Werner’s blog: Why fuel tax cuts are not the answer to B.C.’s gas price woes

Motorists in Vancouver, B.C., have seen gas prices push record highs of nearly $2.30/L amidst global supply shortages due to sanctions on Russian oil, as well as local factors that have seen a huge spike in the refinery margin. No wonder politicians are rushing to provide relief to motorists, as gas prices have always been a touchy issue in politics. Unfortunately, some governments have turned towards the wrong approach: cutting fuel taxes, and some politicians are calling for similar action in B.C. So why is cutting fuel taxes a bad idea? In this excerpt from his latest blog post, UBC Sauder School of Business Associate Professor Werner Antweiler provides five reasons.

Reason #1: Some, and possibly much, of the fuel tax cut ends up with oil producers, not motorists

When governments raise or lower taxes, not all of the increase or decrease is passed on to consumers. Economists call this phenomenon "imperfect pass-through.” I wrote about it in my blog Tax Pass-Through for Beginners, and it is a common topic in many public economics textbooks and articles. Most researchers consider the case of tax increases and find that under certain conditions, including available storage, taxes get passed on to consumers nearly in full. In general, the rate of pass-through goes up when supply is more elastic and demand is more inelastic. When markets are imperfectly competitive, we may get both over-shifting and under-shifting. When fuel taxes are lowered, however, it is possible that a larger portion of the tax cuts are not passed on to consumers fully, but stick with the producers. With a time-limited tax cut, there is even greater risk that pass-through is incomplete. And what is the point of cutting taxes when a large chunk stays with the producers rather than consumers? How would consumers tell the difference as fuel prices are highly volatile? And fuel producers are the last stakeholders that need help at this time; their profits are way up already.

Reason #2: There is no free lunch

When it comes to government revenues and expenditures, there is no free lunch. When governments reduce revenue by cutting fuel taxes, the money is missing and ultimately this means governments will need to reduce other programs and expenditures. So, cut fuel taxes and cut health care? Or add the revenue shortfall to the provincial debt and pass it on to the next generation of taxpayers? B.C.'s neighbour, Alberta, is in a different position. As an oil-producing province, Alberta's government is benefiting from a windfall in taxes and royalties. They can afford to lower some taxes because they gain other taxes and royalties. B.C., on the other hand, is not in that same fortunate position – cutting revenue in one place means cutting expenditures in another. If the government wants to provide relief, it should figure out carefully where it is needed most, and set priorities.

Reason #3: It's a “beggar-thy-neighbour” policy

There is a global shortage of oil – at least for some time until various producers can increase production to offset the missing oil from Russia. Demand needs to adjust to match the supply shortfall, and the only mechanism through which this happens is higher prices. Take two jurisdictions: one that can afford to lower its fuel taxes to keep demand high, and another jurisdiction that cannot afford to do that. Most of the burden of adjustment shifts to the jurisdiction that cannot afford to lower taxes. In other words, rich jurisdictions can shift the adjustment problem to poor jurisdictions, and rich countries to poor countries. Cutting fuel taxes amounts to propping up demand. What is intended as relief for domestic motorists ends up putting a higher burden on foreign motorists. It's a “beggar-thy-neighbour” policy: whatever the good intentions of the tax cut policy, it puts a negative externality on other jurisdictions.

Reason #4: Not everyone needs relief

There are a lot of cars on the roads in B.C. that suggest their owners are wealthy: Lamborghinis and Ferraris, Porsches and high-end Teslas. Owners of these vehicles do not need any relief; they don't blink an eye when they fill up their tank with premium gasoline. They can easily afford to pay higher gasoline prices. It is difficult to feel sympathy for motorists who drive vehicles with oversized engines or whose driving style signals that they have little concern about fuel economy. Not everyone needs relief. If you bought a fuel-inefficient vehicle, you have to bear the consequences of that choice.

Those who suffer the most due to high fuel costs are low-income households, because fuel costs are regressive—lower-income households spend a larger share of their income on energy than high-income households. And the motorists who are affected most are long-distance commuters who do not have transportation alternatives (e.g., public transit) or who must use their vehicles for work. So how can one target relief to these individuals? The answer is definitely not through giving everybody a fuel tax cut. Those who use their vehicle for work should be able to pass on the higher cost to their employers or through the products and services they provide. Providing targeted relief is rather difficult. But we know that low-income households suffer the most, and thus relief should target them most. What we also know for sure is that cutting fuel taxes benefits the rich more than the poor.

Reason #5: There is a better way

Economists know that interfering in the supply and demand of the market makes little sense unless it is meant to correct an externality, such as pollution. When there is a supply shortage, the market needs to adjust through higher prices. What we care about are distributional outcomes: who is particularly worse off. For energy costs, that tends to be low-income households. It is possible to use policies that do not change the incentive to drive less. Providing targeted support to particularly hard-hit groups, or financial support broadly to low-income households, is a much better way. This is what B.C. has been pursuing with a one-time fuel relief, distributed through ICBC, worth $395 million. Every motorist gets $110, and owners of commercial vehicles $195. Still, the targeting is not perfect (and yes, it includes owners of electric vehicles), but it is still much better than interfering in the fuel market. Of course, the criticism that $395 million is now missing somewhere else in the provincial budget still applies. If prices remain high, this relief will do little to dampen motorists' frustration. But even lowering fuel taxes won't do much either when prices have risen from $1.55/L in December 2021 to $2.25/L in May 2022. Even fuel taxes don't come to 70 cents/L. The bottom line: if we need to support households, support their income, not their fuel expenses.

So how can we deal with sky-high fuel prices?

In the short term, we need to encourage more people to return to using public transit. Ridership was down during the pandemic, as many people reverted to using motor vehicles out of concerns for COVID-19 transmission. That extra demand on gasoline is also contributing to high fuel prices in B.C. Ridership has not yet fully recovered to pre-pandemic levels, and now is the time to consider returning to using public transit.

In the long term, we need to accelerate the transition to using electric vehicles. If we use B.C.-made electricity, we won't be paying oil producers for their overpriced products. The sooner B.C. can become energy independent, the better for motorists in this province. The future of driving is electric. In July 2020, I wrote about how much money could be saved by driving electric in Canada. At the time, driving electric had one-quarter of the per-kilometre cost of driving with gasoline. That gap has now widened substantially.