Tax Russian Oil

A tax on Russian oil would be paid mostly by Russia and would not greatly raise the price of oil. I often assign a question like this to my Econ 101 students. Ricardo Hausmann runs through the argument:

At first sight, imposing a tax on a good must increase its price, making energy even more expensive for Western consumers. Right? Wrong! At issue is something called tax incidence analysis, which is taught in basic microeconomics courses. A tax on a good, such as Russian oil, will affect both supply and demand, changing the good’s price. How much the price changes, and who bears the cost of the tax, depends on how sensitive both supply and demand are to the tax, or what economists call elasticity. The more elastic the demand, the more the producer bears the cost of the tax because consumers have more options. The more inelastic the supply, the more the producer – again – bears the tax, because it has fewer options.

Fortunately, this is precisely the situation the West now confronts. Demand for Russian oil is highly elastic, because consumers do not really care if the oil they use comes from Russia, the Gulf, or somewhere else. They are unwilling to pay more for Russian oil if other oil with similar properties is available. Hence, the price of Russian oil after tax is pinned down by the market price of all other oil.

At the same time, the supply of Russian oil is very inelastic, meaning that large changes in the price to the producer do not induce changes in supply. Here, the numbers are staggering. According to the Russian energy group Rosneft’s financial statements for 2021, the firm’s upstream operating costs are $2.70 per barrel. Likewise, Rystad Energy, a business-intelligence company, estimates the total variable cost of production of Russian oil (excluding taxes and capital costs) at $5.67 per barrel. Put differently, even if the oil price fell to $6 per barrel (it’s above $100 now), it would still be in Rosneft’s interest to keep pumping: Supply is truly inelastic in the short run.

…In other words, given very high demand elasticity and very low short-term supply elasticity, a tax on Russian oil would be paid essentially by Russia. Instead of being costly for the world, imposing such a tax would actually be profitable.

Addendum: Many people in the comments aren’t getting this so let me note that there is a big difference between taxing oil and taxing Russian oil, it’s only for the latter good that demand is relatively elastic.


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