The Ramsey Club vs the Pigou Club

by on March 2, 2007 at 7:19 am in Economics | Permalink

It’s quite surprising that the major consumers of the world’s oil have not been able to agree to an oil tax under the auspices of something like the Kyoto Protocol.  It’s surprising because if the major consumers of oil all increased taxes they would end up bearing very little of the burden. 

The result is a simple application of the theory of tax incidence.  The burden of a tax falls on those who can least afford to escape the tax.  The world’s demand for oil is inelastic but the supply is even more inelastic.  What is Saudi Arabia, for example, going to do with its oil except sell it?  The oil is already fetching a price well above cost so if there is a world tax on oil that’s like a tax on land – Saudi Arabian land to be precise – and a tax on land is born by land owners not by consumers.

Members of the Pigou Club should take note.  For the Pigou Club to work to alleviate global warming the Pigouvian tax must reduce the global consumption of oil (not just say US consumption) but with the supply of oil being very inelastic that’s not going to happen.  A tax could drive high-cost US producers out-of-business but the major world producers are going to keep selling even with a high tax. In other words, membership in the Pigou club has few privileges unless you can put the major producers under (does that advice sound familiar?)

If you want to tax Hugo Chavez, however, please do join the Ramsey Club.

1 Stephen Gordon March 2, 2007 at 8:41 am

It’s not clear that supply really is that inelastic, at least, not in the time horizons that matter for climate change policy. The second-largest reserves – the Alberta oil sands – are quite costly to develop, and they require high producer prices to justify production.

2 Ted Craig March 2, 2007 at 8:59 am

The best argument for moving from CAFE to a carbon tax is it is more transparent. Other than that, I’m not sure it has much of an effect. Europe has a high fuel tax and SUVs are the fastest growing vehicle class there.

3 B.H. March 2, 2007 at 11:41 am

We need to distinguish between ultimate reserves of oil (which are like Ricardian land) and extraction
of oil (which is like improvements to oil). A buyers’ cartel, a monopsony conspiracy, which is what
you are discussing, might be able to capture some real rents, but it would also reduce the incentive to
explore and drill. As older oil fields (inelastic short run supply) run dry, why open up new fields,
if they are only going to get tax heavily. That will reduce oil supply and greenhouse gases, to be sure,
but it would make petroleum very expensive to users in the long run.

This seems to be a dynamic, bilateral-cartel game theory problem with an uncertain exhaustible
resource, combined with global externalities and political rivalry. I am over my head here.

4 John Thacker March 2, 2007 at 1:31 pm

For the Pigou Club to work to alleviate global warming the Pigouvian tax must reduce the global consumption of oil (not just say US consumption) but with the supply of oil being very inelastic that’s not going to happen.

Well, I suppose one could say that the current US tax on oil is much lower than that of other rich countries, so a tax increase just here would be fairly close to the Ramsey Club idea anyway, especially given how much of it we consume. Now a tax on domestic *production* alone (as some in CA proposed recently) doesn’t make as much sense.

A lot of the countries with lower oil taxes are major oil producers who would obviously resist the Ramsey Club idea anyway.

5 rich March 2, 2007 at 3:40 pm

An Gas tax is already in place, this is just another way to raise taxes. I would be up for an increase in the gas tax if you agree to lower the Capital Gain tax from 15% down to 10%. Is it a deal? Or the real reason for this tax is to take more tax dollars from the common man? So you call it, is it about the money or the enviroment?

6 Eric Rasmusen March 3, 2007 at 11:27 am

Relate this idea to Tyler’s post on the desirability of a VAT. The carbon tax is a flat tax. If carbon is inelastically supplied, that’s even better—it’s an efficient tax (thus, Ramsey). See my post on this– but also Tyler Cowen’s political warning in his post above.

7 Bupa March 5, 2007 at 2:09 pm

Inelastic? When the price of oil falls, OPEC meets and agrees to sell less.

When the price of oil is high, OPEC meets and agrees to supply more.

I thought inelastic means price insensitve? I’m confused.

8 Murphy March 6, 2007 at 9:27 am

To Rich,

Do not lower capital gains taxes. That relieves the tax on those that can best afford it. Instead, raise the bottom point at which people begin paying income taxes. Those on the bottom of the income scale, spend all they earn. If they end up with more from paying lower income taxes, they will spend it, increasing consumption. Raise taxes on carbon fuels across the board, and lower income taxes for the lowest on the income scale. Works all around.

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