Many gas taxes, but falling over time

Filed Under (Environmental Policy, U.S. Fiscal Policy) by Don Fullerton on Apr 1, 2011

Per gallon of gasoline, are we paying more in taxes over the years, or less?   In my last post, I examined the Federal gas tax and inflation adjustments.  As it turns out, the overall price of gasoline adjusted for inflation just hasn’t changed that much over the past fifty years!  Regarding the Federal tax of 18.4 cents per gallon as a tool to collect revenue, however, the impact is significantly weakened by inflation.  It is a “unit tax” (fixed over time per unit of gasoline), and so it becomes a smaller fraction of price as the gas price rises.  In contrast, any “ad valorem” tax would be a fixed percentage of price (like an 8% sales tax).  When inflation increases the price, an ad valorem tax rises with it.

State and local gas taxes in Illinois are a bit more complicated. In 1990, the State of Illinois raised the gas tax from 16 cents to the current 19 cents per gallon – another “unit” tax.  The flat blue line in the figure below looks at that same fixed 19 cents per gallon since 1990.  The orange line shows its “real” value, adjusted for inflation, all in current 2011 dollars.  It shows that the 19 cents today is really the equivalent of 33 cents back in 1990.  So the real value of the state’s unit tax on gasoline has fallen from 33 cents to 19 cents per gallon.

In addition to the 19 cent per gallon state gas tax, we also pay 2 cents per gallon to the city of Urbana.  Furthermore, gasoline is subject to the general sales tax, which in Urbana is 8.75%.  (It is composed of 5% to the state, 2.25% to the city, 0.5% to the county, and another 1% to the school district). 

Here is how it all works.  Suppose the net-of-tax price of gas kept by the service station is exactly 3 dollars.  Then the combined state and local ad valorem sales tax (8.75%) applies to that $3.00 per gallon.  That tax would be $0.2625 (in other words, 26.25 cents).  Then the federal unit tax is 18.4 cents, the state unit gas tax is 19 cents, and the city unit gas tax is 2 cents.  The total of all those taxes is 75.65 cents per gallon.  These four major taxes per gallon are shown in the table.

Level of Tax

Tax in Cents per gallon

Federal unit tax


Illinois unit tax

Urbana unit tax


Combined sales tax





That total 76-cent tax adds to the $3 per gallon price, and you pay $3.76 per gallon.   (And actually, a few other minor taxes are ignored here, such as the “Underground Storage Tank” fee and other environmental fees!)

 Yet only the ad valorem sales tax can keep up with inflation.  With every year that a unit tax on gasoline is not updated, the tax loses its value and fails to collect as much real revenue.   The State of Illinois revenue from the 19 cent gas tax is falling in real terms with inflation, as all the necessary expenditures by the State are rising.

Gas prices are back in the news

Filed Under (Environmental Policy, U.S. Fiscal Policy) by Don Fullerton on Mar 11, 2011

Gas prices are back in the news, simply because gas prices are rising.  Reporters like to discuss WHY gas prices are rising, but who knows?  The price of gasoline or crude oil can vary with any change, either in supply or demand.  We can always point to shifts in demand (like the growing economies of China and India), and we can always point to shifts in supply (like the shutdown of production due to unrest in countries of the Middle East and North Africa).  But it’s very difficult to sort out the net impact of each such factor, since the price is affected daily by so many different changes.

Instead of trying to answer that question here and now, let’s take a step back and look at whether any of the current changes are really that unusual.  Is the price of gas really high by historical standards?  And how much of that gas price is driven by energy policy, taxes, and factors under the control of policymakers?  In other words, let’s just look at the facts for now, and then try to analyze them later!

Here are the facts, for the fifty years since 1960.  The first figure below is from the U.S. Energy Information Administration (EIA).  Look first at the BLUE line, where we see what you already know:  the nominal price of gasoline has risen from $0.31/gallon to what’s now $3.56/gallon.  It’s driving us broke, right?

Well, not so fast.  The RED line corrects for inflation, showing all years’ prices in 2011 dollars.  So both series stand at $3.56/gallon in 2011, but the red line shows that the “real” (inflation-corrected) price of gasoline back in 1960 was $2.33/gallon.  In fact, compare the red line from 1960 to 2009: over those fifty years, the real price of gasoline only changed from $2.33 to $2.42 per gallon – virtually no change in the real price at all! 

From 2009 to 2011 the real price increased beyond $2.42, rising to $3.56/gallon, but that may be temporary.  You can see that the red line bounces around for the whole fifty year period.   In 1980, the real price was $3.35/gallon, so the current price is not much different from previous upward blips in the real price of gas.

Now look at the U.S. Federal Gasoline Tax Rate, in the next figure.  The red line in the next figure shows that the nominal statutory tax rate was four cents per gallon for years, and then it was increased in various increments to 18 cents per gallon today.  But of course, inflation has changed the real value of that tax rate as well.  Using 2011 dollars again, both real and nominal tax rates are 18 cents per gallon today.  But in 2011 dollars, the 4 cents per gallon back in 1960 was really equivalent to 29 cents today.  In other words, the real gas tax in the green line has fallen from 29 cents per gallon fifty years ago to only 18 cents today.

The gas price may be rising, but not due to any increase in the Federal gas tax.  That Federal gas tax is falling in real terms.  In the next entry, we’ll take a look at the various State gas tax rates, and we’ll look at how many of those taxes are fixed per gallon – so that they fall in real terms as inflation reduces the real value of those State tax rates.

How Much Should Congress Leave to the Regulators?

Filed Under (Environmental Policy, U.S. Fiscal Policy) by Don Fullerton on Feb 11, 2011

The very existence of the Environmental Protection Agency (EPA) has long been a point of contention between the two political parties.  What is, and what ought to be the role of the EPA with regard to policy making?  Congress cannot possibly enact laws that contain every detail about subsequent implementation, monitoring, and enforcement.  And they should not put everything in the law anyway, in order to allow enough flexibility to deal with future contingencies.  Besides, those in Congress don’t have the science background necessary to decide all of the details of some technological aspects of pollution prevention.

The law does not say that every electric power plant must reduce emissions of each pollutant to no more than some number, like 37 micrograms per cubic meter.  Instead, the law from Congress just says that EPA should protect human health to an adequate margin of safety.

Yet some would prefer that the EPA disappear, along with every agency having any regulatory power.  This agency, which was conceived in 1970 under Richard Nixon, has analyzed and supported some of the most important pieces of legislation of the last forty years, ranging from the Endangered Species Act to – more recently – the new emissions standards going into effect this year. 

In 2007, the United States Supreme Court ruled in a 5-4 decision called “Massachusetts vs. EPA”, that the EPA could in fact regulate greenhouse gases under the Clean Air Act, on the grounds that such emissions do affect human health.  When combined with the new Republican-dominated Congress, we have set the stage for yet another ideological battle. 

Throughout the past decade, much of the discussion about controlling carbon dioxide emissions has largely centered around the idea of Cap and Trade.  That system would effectively put a price on each unit of pollution emissions.  It would create a market where the need for emissions and the cost of emissions are balanced in a way that can achieve economic efficiency.  However, the most viable attempt at this in recent years, the Waxman-Markey bill of 2009 (H.R.5454), passed the House and not the Senate.  It would not even get past the House in this term.  

The question then becomes, what exactly are the cards that the EPA retains in their deck? 

A recent article is titled “Greenhouse Gas Regulation Under the Clean Air Act” by researchers at Resources for the Future (RFF, by Burtraw, Fraas, and Richardson).  It seeks to explore the options available to the EPA, in-depth.  What they find is that the EPA can implement measures that will reduce greenhouse gas emissions significantly in a measured and cost-effective manner.  For this to happen, however, they argue that the EPA must become bold and decisive in their actions. 

Bold action may be taken as an example of government overreach, and so the EPA must be careful.

Republicans are currently in discussion to introduce the Energy Tax Prevention Act of 2011 .  They recognize that the EPA holds some powerful cards after the Supreme Court ruling in 2007, and they want to take that power away.  This Act would shift the EPA’s ability to regulate from the Agency to the legislative branch.  Yet such an action could take any decision-making ability from the scientists and put it in the hands of the politicians.  As EPA leader Lisa Jackson said, “Politicians overruling scientists on a scientific question – that would become part of this committee’s legacy.’”  Herein lies a problem with democracy.  The people in charge of making the decisions that affect us all, often have little knowledge of the actual issues at hand.  After all, Republicans from oil-rich states like Oklahoma still claim global warming is nothing but a hoax.

The State of the Union may be strong, but the state of America’s energy policy is less clear

Filed Under (Environmental Policy, U.S. Fiscal Policy) by Don Fullerton on Jan 28, 2011

On Tuesday night, President Obama gave the State of the Union (SOTU) Address (transcript) before a joint session of Congress.  The speech drew upon imagery from the Cold War past in order to spur action regarding America’s energy policy.  “This is our generation’s Sputnik moment,” the President declared, and thus he will send a budget to Congress that invests “especially [in] clean energy technology, an investment that will strengthen our security, protect our planet, and create countless new jobs for our people.”  To deal with this “Sputnik moment”, the President set forth two goals: (1) become the first country to have a million electric vehicles on the road by 2015; and (2) get 80% of America’s energy from clean sources by 2035. 

(Not quite as inspiring as President Kennedy’s urging on May 21, 1961 that “this nation should commit itself to achieving the goal, before the decade is out, of landing a man on the moon and returning him safely to the earth.”  On July 20, 1969, Apollo 11 landed on the Moon and Neil Armstrong took his first step on the lunar surface.)

I have three issues with the President’s approach.  First, the wording of the goals in the SOTU Address needs to be parsed carefully in order to understand their meaning or lack of meaning.  For instance, does “electric vehicles” mean all-electric vehicles or do hybrids count towards that goal?  Similarly, what is the definition of “clean sources”?  Fortunately, in this case we have an answer later in the Address.  As the President admits, “Some folks want wind and solar.  Others want nuclear, clean coal and natural gas.  To meet this goal, we will need them all.”  However, ambiguity still exists because clean coal and natural gas technologies can be deployed with or without carbon capture and sequestration technologies.

Second, the President did not offer details about HOW to achieve these goals.  The Address includes references to investments in clean energy technology, but it specifies neither investment level nor investment horizon required to meet the stated goals.  He did not say, for example, $10 billion annually for 10 years.  If clean energy is really a priority for the President, and given concerns about the fiscal deficit, then clarity about the needed investment level would be helpful so that other programs can be identified for cuts in order to balance the budget.  Also, the President said that “clean energy breakthroughs will only translate into clean energy jobs if businesses know there will be a market for what they’re selling.”  I agree.  However, an efficient, well functioning market requires a price signal.  This brings me to my last point.

Third, the President did not directly address environmental policy when setting his goals.  If the President really means “low-carbon” or “no carbon” when he says “clean”, then the absence of a carbon policy in the Address becomes conspicuous.  Specifically, the President did not indicate if he would again push for a cap-and-trade bill.  Given the composition of the new Congress, a cap-and-trade bill or any other piece of legislation that puts either an explicit or implicit price on carbon emission seems politically infeasible.  To have a market for these clean energy technologies, where is the price signal going to come from?  

In their forthcoming book called “Accelerating Energy Innovation: Insights from Multiple Sectors”, Rebecca Henderson and Richard G. Newell look at lessons from the histories of innovation in other industries and implications for the energy industry.   The introduction says: “Taken together the histories point to three key factors as critical to accelerating innovation: (1) well funded, carefully managed public research that is tightly linked to the private sector; (2) rapidly growing demand; and (3) antitrust, intellectual property and standards policies that together promote vigorous competition and the entry of new firms.”

How many people would ‘demand’ electric vehicles at a high price, just out of the goodness of their hearts?  Or would that demand depend on the existence of a policy that raises the price of burning fossil fuels?

The President noted that when Sputnik was launched, NASA did not exist.  Yet, the Department of Energy has existed for many years, and America’s energy policy is still unclear and uncertain.

It’s Not a Simple Choice!

Filed Under (Environmental Policy) by Don Fullerton on Jan 16, 2010

A lot of research in environmental economics is all about the choice of environmental policy: a pollution tax, an abatement subsidy, tradable permits, or some regulatory mandate.  Economists have made two primary distinctions.  One distinction is between a price instrument (like a tax or subsidy) and a quantity instrument (like a fixed number of permits, or nontradable quota).  It’s a bit esoteric, but the choice between those two categories depends on uncertainty about the cost of abatement, and the slope of the marginal abatement cost curve.

A different key distinction is between a market based instrument (like tax OR tradable permits), as opposed to command and control regulations (like quotas or technology requirements).   This distinction is not so esoteric: having a tax or permit price per unit of pollution provides incentives to abate pollution in all the cheapest ways, and therefore minimizes the cost of abatement.  In contrast, regulators may easily require forms of abatement that are much more expensive.  Estimates suggest that command and control regulation can be six times as expensive as using market based instruments.

The point of this blog, however, is that these choices are too simple.  They do not encompass actual policy choices that are not only more complicated, but that cannot even be so categorized.   The “tax” is usually not on pollution itself, but on gasoline or on a car.  Also, virtually every “reform” is a package, and should be considered as a package!  I’ve shown in earlier research that the combination of a subsidy to abatement plus a tax on output can be functionally equivalent to the ideal tax on pollution.

Another “combination” is in the European Union, where a cap-and-trade carbon permit system applies to about half the economy, including electricity generation and major industries, but which does not cover small industries, residences, and transportation.  So they are now considering a carbon tax for the “nontrading” sector.

And anything done in the United States is likely to be a hybrid.  The Congress seems to want a cap-and trade permit system, or at least to call it a cap-and-trade permit system.  But that variable price may have a ceiling, and it may have a floor.  At the extreme, in a hybrid system as the ceiling and floor get closer to each other, the system converges to the single price of a carbon tax.  In other words, it’s not really one or the other.

Despite the complications, it may be worth our while to think about the ideal combination of policies, not the choice among distinct alternatives.

Does a Carbon Tax need a “Border Tax Adjustment”?

Filed Under (Environmental Policy) by Kathy Baylis on Dec 4, 2009

When our colleague Don Fullerton was in Brussels this week speaking at a conference on climate change, he voiced support for border adjustments for carbon policies. This idea was promptly rebuffed with cries of ‘protectionism’, particularly from the business participants. Now, a border adjustment is just a friendly way of saying ‘an import tariff,’ so it’s understandable that people might see them as a harbinger of protectionism. Like most trade economists, I’ve seen many examples of trade policies that were reputedly intended to ‘level the playing field’, e.g. countervailing duties and anti-dumping tariffs, promptly get co-opted and used as a means to protect the loudest domestic industries, so I am sympathetic to this concern. That said, I think there are a number of compelling arguments for introducing some border controls along with a stringent domestic carbon policy.

Think of a carbon tax or cap-and trade system like a Value-Added Tax (or VAT), where border-adjustments are common. Most countries that tax the value-added in production of each good also tax imported goods at the same rate. They do this to ensure that imported goods aren’t given an unfair advantage over the taxed goods produced domestically. The same logic applies to a carbon tax, or a cap-and-trade system on emissions. The idea is that we would like to tax imports at an equivalent rate as domestic production. Thus, we would impose a tax based on the average carbon content of the equivalent domestic product. This approach conforms with the WTO rule of equivalence – that a country doesn’t favor its own producers over producers in another country.

Is designing a border adjustment going to be harder to do for carbon than for a VAT? Definitely, because carbon content is harder to measure than value-added, which is just a price. It also means using domestic carbon content as a proxy for the carbon content in imported goods, which is not going to be accurate. The problem is that the alternative is trying to estimate specific carbon content for all imports, which is not only impossible, but also generates the potential for problems with the WTO.

Now you might well be thinking, you’re suggesting imposing an imperfect, potentially arbitrary tariff on billions of dollars of imports. How can this be a good thing? Let me walk through a few arguments.

1) If you don’t have a border adjustment, other countries have an incentive not to sign on to an international carbon agreement. By imposing a carbon policy domestically, we are raising the marginal cost of production inside the United States, so it gives firms the incentive to move to a lower-cost location as long as they continue to have access to the US domestic market. From the perspective of, say, Indonesia, a US carbon policy might make the US look quite tempting as a potential market. And the last thing they want to do is to get rid of this advantage by imposing a carbon policy themselves.

2) In contrast, a border adjustment means that a country like the US or Europe does not have to wait for an international climate agreement before implementing a carbon policy. In short, because it neutralizes the potential negative trade effects of a carbon policy, it becomes easier for a country to ‘go it alone’ and not have to wait for other developed and developing countries to sign on to a Kyoto-like agreement.

3) Similarly, if you do have a border adjustment, it can be used as an incentive to get other nations to implement a carbon policy, particularly developing countries with a large export base. Only those countries without a carbon policy would be subject to a border adjustment, and the revenue from the border adjustment accrues to the importing country. So an exporting country faces the choice of letting their firms pay the tariff to someone else, or collecting that revenue themselves in the form of a carbon tax or (auctioned) cap and trade permits. So even if the border adjustment is imperfect, one can hope it’s temporary.

I can see my trade colleagues wincing at their computer screens while they read this. Yes, we have had loads of trade measures that were supposed to be temporary that ended up becoming enshrined by the interests that they benefit. So my last argument is for them.

4) Without a border adjustment, import-competing industries will demand special treatment in the form of free permits, or, of more concern, outright exemptions from the carbon policy. Why do I claim this? We’ve seen it in Europe. Under the European Trading System for carbon, each country was allowed to exempt certain industries from the cap-and-trade system, and they particularly targeted those firms in ‘trade-sensitive’ industries. Along with generating concerns about environmental efficiency, such exemptions generate potentially large economic inefficiencies domestically and are incredibly arbitrary. Thus we tend to see the most politically-sensitive industries often identified as the most ‘trade-sensitive’. At least a border adjustment could be designed to be neutral across domestic industries, reducing the potential gains for firms in politically-powerful positions. As an aside, note that industry-specific subsidies could include exemptions to costly general environmental regulations and are subject to countervailing duties (CVD). Thus, I wonder if we might see such exemptions generating a cascade of CVD cases.

OK, I always find it frustrating when people from other disciplines pretend to be economists, so let me be clear that I’m not in any way a trade lawyer, so I can’t speak convincingly on the trade legality of these ideas. That said, we know that border adjustments for VATs are allowed under the WTO. You might also be concerned, however, that any border adjustment policy might spark a trade war, which our anemic global economy certainly does not need. In response, let me note that when the Uruguay round of the GATT was concluded, countries signed on to a ‘peace clause,’ where they agreed not to take trade actions against their fellow countries on agricultural subsidies as long as those subsidies conformed to the Agreement on Agriculture. To facilitate carbon policy, I wonder if there might be the potential to negotiate a similar peace clause for environmental subsidies and/or border adjustments as long as those border adjustments conform to some internationally-agreed upon rules. For example, these rules might try to ensure that countries treat importers no differently than they treat their domestic industries, and that the border adjustments be transparent and apply equally across industries.

In conclusion, border adjustments might help make domestic carbon policy both more palatable and more efficient, and could, in fact, be less harmful to free trade than allowing one-off industry exemptions.

Recognizing the Costs and Benefits of Climate Change Policy

Filed Under (Environmental Policy, Uncategorized) by Jeffrey Brown on Nov 4, 2009

I am posting a day later than usual this week because I spent a good part of yesterday participating in a fascinating discussion about U.S. policy towards climate changes sponsored by the Center for Business and Public Policy, the Institute for Government and Public Affairs, and the Environmental Change Institute (all at the University of Illinois).  Three highly accomplished experts on climate change (Charlie Kolstad, Don Fullerton, and Nat Keohane) discussed the various approaches to tackling this global policy priority.  The conversation was refreshing for its analytical clarity, its recognition of both the benefits and costs of alternative policies, and for the fact that it was good economics set against a backdrop of political realism.  It left me wishing that more of our policymakers in Washington would have such high quality conversations when making their decisions.   


In preparing my own thoughts for this event, I read through some of the material from two of the many “sides” in the debate over climate policy legislation – the views of the U.S. Chamber of Commerce and the views of the Obama Administration.  Doing so brought back memories of my own days in the White House (in 2001-02 under President Bush).  Specifically, it made me remember the constant struggle between the economists and policy wonks who want to have honest and nuanced discussions about complex issues, and the “spin masters” whose job it is to effectively communicate to the public in a simple way.  I understand the value of simplicity for communication, but all-too-often, the truth gets “simplified away.”


Economics is fundamentally about trade-offs.  Perhaps no phrase is more famous for capturing this idea than “there’s no such thing as a free lunch.”  But to listen to the opponents and proponents of climate change legislation – at least after they have been filtered through the communications shops – one could be forgiven for thinking that our policy makers do not understand this.    


Let me give two examples – one from each side.


The U.S. Chamber of Commerce has an official position on climate policy that states:


“Our position is simple: There should be a comprehensive legislative solution that does not harm the economy, …”


What is remarkable about this statement is that they do not say that the legislative solution should be one in which “the benefits clearly outweigh the costs.”  Rather, they are imposing a truly impossible standard – that the solution “does not harm the economy.”  The most straightforward interpretation of this is that they are unwilling to accept any cost or slowdown in economic growth in order to reduce emissions.  Unless you believe that there are no costs to climate change and/or no benefit to any solution, this cannot possibly be an optimal – or even rational – policy.  


Proponents of climate change often make equally vacuous statements.  To hear many in the Obama Administration speak of climate change, you would think that environmental regulation is good for the economy rather than a cost.  They focus their attention on the number of “green jobs” that will be created, while largely ignoring the large number of jobs in other industries that will be destroyed.  I’ve yet to see a single study showing that environmental regulation is a NET positive for economic growth or job creation in the U.S. 


What we need – on this and so many other issues – is a “grown-up conversation” about the costs and benefits.  Of course we know that reducing emissions levels will be costly.  Of course we know that it will require changes in the way we consume and produce energy.  The question is not whether climate policy can be done at no harm to the economy or can even benefit the economy – the question is whether the benefits of reducing emissions is worth the cost. 


Fortunately, even if the “talking heads” are not having these discussions, serious thought leaders like those at our forum yesterday are.  Let’s just hope that policymakers listen.











The True Size of Government

Filed Under (Environmental Policy, U.S. Fiscal Policy) by Don Fullerton on Sep 25, 2009

In 2008, the federal government’s receipts were 17% of GNP, and its expenditures including transfer payments were 21.4% of GNP (implying the budget deficit was 4.4% of GNP).  If State and Local taxes and expenditures are added to those numbers, they become 30.5% and 35.2% of GNP, respectively.  For many reasons, however, government’s reach is wider than reflected in those numbers.  Government does not just spend its own tax revenue; it spends other people’s money as well.

For just one example, consider environmental regulations.  I have not seen a recent estimate of the total costs of environmental protection, so I will rely on some older numbers.  Note, however, than none of this discussion is meant to imply that the environment should not be protected!   Maybe protections should be more limited, or expanded.  The point is just that measured dollar expenditure by government does not accurately reflect its true size.

In “The Cost of Clean”, the U.S. EPA in 1990 estimated that the total private cost of required environmental protection was approximately $115 billion (in 1990 dollars) or 2.1% of GNP.  By the year 2000, they said the value could approach 2.8% of GNP.  If I assume the same rate of growth through 2008, then these private costs of environmental protection could be as high as 3.5% of GNP by 2008, a figure that would be $514.0 billion, or 21.6% of non-defense federal expenditures.

This cost of environmental protection comes mainly in the form of mandates imposed on firms.  Examples of mandates include the forced adoption of best practices pollution abatement technology or binding emission rates (e.g. limits on pollution per unit of output).  However, these mandates are just like taxes in two respects.  First, the government imposes these costs on private firms.  Second, the mandates provide “public goods” like clean air and water that we all can enjoy.

In other words, if these costs to private firms were converted into an equivalent tax program with direct government expenditures, then U.S. discretionary spending would appear to be 21.6% higher.  These expenditures do not appear explicitly in the federal budget, so they merit further study.  How do we divide our limited resources between private or public consumption, versus private or public investment?  How much of that environmental spending is in each category?  What are we getting for these outlays?  How can we measure the value of the improved environment?  Do these expenditures provide environmental benefits now, or are they investment in the future?

In order address these questions, a full “environmental budget” would need to show each cost, including the cost of complexity created by mandates.  In addition, some environmental protection programs are required by state and local governments (just like taxes).  Each of the programs has implicit transfers from one state to another, and from one income group to another (just like taxes).  Why are these programs not evaluated just like taxes?

Who Bears the Burden of Energy Policy?

Filed Under (Environmental Policy) by Don Fullerton on Sep 4, 2009

Economists have tools to analyze the distributional effects of income taxes, payroll taxes, property taxes, and corporate income taxes.  Some existing research even looks at distributional effects of environmental or energy taxes used to help control pollution or energy consumption.  Yet most pollution policy does not involve taxation at all!  Instead, we use permits or command and control regulations such as technology standards, quotas, and quantity constraints.  Existing studies of energy policy are mostly about effects on economic efficiency, addressing questions such as: how to measure the costs of reducing pollution or energy use, how to measure benefits of that pollution abatement, what is the optimal amount of protection, and what is the most cost-effective way to achieve it.

Yet environmental mandates do impose costs, and an important question is who bears those costs.  Moreover, those restrictions provide benefits of environmental protection, so who gets those benefits?  Full analysis of environmental policy could address all the same questions as in tax analysis.  Perhaps it could use the same tools to address distributional effects – not of taxes, but of these other policies that are used to protect the environment.

Thinking about the distributional effects of environmental policy is interesting and difficult.  For example, a standard tax analysis would point out some complex implications of an excise tax: not only does it affect the relative price of the taxed commodity, and thus consumers according to how they use income, but it also impacts factors intensively used in the production of that commodity, and thus individuals according to the sources of their income.  Yet an environmental mandate can have those effects and more!  Consider a simple requirement that electric generating companies cut a particular pollutant to less than some maximum quota.  This type of mandate is a common policy choice, and it has at least the following six distributional effects.

First, it raises the cost of production like a tax, so it may raise the equilibrium price of output and affect consumers according to spending on electricity.

Second, it may reduce production like a tax, reduce returns in that industry, and place burdens on workers or investors.

Third, a quota is likely to generate scarcity rents.  For simplicity, suppose pollution has a fixed relation to output, so the only “abatement technology” is to reduce output.  Then a restriction on the quantity of pollution is essentially a restriction on output.  Normally firms want to restrict output but are thwarted by antitrust policy.  Yet in this case, environmental policy requires firms to restrict output.  It allows firms to raise price, and so they make profits, or rents, from the artificial scarcity of production.  Just as tradable permit systems hand out valuable permits, the non-tradable quota also provides scarcity rents – to those given the restricted “rights” to pollute.

Fourth, if it cleans up the air, this policy provides benefits that may accrue to some individuals more than others.  The “incidence” of these costs and benefits usually refers to their distribution across groups ranked from rich to poor, but analysts and policy-makers may also be interested in the distribution of costs or benefits across groups defined by age, ethnicity, region, or between urban, rural, and suburban households.

Fifth, regardless of a neighborhood’s air quality improvement, many individuals could be greatly affected through capitalization effects, especially through land and house prices.  Suppose this pollution restriction improves air quality everywhere, but in some locations more than others.  If the policy is permanent, then anybody who owns land in the most-improved locations experience capital gains that could equal the present value of all future willingness to pay for cleaner air in that neighborhood. Similar capitalization effects provide windfall gains and losses to those who own corporate stock: capital losses on stockholdings in the company that must pay more for environmental technology, and capital gains on stockholdings in companies that sell a substitute product.

Capitalization effects are pernicious.  A large capital gain may be experienced by absentee landlords, because they can charge higher rents in future years.  Certain renters with cleaner air might be worse off, if their rent increases by more than their willingness to pay for that improvement.  Moreover, the gains may not even accrue to those who breathe the cleaner air!  If households move into the cleaner area after the policy change, then they must pay more for the privilege.  The entire capital gain goes to those who happen to own property at the time of the change, even if they sell it at the higher price and move out before the air improves.  Similarly, new stockholders in the burdened company may be “paying” for abatement technology in name only, with the entire present value of the burden felt by those who did own the stock at the time of enactment, even if they sell that stock before the policy is implemented.

Sixth, strong distributional effects are felt during the transition.  If workers are laid off by the impacted firm, their burden is not just the lower wage they might have to accept at another firm.  It includes the very sharp pain of disruption, retraining, and months or years of unemployment between jobs.  These effects are analogous to capitalization effects, if the worker has large investment in particular skills – human capital that is specific to this industry.  If the industry shrinks, those workers suffer a significant loss in the value of that human capital.  They must also move their families, acquire new training, and start back at the bottom of the firm hierarchy, with significant psychological costs.

The challenge here is that many of these effects of environmental policy are likely to be regressive.  Consider the six categories just listed.  First, it likely raises the price of products that intensively use fossil fuels, such as electricity and transportation.  Expenditures on these products make up a high fraction of low income budgets.  Second, if abatement technologies are capital-intensive, then any mandate to abate pollution likely induces firms to use new capital as a substitute for polluting inputs.  If so, then capital is in more demand relative to labor, depressing the relative wage (which may also impact low-income households).  Third, pollution permits handed out to firms bestow scarcity rents on well-off individuals who own those firms.  Fourth, low-income individuals may place more value on food and shelter than on incremental improvements in environmental quality.  If high-income individuals get the most benefit of pollution abatement, then this effect is regressive as well.  Fifth, low-income renters miss out on house price capitalization of air quality benefits.  Well-off landlords may reap those gains.  Sixth, transition effects are hard to analyze, but could well impact the economy in ways that hurt the unemployed, those already at some disadvantage relative to the rest of us.

That is a potentially incredible list of effects that might all hurt the poor more than the rich.  The challenge for those of us who want to claim to do policy-relevant research, then, is to determine whether these fears are valid, and whether anything can be done about them – other than to forego environmental improvements!