DP7161 Estimating the Effect of a Gasoline Tax on Carbon Emissions

Author(s): Lucas W Davis, Lutz Kilian
Publication Date: February 2009
Keyword(s): carbon tax, elasticity, gasoline consumption, gasoline tax, global warming, price endogeneity
JEL(s): C53
Programme Areas: Public Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=7161

Several policymakers and economists have proposed the adoption of a carbon tax in the United States. It is widely recognized that such a tax in practice must take the form of a tax on the consumption of energy products such as gasoline. Although a large existing literature examines the sensitivity of gasoline consumption to changes in price, these estimates may not be appropriate for evaluating the effectiveness of such a tax. First, most of these studies fail to address the endogeneity of gasoline prices. Second, the responsiveness of gasoline consumption to a change in tax may differ from the responsiveness of consumption to an average change in price. We address these challenges using a variety of methods including traditional single-equation regression models, estimated by least squares or instrumental variables methods, and structural vector autoregressions. We compare the results from these approaches, highlighting the advantages and disadvantages of each. Our preferred approach exploits the historical variation in U.S. federal and state gasoline taxes. Our most credible estimates imply that a 10 cent per gallon increase in the gasoline tax would reduce U.S. gasoline consumption by 4% and reduce total U.S. carbon emissions by about 1%. We conclude that there is no statistical evidence that a gasoline tax increase of the magnitude recently contemplated by policymakers would reduce carbon emissions enough to reach the targets described by the United Nation?s Intergovernmental Panel on Climate Change in 2007.