1. Skip to navigation
  2. Skip to content
  3. Skip to sidebar

The Ludwig von Mises Institute

Advancing Austrian Economics, Liberty, and Peace

Advancing the scholarship of liberty in the tradition of the Austrian School

Search Mises.org

Fallacies of the Oil Tax

Mises Daily: Tuesday, November 21, 2000 by

A
A

Hal Varian, whose mathematical textbook has been the bane of economics graduate students for many years, has now weighed in on a solution to our oil problems: increase the federal tax on gasoline. In a recent New York Times op-ed, Varian says that a stiff, new tax on gas will discourage motorists from driving, which would mean we would use less gasoline and, ostensibly, conserve precious fuel.

Thus, we have what supposedly is one of the "best minds" in economics demonstrating not only the statist bias that permeates the economics profession but also his appalling ignorance of how markets work for factors of production. While politicians and economists will hail his idea, in reality, it is nothing more than a prescription for needlessly lowering our standard of living and further disrupting oil markets. A scheme to eliminate U.S. "dependence" upon oil from OPEC nations would ultimately force American oil producers to purchase even more petroleum from overseas.

First, let us examine how such a tax is supposed to work. Next, I will explain why this tax would distort structures of production and result in further damage to domestic oil production. What we will find is that Varian takes a kernel of truth – that higher prices for fuel will mean people will purchase less of it – and wraps it in the falsehood that government best "protects" natural resources.

According the Varian, the logic is simple. A stiff, new tax on gasoline will make the product more expensive, which means people at some point will purchase less of it. If people purchase less gasoline at the present, then the demand for petroleum will fall. If demand for crude oil falls, then less will be used more, thus saving oil for future generations.

However, Solomon’s logic has some huge holes that are uncovered when one applies the analysis of Austrian Economics. Varian operates according to an inferior set of tools that gives an incomplete picture of exchange and production and these tools literally invite wrongheaded policy prescriptions.

First, and most important, Varian seems to have no concept of the importance of private ownership of the factors of production. His infamous text, while literally swimming in multi-variable calculus, devotes one sentence to property rights (p. 435), and that has to deal with the issue of externalities. In the area of decisions regarding production, Varian says nothing about ownership of productive inputs and, perhaps, for good reason. According to most mainstream economists, it matters not a whit whether factors of production are owned by government or by private individuals. In fact, the bias often leans toward government ownership, since it is believed that because government does not try to make a profit, it will be less reckless in using those resources.

Even if private individuals own factors of production, many economists believe that government should strongly regulate their use in order to ensure that individuals do not "waste" them. In the case of oil, mainstream economists believe that oil producers and clueless consumers will gobble up all of the fuel in the present, leaving nothing for future generations who will have to struggle with cold houses and no private personal transportation (which, in actuality, is what the left wants, anyway). Forcing consumers to pay higher prices now through new taxation will solve this problem, Varian and his colleagues believe.

As Ludwig von Mises and Murray Rothbard have pointed out, however, is that private ownership of factors of production is essential in order to perform needed economic calculation. This was the heart of the Socialist Calculation Debate between Mises and the rest of the economics profession in the late 1930s. (The profession, of course, declared Mises’ opponent Oskar Lange the winner in his contention that government ownership of production would actually work more efficiently than private ownership.)

In the case of the Varian Tax, government would not own the factors of production outright, but would certainly be indirectly controlling their use. That is because a new tax on gasoline would affect – directly and indirectly – the value of each of the factors of production used in the making of gasoline.

The entire new gasoline tax, contrary to popular belief, would not be passed onto consumers. For example, if the government mandated a 50-cent tax on gasoline, the price of gas would not necessarily rise by 50 cents. While prices would increase substantially, they would certainly rise by less than the tax, which would mean that retailers would find their real returns shrinking. That is, after the tax were levied, retailers would discover that their personal returns would be less than they had been before the implementation of the tax.

Lower prices for the retailers would mean lower revenues and less profitability, and given that the value of the factors of production is derived from the value of the final product they create (the consumer good), the worth of the factors of production that go into the making of gasoline would also be depressed.

Furthermore, because the oil refining process allows some leeway in making different products from petroleum, production would be diverted from making gasoline to other products such as petrochemicals, nylon, and other synthetics. The increased supply of those products would force down their prices as well.

Ironically, such a tax would hinder exploration and drilling for oil in this country, as the lower real prices for oil would make such actions less profitable. Instead, oil companies would find themselves purchasing increasing amounts of oil from OPEC nations. Such a result would be the opposite of what the tax was intended to do.

The problem here is that Varian wants the government to "play market" when it comes to setting prices. In a free market, a high price – and high profits – for something sends a signal to other producers to enter the market. Such action will both lower the price to consumers as more goods are created and, at the same time, bid up prices paid to the relevant factors of production.

In the case of using a tax to increase prices, the opposite would occur. The high tax would drive producers and factors of production out of the market. As a result, people would be forced to seek out substitutes that in ordinary circumstances they would not wish to purchase, thus needlessly reducing standards of living for millions of people.

Despite the charge made by mainstream economists and other leftists that markets waste resources, the opposite is true. There is no better way to gauge the true value of a resource than to allow market participants to determine what resource will be used, and how it will be priced. In addition to setting the use for resources at the present time, the free market also provides the best way to accurately price resources for the future.

While Varian’s proposal may seem attractive to some economists and the political classes, it is actually nothing more than a pig-in-a-poke. In the name of conservation, it promotes waste, and in the name of efficiency, it promotes the dead hand of state control over the lives of individuals.

--------

William Anderson (send him mail), is a former Mises Institute scholarship student who now teaches economics at North Greenville College. See Anderson's Daily Article Archive