Green Taxes Part II: Potential Revenue for Illinois?

Posted by Don Fullerton on Jul 7, 2011

Filed Under (Environmental Policy, U.S. Fiscal Policy)

Last week, I wrote about carbon pricing as a way to meet the Illinois state revenue needs (instead of an increase in the income tax).  This week, in the “continuation”, I write about a possible increase in the gasoline tax.  First, I’ll set the stage again.

In early January 2011, the State of Illinois enacted legislation to raise the personal income tax rate from 3% to 5% and to increase the corporate income rate from 4.8% to 7%.  Along with a cap on spending growth, these tax increases reduce the state’s projected budget deficit in 2011 by $3.8 billion (from $10.9 to $7.1 billion).  The governor justified the tax increases on the grounds that the State’s “fiscal house was burning” (Chicago Tribune, January 12, 2011).  In my piece with Dan Karney for a recent IGPA Forum, we don’t debate the reasons for the underlying fiscal crisis in the State of Illinois, nor argue the merits of cutting spending versus raising revenue to balance the budget.  Instead, we just stipulate that politicians decided to raise revenue as part of the solution to the State’s deficit.  Then we analyze the use of “green taxes” as an alternate means of raising revenue that could mitigate or eliminate the need for increasing income taxes.

In general, green taxes are taxes either directly on pollution emissions or on goods whose use causes pollution.  In the revenue-raising context however, the basic argument for green taxes can be summarized by the adage: “tax waste, not work”.   That is, a tax on pollution might have good effects on the environment, because it discourages pollution.  In contrast, an income tax discourages earning income.

While many green taxes could be implemented, we focus on four specific examples that have the potential to raise large amounts of revenue: carbon pricing, gasoline taxes, trucking tolls, and garbage fees.  Indeed, as we show, a reasonable set of tax rates on these four items can generate as much revenue as the income tax increase.  We apply each hypothetical green tax directly to historical quantities of emissions (or polluting products) in order to obtain an approximate level of potential revenue generation. 

In a short series of blogs, one per week, we now discuss each of the four green taxes and their potential for revenue generation.  This week: Gasoline Taxes.

Gasoline sales in Illinois are subject to a state excise tax set in 1990 at $0.19 per gallon.  In addition, other state fees and a federal excise tax of $0.18 per gallon are applied to gasoline sales for a total tax rate in Illinois of $0.61 per gallon, according to the American Petroleum Institute.  However, economic studies find that the existing tax rates on gasoline are below the optimal rate that would account for all the costs of pollution and time wasted due to traffic jams.  For instance, the “optimal” U.S. total gasoline tax has been estimated to be about $1 per gallon, according to Ian Parry and Kenneth Small (2005), “Does Britain of the United States Have the Right Gasoline Tax” [American Economic Review, 95(4): 1276-89].  Illinois would have to raise the tax rate by 40 cents to reach that $1 total optimal rate.  The third line of table 2 shows that a $0.40 per gallon gasoline tax hike would collect approximately $2.0 billion (just over half of the $3.8 billion from the income tax increase).  Yet that tax increase would raise by 12.4 percent the $15.9 billion Illinoisans spend annually on gasoline.

Table 2 includes alternative calculations of revenue generation levels from a gasoline tax.  For example, a generic 5 cent per gallon excise tax increase would generate $250 million (see table 2 line 1). 

The existing $0.19 per gallon excise tax in Illinois is not indexed to inflation, so the real revenue to the State from the gasoline excise tax has steady fallen over time.  The second line of table 2 calculates that the state could adjust the tax rate back to its 1990 purchasing power by raising the rate 14 cents per gallon (from 19 cents to 33 cents).  That would just account for inflation since 1990.  The increase in revenue would be $700 million (which is 18.3% of the expected revenue from the income tax increase).

Illinois residents would then pay 4.4% more for gasoline, INSTEAD of paying more income tax.  The point is that the gas tax would discourage driving and air pollution, instead of discouraging workers from earning income.