A case for cutting fuel duty?

What, if any, should be the link between the price mechanism and “fairness”? Two issues raise this question.

One is that Royal Mail is planning a scheme to protect the poor from its price rises. The other is FairFuel UK’s campaign for a cut in fuel duty to offset rising petrol prices.

Conventional economics says both are bad ideas. It says:

The function of the price mechanism is to signal that some things - such as petrol or stamps - are becoming scarce or expensive and so people should economize upon them. Blunting these signals by tax cuts or subsidies to selected groups results in a misallocation of resources - over-consumption of stamps and petrol and, by implication, under-consumption of other things. 

The best way to protect the worst off from price rises is to raise their incomes, not to tweak prices. The price mechanism and redistribution are analytically (roughly) separate things.

But how strong is the argument now? Three things make me doubt it.

1. At a time of mass unemployment, minor misallocations of resources are very secondary issues; it takes a lot of Harberger triangles to fill an Okun gap. Any boost to spending power, which helps fill that Okun gap, should be welcomed.

2. The rise in oil prices might not entirely reflect the rational working of the price system, but rather speculation triggered by easy money.

3. It could be that lower fuel duty is the simplest and most effective response to the recessionary impact of higher oil prices.

The UK consumes 1.67mbd of oil. The $15pb price rise we’ve had so far this year would therefore cost consumers £5.8bn - just under 0.4% of GDP - if it persists for 12 months. This is equivalent to an unanticipated tax rise. What should the government do about this?

It is, of course, mere gibber to claim - as Osborne does - that the government can do nothing as it “has run out of money. ” In principle, a tax cut or benefit rise that doesn’t (greatly) affect relative prices would be a good way of offsetting the recessionary shock. But there are drawbacks to the obvious possibilities:

- An income tax cut might be partially saved, and would not help those who suffer from higher oil prices who aren’t in work - such as the unemployed and pensioners facing higher prices generally because of higher transport costs.

- A cut in VAT imposes administrative costs onto firms and does not greatly help those who face higher food prices  because of higher transport costs.

It might, then, be that a cut in fuel duty commends itself not on the grounds of fairness - most of those calling for it simply have an excessive sense of their own entitlements - but because it is one way of mitigating an adverse supply shock. 

Comments

[Frances Coppola]

Price signals are already distorted of course by the fact that something like two-thirds of the cost of petrol is duty. Petrol users pay more tax than people who don't use petrol. Therefore a cut in fuel duty is not a "subsidy", it is simply a reduction in the additional amount of tax that petrol users already pay. The exception would be a duty cut to particular types of user (such as disabled people) or to people in certain areas (such as Orkney and Shetland). This would indeed cause distortions - though these might be seen as socially useful ones.

I agree with you about the adverse affect of oil price rises. A brief study of the 1970s is sufficient to show just how economically destructive oil price rises can be. Cutting fuel duty would seem to be an obvious mitigating measure.

[Steve Williams]

'But how strong is the argument now?'

Extremely weak in the case of stamps, that's for sure. It's difficult to believe that poor people are frivolously wasting money on stamps, when nobody sends letters recreationally any more. So those stamps are being affixed to official documents and to pay utility bills, the sort of postal communication that if you don't do it, leads to extremely adverse consequences. It's necessary consumption, not discretionary consumption, so a subsidy for the poorest is fair.

[Greg]

Rather than subsidise car drivers, or heavy users of the mail, the government should target services that unemployed people use. Decrease bus fares, say.

Better still would be to transfer the 0.4% of GDP directly to the poor and let them choose how to spend it.

A fuel duty cut - any tinkering with prices - is political pandering dressed up in faux economese.

[Account Deleted]

The Royal Mail's sketchy plan talks about freezing stamp prices for families "of modest means". How, I wonder, are they going to identify these worthy citizens?

Will cheap stamps depend on having a Post Office card account? Is this in any way related to the Government awarding the contract for replacing Giro cheques to Citibank/PayPoint, which is likely to reduce the PO's passing trade?

It's interesting that the Royal Mail's success was built on the introduction of the penny post, a flat fee that replaced a multiplicity of different postage rates. Over time, that simplicity has been eroded by the introduction of different classes of service. Now we have the second degree: different classes for different classes.

[D]

Isn't this just pricing to market? If you're running an operation the size of RM you want to be able to sell high-margin to those who can pay that amount and high-volume low-margin to those who can't. It's the reason you have pensioner's concessionary rates and student discounts.

[dirigible]

"it takes a lot of Harberger triangles to fill an Okun gap"

What?

[guthrie]

The Royal mails difficulties are simply because they were looted by certain governments a while back instead of allowed to re-invest, and then banned from cross subsidising the universal mail servive from some more lucrative parcel markets, finally private companies without a universal obligation were encouraged to take over part of the royal mail work whilst still using the Royal mail to do the final delivery but pay them a ridiculously low price.
Basically it's a stitch up, just like the current police privatisation.

Keeping fuel duty high is necessary to help encourage efficiency in order to try and meet Co2 reduction targets.

[Keith]

Cutting fuel duty has no economic justification..Carbon based fuel is scarce and pollutes the environment. It seems logical to appropriate some of the consumer surplus from consumption of oil to the Treasury. Making public transport more available and cheaper is a more cost effective policy but requires a commitment to public investment politicians seem to lack.

The problem with the post office is as has been pointed out above that a universal service obligation and privatisation are probably in compatible. Cross subsidy can be seen as a benefit of traditional Nationalisation, or a defect, but for certain services to be available every where and to everyone may require it. Politicians have been far too willing to allow revenue streams to be hived off without considering the social implications.

[Blissex]

As usual, the single most important thing for the UK is the oil production and consumption graph here:

http://mazamascience.com/OilExport/output_en/Exports_BP_2011_oil_mtoe_GB_MZM_NONE_auto__.png

For net oil importers like the UK is now, high oil duties mean much better trade balances, and lower oil duties translate into more oil imports and thus more money to oil producers.

[Jim M.]

@ dirigible:

This may help! Or not.

* For economists under the age of 40, who may be less familiar with these archaic terms: A Harberger triangle is the area in a supply and demand diagram that measures the deadweight loss of taxation. An Okun's gap is the loss in output and employment when the economy falls below potential because of insufficient aggregate demand.

h/t G. Mankiw

[Leigh Caldwell]

To add a nuance to D's point, the stamps question (apart from straightforward income redistribution) can be seen as price discrimination. This is known to be efficient _where there are high fixed costs_ of providing a service, as it allows those who can afford more to pay a higher share of the fixed cost, opening the service up to a greater number of consumers and increasing total consumer surplus.

This is certainly the case for stamps, and probably not the case for petrol.

[Kristian]

The way duty is calculated needs to change! It should be tied to the quantity (volume) of the product (eg: 80p per litre), not a percentage of the market price (eg: 60% of the market price).

There's already VAT - a second tax component that tracks the retail price of fuel. Why is duty also tied to volatile market rates instead of volume of consumption?