United States would be vulnerable to a serious disruption in supplies, there are two reasons why we would be better able to respond than we did in the ‘70s.

First, U.S. taxpayers have already spent $17 billion to build a strategic petroleum reserve of considerable size: 500 million barrels of oil, or the equivalent of 120 days of imports. Oil tax advocates are asking American taxpayers to pay again for protection that they have already purchased.

Second, oil prices have been decontrolled. Prices are more flexible when determined in the marketplace as opposed to when they are set by a central bureaucracy in Washington, as they were under price controls. Therefore if supplies become scarce in a free market, prices will rise. Consumers will then use less oil. We now know how effective conservation can be. Since the Reagan Administration decontrolled oil in 1981, we have become 23% more efficient in our use of oil.

A government-imposed tax on oil raises a number of difficult questions. For example, should oil imported from countries with economic troubles, such as Mexico, be taxed? Should low-income households be exempt from paying the higher prices of heating oil caused by a tax? Should producers of alternative energy sources also be taxed? Will certain industries, such as domestic oil refiners, be exempt from paying the tax?

During the 1970s the federal government tried to answer these questions and others with a complex system of oil price controls and allocations. Remember, these were the policies that gave us gasoline lines and fuel shortages, at a cost to the economy of an estimated $2.5 billion a year from 1975 to 1980. A new oil tax could lead us down this path again.

Not only would an oil tax fail to guarantee energy security, it could also harm the economy. One recent study by the Dallas Federal Reserve Bank concludes that a tax would lead to higher inflation and fewer jobs. Therefore, it is questionable how much deficit relief a new oil tax would provide. Higher inflation raises the cost of federal programs indexed to the Consumer Price Index; higher unemployment raises the cost of social programs, and higher interest rates increase the cost of federal borrowing. If this happens, the revenue gain from a tax increase would be greatly reduced.

A new tax also would hurt our international competitiveness at a time when the trade deficit is a major problem. An oil import fee, for example, would make it even harder for energy intensive sectors of the economy, such as steel, chemicals and agriculture, to compete in international markets. And a gasoline tax would have a negative impact, given the important role transportation plays in the production of goods.

Finally, raising the relative price of oil through a tax would force consumers to shift to more expensive sources to meet their energy needs. To the extent this happens, the nation’s well-being suffers.

Improving national security and reducing the deficit are laudable goals. However, energy security is best achieved through deregulation and quick use of the strategic petroleum reserve. Using an oil tax to raise revenue is economically inefficient and may not even bring in much money. Congress should say “no” to a new oil tax.