Refuting Larry Summers: The Case Against Fuel Taxes

Larry Summers, a former Treasury Secretary and Harvard economist, writes in the Washington Post that “the case for carbon taxes has long been compelling. With the recent steep fall in oil prices and associated declines in other energy prices, it has become overwhelming.”  He notes that “when we drive our cars, heat our homes or use fossil fuels in more indirect ways, [we] create these costs without paying for them. It follows that we overuse these fuels.”

Once again, we hear the siren song of climate change.  This would be more compelling save that satellites measurements say the globe has not warmed in as much as 18 years and if the IPCC models had not, almost to the last, over-predicted warming.  Summers would be more persuasive if global sea ice were not at normal levels, and hurricanes, tornadoes, droughts and forest fires all within historical norms.  The data is simply unconvincing, and the rhetoric overblown.

But let us accept, for a moment, the argument that fuel taxes are a good thing.  Just how high a tax would Prof. Summers suggest?  How about $4 / gallon?  Would that not throw the US into a deep recession by creating a policy-driven oil shock?  Would it not lead to under-consumption?   Of course.  But $4 / gallon is, in fact, the fuel tax in most of Europe.  Would Summers then have us think that Europe is under-consuming oil? 

Statistical analysis suggests that it is.  Since 2005, when oil supply growth stalled, through 2013, the correlation between oil consumption and GDP growth was 0.95, that is, GDP and oil consumption growth moved virtually in lock-step together.   For purposes of comparison, the correlation between government deficit spending and GDP growth for these same countries was 0.11, with the lower the increase in debt, the higher increase in GDP growth!   And yet we hear so many economists calling for deficit spending, and nary a one calling for fuel tax relief.

Now, does GDP drive oil consumption, or does oil drive GDP?  Oil permeates our society, just as Summers points out.  It fuels our cars, heats our homes, moves the goods we consume, and provides materials and energy for manufacture and agriculture.  Oil is critical to prosperity and holds a virtual monopoly as a transportation fuel.  In many ways, oil is the principal enabler of modern civilization.

However, under ordinary circumstances, oil is readily available and supply responds to changes in demand.  GDP is the driver, and oil producers respond.  But not so after 2005.  From that time until the recent collapse of oil prices, oil was unaffordable for almost all the OECD countries, and consumption fell broadly in Japan, Europe, and until the surge of shale oil production from 2011, in the US.   But how these countries clung to consumption!  In the PIGS, for example, oil consumption fell an astounding 25-32% from 2005 to the present, and yet virtually every one of them was paying more for oil in 2014, as a share of GDP, than they were a decade ago. 

In the US, some claim that we have fallen out of love with our cars and the demographics mean we no longer need as much mobility.  And yet, gasoline and road diesel have fallen the least of all the petroleum product categories.  From 2005 to 2013, highway gasoline and diesel fell by 3%, but jet fuel fell by 14%, and home heating oil by nearly half.  If Americans fell out of love with their cars, they came to actively dislike flying and virtually renounced being warm.  But Larry Summers want them to heat their homes even less!

What do these societal responses tell us?  If people cannot afford to heat their homes, drive, or fly, then society is under true duress.  And we have a name for such periods: recession.  When oil consumption has been falling, the US and other countries are almost always in recession.  Except when they are suffering stagnation.  When has the US suffered stagnation?  During the late 1970’s and early 1980’s, during a period of high oil prices.  And again after 2005, and particularly after 2011, again during a period of high oil prices.    And this leads us to conclude that, when oil is unaffordable for advanced country consumers, their economies will struggle.  Even Larry Summers notes this: “If the United States had the same income distribution it had in 1979, the bottom 80 percent of the population would have $1 trillion — or $11,000 per family — more.”  That’s the year that per capita US oil consumption peaked: 1979.  And, according to Summers, so did the fortunes of the median American family.

Expensive oil, not a lack of aggregate demand, has been holding back the global economy.

And now oil is cheap—a stunning achievement of American entrepreneurship and private enterprise.  And Summers wants to tax this away, because Americans should not drive, fly or heat their homes.  At least not middle class Americans.

And let’s extend this thinking to Europe.  If oil is key to prosperity, and high oil prices hold back economic progress, then Europe’s sky-high fuel taxes are just killing their economies.  Fuel taxes are a--and possibly the--key driver of Eurosclerosis.  Rather than yet another round of monetary easing, European leaders could take the more obvious path: lower fuel taxes, and let their economies breathe.