Are demand elasticities affected by politically determined tax levels? Simultaneous estimates of gasoline demand and price

Abstract

Raising the price of fossil fuels is a key component of any effective policy to deal with climate change. Just how effective such policies are is decided by the price elasticities of demand. Many papers have studied this without recognising that not only is there a demand side response: quantities are decided by the price but also there is a reverse causality: the level of consumption affects the political acceptability of the taxes which are the main component of the final price. Thus prices affect consumption and consumption levels, in turn, have an affect on taxes and thus consumer prices. This article estimates these functions simultaneously to show that there is indeed an effect on the demand elasticity.

Notes

¹ See Sterner (1990, 2007) or Graham and Gleister (2004) for an overview of models.

² When we assume that we effectively measure the effective tax as the difference between the domestic and international prices. Thus we ignore any small differences in profit margin for petrol stations and differences in transport costs between countries.

³ We strive for simplicity. The model could easily be made more complex to include further determinants of the tax rate and fuel demand, see Hammar et al. (2004) or Fredriksson (1997).

⁴ Asoline consumption is in 1000 metric tonnes.

⁵ Price is total end-use prices for households in US dollars using PPPs. It is weighted average of Premium Leaded, Regular Unleaded, Premium Unleaded.

⁶ International price for Rotterdam, are average of high and low quotes for spot purchases of oil products.

⁷ GDP is from National Accounts of OECD Countries, Volume 1, 2005 and converted using the yearly average 2000 purchasing power parities see Purchasing Power Parities and Real Expenditures, GK Results, Volume II, 1990, OECD 1993.

⁸ Data on number of cars from the International Road Federation (World Road Statistics). A few missing values were generated using exponential interpolation.