Fortune issue: May 24, 1999
ECONOMICS
Gas Tax Now!
First Principles
By N. Gregory Mankiw
Many members of Congress have been pushing for a cut in income taxes, but they've been unsure how to pay for it. Fortunately, I've figured out an answer: with a tax increase. Let's cut income taxes by 10% and finance it with a 50-cent-per-gallon hike in the gasoline tax.
Yes, I know, this may sound like one of those pantywaist ideas only a pointy-headed Cambridge academic can love. But hear me out: By marrying the tax-cutting logic of the Republican right with the environmental concerns of the Democratic left, this might be a package that works for both.
Any would-be tax cutter faces a basic problem: Taxes are at a historical high as a percentage of national income, and the government is running a budget surplus, but cutting taxes somehow seems fiscally irresponsible. The explanation is that the impending retirement of the baby boom, together with the existing commitments to Social Security and Medicare, make the federal government's long-term fiscal position tenuous at best. The era of big government, rather than being over, as President Clinton once claimed, is very much with us.
The debate over tax policy, therefore, needs to go beyond arguments about the level of taxation and consider the mix. Unless we get serious about shrinking the role of government--which neither political party seems willing to do right now--taxes are going to remain high for the foreseeable future. Yet not all taxes are created equal. Some dampen prosperity by adversely changing the incentives people face, while others do the opposite.
Supply-siders have long argued that income taxes reduce the incentive to work and save, and thus depress economic growth. About this, they are exactly right. In the past, however, some supply-siders pushed their arguments to ridiculous extremes--claiming, for instance, that tax cuts would generate so much growth that they would be self-financing. The experience of the Reagan years put this theory to rest, but it should not cast doubt on the more modest view that lower income tax rates would be good for the economy.
Gasoline taxes, by contrast, actually improve incentives in various ways. If you have ever been stuck in bumper-to-bumper traffic, you have probably wished there were fewer cars on the road. A gasoline tax would help to accomplish this by encouraging people to car-pool, take public transportation, or live closer to work.
Another benefit of a rise in the gas tax would be a reduction in the size of vehicles. Whenever a person buys a large car or a sport-utility vehicle, he makes himself safer, but he puts his neighbors at risk. According to the National Highway Traffic Safety Administration, a person driving a typical car is five times more likely to die if hit by a sport-utility vehicle than if hit by another car. A gas tax is an indirect way of making people pay when their massive vehicles impose risk on others, which in turn makes them take account of this risk when choosing whether to buy some monster urban-assault vehicle or go with a sensible compact.
Environmentalists should also favor a higher gasoline tax. The burning of fossil fuels such as gasoline is widely believed to be the cause of global warming. Experts disagree about how dangerous this threat really is, and most economists who have studied the subject believe global warming would not be nearly the economic catastrophe that some environmentalists claim. But there is no doubt that a tax on gasoline, or on fossil fuels more generally, would help cut such emissions.
A common fear about the gasoline tax is that it might fall disproportionately on the poor. Yet that is not necessarily the case. A 1991 study by MIT economist James Poterba called "Is the Gasoline Tax Regressive?" concluded that "low-expenditure households devote a smaller share of their budget to gasoline than do their counterparts in the middle of the expenditure distribution." Moreover, if Congress were to use a hike in the gas tax to pay for a cut in income taxes, there is nothing to stop it from cutting tax rates on lower incomes more than on higher incomes.
Cutting income taxes while increasing gasoline taxes would lead to more rapid economic growth, less traffic congestion, safer roads, and reduced risk of global warming--all without jeopardizing long-term fiscal solvency. This may be the closest thing to a free lunch that economics has to offer.
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N. GREGORY MANKIW is an economics professor at Harvard and the author of Principles of Economics.