Oil: a case for tax cuts?

Raedwald ponders the impact of $200pb oil prices. My question is: if this were to happen, wouldn’t it be a case for loosening fiscal policy?
The case for doing so is simple. Higher oil prices are, in effect, a tax upon oil users - which, directly or indirectly, is everyone. So, shouldn’t this be offset by a loosening in orthodox fiscal policy?
I am NOT talking here about a fuel price stabilizer. The incidence of higher oil prices falls not just upon motorists, but upon workers who lose their jobs because of the lower demand caused by higher oil prices. The case, then, is for a general fiscal loosening - lower taxes or higher spending - so that aggregate economic activity is unaffected by the oil shock, whilst we encourage people to consume less of the devils' excrement.
Let’s do some numbers. Last year, the UK consumed just over 1.6 million barrels of oil a day. This means that every $10pb rise in the oil price, if sustained for 12 months, is equivalent to a £3.7bn tax rise. That’s 0.25% of GDP. The $200pb oil discussed by Raedwald would, then, be equivalent to a tax rise of 2.5% of GDP - enough to cause a recession even in normal times.
Of course, only an arrogant charlatan can claim to be certain where oil’s going. But there’s a risk here. Oil prices are so volatile that a 37% rise in the oil price - equivalent to a 0.9% of GDP tightening - is a one-in-six chance.
In principle, the recessionary effect of this could be offset by looser monetary policy.  But there are two arguments against using this. One is that there is a (slim?) chance that the temporary inflationary effect of higher oil prices will become a permanent one if it raises inflation expectations. Looser monetary policy would add to this danger. The other is that looser policy would have to take the form of quantitative easing, and the effectiveness of this in boosting real economic activity is doubtful.
Fiscal policy, then, is the more obvious way of offsetting an oil shock. A cut in VAT of one percentage point would put £4.1bn (pdf) into the economy, just offsetting the effect of a sustained $11pb rise in oil prices.
So, why shouldn’t fiscal policy loosen in the event of oil prices rising? Two obvious counter-arguments seem weak to me.
1. “It would add to the deficit.” True, but not obviously relevant. For one thing, the revenues of oil producers are likely to be recycled into western government bond markets; in the last five years, oil exporters' holdings of US Treasuries have almost trebled, to $218bn. This would hold borrowing costs down. Also, if oil does take off, there’ll probably be clamour for safe assets - equity prices at $200pb would not look pretty - and this high demand for index-linked gilts will make the deficit easily financeable.
2. “Loosening policy now would reduce credibility.” This matters only to the extent that it would raise gilt yields - and I suspect (though we can’t be sure) any adverse effect here would be offset by point 1. It could also be mitigated by ensuring that the fiscal loosening were temporary - for example, by a one-off cut in VAT.
A more valid counter-argument would be the Ricardian equivalence one; a temporary tax cut would have no stimulatory effect as people would merely anticipate higher future taxes. This argument, however, implies that a loosening would do no damage either.
There is, therefore, surely a case for considering using fiscal policy to offset an oil shock.

Comments

[Matthew]

Surely it depends whether it permanent or temporary (or as good as)? If the former then the country (as an oil importer) is simply worse off, and has to juggle with that at some point.

Also we still produce oil, we're now a net importer but only by about 300-400m barrels a day.

[chris]

You're right, Matthew. We can't avoid the fact that higher oil prices make us worse off. What we can do, though, is smooth out the impact. So rather than the pain all coming this year, fiscal policy can be used to spread it out over several years. Our future selves can thus help out our current ones.
I'm not sure it much matters who produces the oil - whether the money goes to owners of a North Sea field or to a Saudi one is (for moy purposes) not significant.

[Matthew]

Surely it matters? Not least the govt has more tax raising powers on domestic oil fields?

[David Ellis]

Tax on oil is the government taking a share of the profits. To cut this tax would dramatically cut the revenue raising capacity of the government which claims to be trying to pay off the `nation's credit card' and would stimulate the further importation of oil (further deterioration in balance of payments) which will have to be paid for by further loading the nation's credit card. A double whammy to the deficit.

Pehaps a better solution would be for the government to import the oil and sell it on and thereby pocket all of the profit in the difference between the wholesale and retail prices. It could then cut the price at the same time as increasing its income. A double positive.

[Ralph Musgrave]

I agree with Chris Dillow.

[The Silent Sceptic]

Does anyone have any idea where the optimal oil price for governmental revenue raising lies (in the Laffer curve sense)?

Clearly in the very short term we are prisoners to the oil price, but in the longer term our consumption would adapt. The question is at what point government revenue is maximised, and furthermore, does the current administration have an idea where this point is. And yet further, are they driving us towards it?