Saturday, July 29, 2006

Would a gas tax be regressive?

Jim over at OIFS is doing his usual good job of making people uncomfortable--in a good way. As the call for an increased gas tax builds to a loud whisper, Jim notes that opponents are quick to play the regressive card. Put simply, a regressive tax takes a larger percentage of income from the poorer than from the richer. A famous example would be a tax on food. Since poorer households spend a larger share of their income on food, a flat tax would necessarily affect poorer households more by the same measure. This is the reason most state sales taxes exempt basic food purchases. The opposite of a regressive tax is a progressive tax, which taxes something richer households spend a larger share of their income on, like a tax on second homes.

Jim's argument is that a lot of things stick it to the poor. If we avoided all of them, we wouldn't get much done. He offers a neat example that 25-35% of Interstate highway construction expenses are mitigating the costs to third-parties. Why not ask what it would take to mitigate the costs of a $1 gas tax to the poor and then get on with the discussion? Well, let's do it. I looked into the 2004 BLS Consumer Expenditure Survey (CE) to get an idea of the costs to the poor. I'll define "poor" arbitrarily as the lowest income quintile (roughly less than $20,000 pre-tax annual income). That should catch most poor and near poor households.

The first thing I found is the same thing Poterba (1991, paywall) and others have noticed--unlike a tax on food or housing, it isn't at all clear whether a gasoline tax would be regressive. Start with the fact that a full 1/3 of households in the lowest income quintile don't even own a car. Effects on those households would be only indirect via rising prices of other goods (food, mass transit). Then continue up the income ladder to find that the second and third quintiles actually spend a larger share of income on gasoloine than the poor. The two highest income quintiles do spend a smaller share on gas, but the dropoff is much smaller and more gradual than for food or housing. (BLS 2004)

Still, one could argue that even if a gas tax doesn't necessarily take a larger share of the poor's income, the share it does take may be more important (the eat or drive argument). Well, that's a separate debate, but if you agree that the burden is unfairly placed on the poor, then push for a gas tax with mitigation! What would it cost?

Again basing my numbers on the 2004 CE, the average poor household purchases about 400 gallons of gas in a year (1), about half the amount of the average household. Given an estimated 100 million total households currently (Census Current Population Report 1996), a gas tax that increased pump prices by $1 per gallon (2) would impose a direct burden on the poor equal to $400 (400 gal*$1/gal) per household. Since about 20 million households meet my definition of poor, complete mitigation would cost $8 billion.

$8 billion per year sounds like a whopping lot of money, but remember what those Interstate mitigation costs were? A gas tax of this size would raise about $125 billion per year (3). Compensating the poor would represent only 6.4% of the total revenue generated.

What about the effects on the other four quintiles? Well, I note that well over half of those households are college educated, and they spend more than the amount of the tax on "television, radios, and sound equipment" (BLS 2004). I'll bet they can figure something out.

(1) $730 spent on gas [BLS 2004]/$1.81 average 2004 price of regular [EIA 2006]
(2) This would represent a total tax of around $1.56/gal using elasticity estimates from Greene and Ahmad (2005) cited in Econbrowser (2006). This is because part of a tax would be absorbed by gas suppliers.
(3) Given an estimated long-run demand elasticity of -0.335, the tax would reduce gas consumption by about 9.5%, reducing average household consumption to about 800 gallons per year. 800 gallons * $1.56 * 100 million households = about $125 billion in total revenue.

Correction: I got so immersed in the household data I sort of forgot it was only part of the picture. Non-household purchases of taxable gasoline might add another 30-40 billion gallons to the quantity side (EIA 2006). Of course, that just makes the mitigation costs to the lowest income look even cheaper!

14 Comments:

Anonymous Liam said...

You seem to be over-complicating it. If the tax is a fixed amount, then it is regressive by definition.

The impact on each individual low income earner will very according to their behaviour, but it's still a regressive tax because any time they choose to purchase gas the tax they are paying on the amount of gas they are buying represents a greater proportion of their income than it would for anybody on a higher income buying the same amount of gas.

That people earning more may choose to buy more gas, and conversely that people earning less may choose to buy less, does not mitigate the regressiveness of the tax.

6:12 PM  
Anonymous Anonymous said...

Honest, good thoughts, Joe. I for one would be glad to see something of the sort.

However, think of the consequences. Who would really benefit? With oil companies making record profits over the past few years, wouldn't it be better to strip the dough directly from the pockets of the rich? C'mon, $80,000 profit per minute for Exxon last quarter is a bit excessive, don'tc'ha think? They would be the beneficiaries of any sort of tax break. Ordinary folks like us just don't matter when it comes to the almighty dollar.

And just who would administer these taxes? Our government? Hah, buddy, the joke is on you!

I say take it back from the fat cats, and dump the money into developement of alternative modes of transport, social programs, shelter and food for the poor. Administered by an honest man (or woman).

Just my opinion.

7:18 PM  
Blogger Joe said...

Liam, Thanks for the comment. I think we're interpreting the definition differently. If we agree that a regressive tax is one that takes a proportionally greater amount from those with lower incomes, then I'm looking at effective regressiveness and you're looking at potential regressiveness. I think.

Any tax has the potential to be regressive. Whether or not it is effectively regressive depends on both how the tax is levied and the income elasticity of demand for the taxed good. By your logic, a flat luxury tax would be regressive, but I argue such a tax is unlikely to be regressive in practice. If lower income groups spend a smaller share of income on a good, the regressive effects of a tax are mitigated to some degree.

In this case, the gas tax is not effectively (very?) regressive. It would represent about 2.2% of expenditures for each income group except the highest fifth (slightly more for the 2nd and 3rd), which would spend only about 1.7% of its budget on the tax.

Labeling the gasoline tax regressive implies that the burden falls disproportionately on the poor, and that doesn't seem to be true. I'll keep thinking about your strict definition of regressiveness, though. It brings up some interesting questions.

10:58 PM  
Blogger Joe said...

anonymous,

I think getting the money from ourselves might be less costly in the end ;-)

Suppliers would pay for some portion of a gasoline tax, though it would be the smaller share (56 cents per gallon of the 1.56 total, if the elasticities held up). A 9.5% drop in volume wouldn't feel that great either. On second thought, you're right, that sounds pretty weak. Oh well.

11:04 PM  
Anonymous Liam said...

Joe, I honestly think 'regressive tax' is an absolute of principle not rendered more or less so based on consumer behaviour following the application of the tax - though absolutes don't help debates.

Rather than go around in circles on you though, ultimately what I understand you are considering is the effective burden on consumers should (what I describe as) a regressive tax be applied.

I do see a couple of problems though. If a regressive tax is large enough to reduce demand for those on lower incomes - assuming we're not talking neccessity goods that remain constant (which likely applies to a portion of gas purchases) - then by your definition it would mean the impact on those lower earners is technically lessened even though in reality a different kind of burden now applies.

Secondly I do like the absoluteness of the definition because it means it applies the same to every single consumer in recognizing exactly whatever amount they purchase. However by factoring in the general patterns of expenditure as you do in your formula, you ignore the individuals that don't fit the pattern (whilst obviously catching most, or the general wouldn't exist).

You are right of course in that it is our interpretation of the definition that we differ on, as I would call a fixed amount tax on extreme luxury goods regressive by definition but certainly accept that in those cases it would have zero impact on lower-income earners.

I guess I see progressive and regressive as mathematical concepts holding no value judgements in and of themselves, but I would myself judge the impact of their application to be good or bad.

I'd be in favour of a technically progressive tax (I'm biased, in that despite the ease of application and collection I'm never in favour of regressive taxes) applied centrally on income. But then I gave up my car 18 months ago and I'd be in favour of much more radical legislation to reduce gas consumption and automobile use anyway. And yes I know it wouldn't have a chance of ever being passed into law.

1:08 AM  
Anonymous Jim said...

Joe,
I wish I could come up with such a rational, thoughtful, and fact-filled analysis once in while. I agree with Liam in that regressive is regressive, but the absolute definition is moot for many people if they're not paying the tax in the first place. A food tax isn't effectively regressive for someone who raises his own crops and livestock. A fuel tax isn't effectively regressive for someone who walks, rides a bike, or takes the bus.

If we look at driving as a necessity on par with food, then the regressiveness of the tax seems mean-spirited and unfair to the lower quintiles. If we view driving as a luxury with harmful side-effects, like cigarettes or liquor, then a flat/regressive "sin tax" might seem justified. Anyway, thanks for clarifying my original point with the excellent analysis.

8:16 AM  
Blogger Joe said...

Liam,

If a regressive tax is large enough to reduce demand for those on lower incomes - assuming we're not talking neccessity goods that remain constant (which likely applies to a portion of gas purchases) - then by your definition it would mean the impact on those lower earners is technically lessened even though in reality a different kind of burden now applies.

A good point. I considered the average elasticity of demand in calculating the 9.5% quantity reduction. Looking around, though, it surely seems like the poorer here are more likely to hop on bikes, sidewalks, busses as gas gets more expensive. If the poor's gas consumption is reduced by more than the rich, perhaps that is regressive. But jumping up to what Jim said, I guess it depends on whther we view driving as primarily a good or a bad. Given current conditions, switching away from driving now may be an advantage in the future, but I admit that smacks of Big Brother.

you ignore the individuals that don't fit the pattern (whilst obviously catching most, or the general wouldn't exist)

The problem with macro analysis in general. I think this is where mitigation in the form of transfers could be useful. If income assistance is indexed to prices, then this might happen automatically. Yeah, this seems like a problem, though.

I'd be in favour of a technically progressive tax (I'm biased, in that despite the ease of application and collection I'm never in favour of regressive taxes) applied centrally on income.

I suppose a gas tax appeals to me because it (maybe) points out to folks that, "Hey, this driving costs society a lot." I don't have a problem with people driving, but I think thay should pay the full cost of every trip.

Aside from direct transfers, it would be an interesting to come up with a progressive tax on driving.

Thanks again for the thoughts, Liam.

10:30 AM  
Anonymous Jim said...

Please pardon me for soiling your blog with politics for a moment. It's interesting to me that your calculation of mitigation is so cheap (and I believe that it's reasonably accurate). To hear politicians talk, you'd think various mitigations of this sort were going to be prohibitively expensive. Likely, this isn't the first time this idea has been bandied about. So why is there no political will for this type of thing? My guess is that the Republicans like to make their tried and true class warfare arguments, and the Democrats like to have a cheap cause that they can drag out election after election. You can sort of see it in the comments on my blog that people on either side can't seem to let go of the same old tired arguments. This politics imprints itself on the brains of otherwise smart people.

10:08 PM  
Blogger Keasty said...

Thanks Joe. Heavy stuff. Did you post a question on the DROPPING KNOWLEDGE site? You should check it out.
Glad you enjoyed the drive recently!!!
We just packed our Bike Friday tandem into the 2 suitcases for air travel (Seattle to Toronto) Thurs morning.

11:02 PM  
Anonymous sans auto said...

I'm really not this mean and I would probably qualify as poor, but I like making people have to choose between gas and food. Hopefully they will choose food and choose to exercise to get somewhere. This world is really going in the right direction when the poor are becoming healthier by actively getting places, while the rich get fatter and lazier spending more money to sit on their fat butts. I look forward to the day that the rich die out from the diseases of affluence and the poor take over.

10:12 PM  
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