An iron law of economics is that people respond to incentives. If the petrol price goes up, it should be of little surprise that consumers alter their choices at both the petrol pump and the car dealership.
In a paper recently published in Energy Economics, Shuhei Nishitateno and I examine these responses to changes in petrol prices. Our research uses data for 132 countries over the period 1995-2008.
Our results indicate that a 10% increase in the pump price of petrol on average causes a reduction in petrol use of around 3%. Petrol consumption is what economists call “price inelastic”. This means that while higher prices do reduce consumption, the response isn’t as big as it is for some other goods.
Part of the response to higher petrol prices is via vehicle choice. If petrol is more expensive, consumers are less likely to opt for a gas guzzler. A 10% increase in petrol prices typically results in a 2% improvement in the fuel economy of new vehicles. Our findings are similar to most previously published estimates, although are for a more internationally representative sample of countries.
Australia’s gas guzzlers
In the take-up of fuel-efficient vehicles, Australia remains near the back of the pack. Data from the International Energy Agency reveal that new vehicles sold in Australia on average guzzle more gas than new vehicles sold in Europe, Japan, China, or India. Australia performs only slightly better than the home of the SUV, the United States.
There are a number of reasons for Australia remaining in the slow lane in terms of adopting fuel-inefficient vehicles. One is that Australia is less cramped than most other countries: we have enough space to find a park for our four-wheel drives. Another is that, among developed countries, the tax included in our pump price is relatively modest. Our petrol taxes are lower than those for all OECD countries outside North America.
In 2001, the Federal Government removed the automatic indexation of Australia’s petrol excise, freezing the excise at 38.1 cents per litre. While we also pay GST on petrol, this decision has meant that the total tax we pay at the pump has not kept up with inflation. Fuel excise collections are expected to continue to fall in real terms.
Our research indicates that our falling fuel tax is slowing our take-up of fuel-efficient vehicles. The 2001 decision has also reduced the revenue available for transport infrastructure and other priorities. Shrinking excise revenues create increasing pressure on the government to look to other taxes to raise the revenue that it needs.
Using taxes to improve incentives
No-one likes paying tax. But almost everyone agrees that some taxes are necessary.
Economists typically argue that there is a special role for taxation of activities involving negative externalities. The congestion and emissions associated with road use are classic examples of negative externalities. As well as being a good revenue raiser, addressing negative externalities has been a part of the justification for fuel taxes both here and overseas.
In this context, there are opportunities to realign our road taxes to improve the incentives that road users face. One option is a return to indexation of the petrol excise. This would prevent the erosion of government revenue and strengthen the incentive to use petrol efficiently.
Another possibility is for the states to reduce stamp duties or annual vehicle registration fees and instead look to raise more revenue from congestion charges. Doing so would mean that those who drive at off-peak times, or who drive less, would make a smaller contribution to the government coffers.
The Henry Review threw its support behind a move to congestion taxes. The Review was less enthusiastic about fuel taxes, but did rate them as more efficient than major revenue sources such as labour and corporate income taxes (Chart 1.5).
Petrol subsidies overseas
Some countries provide large petrol price subsidies to consumers. In Indonesia, more than 10% of government revenue goes to subsidising fuel. Fuel subsidies involve a high cost, as they displace resources that could be used to build schools, hospitals, or roads. By encouraging fuel use, the subsidies also exacerbate Jakarta’s famous traffic jams and smog. The subsidies work against the Indonesian Government’s goal of a transition to more fuel-efficient vehicles.
Where is petrol cheapest? In Venezuela, you can fill up your car for just a couple of cents a litre. The result? Venezuela’s petrol consumption and road-sector emissions are high for a country of its level of economic development, and those who can afford it are more likely to buy fuel-hungry vehicles such as Hummers. It is hard to escape the iron law of economics.
Read a response to this research.
Gasoline prices, gasoline consumption, and new-vehicle fuel economy: Evidence for a large sample of countries is published in Energy Economics. The paper and data can be accessed from Paul Burke’s website.