Some Thoughts on Tradeable Gasoline Rights

Cite this Article
Thomas A. Lambert, Some Thoughts on Tradeable Gasoline Rights, Truth on the Market (June 06, 2006),

Marty Feldstein has an interesting idea about how to reduce America’s oil consumption, but I’m not quite ready to sign on.

In an op-ed in yesterday’s WSJ, Feldstein proposed a “cap and trade� system for gasoline. Under the proposed system, the government would set a limit on the amount of gasoline Americans could purchase annually and would then allocate rights to purchase that amount of gasoline. Each household would receive some number of tradeable gasoline rights (“TGRs�), and consumers would have to “spend� one right (in addition to the actual cash purchase price) for each gallon of gasoline purchased.

Feldstein argues that his system, which resembles the emissions trading system that governs sulphur dioxide emissions under the Clean Air Act, would create incentives for Americans to reduce their gasoline consumption and would “raise[] the income of a majority of households,� which could conserve gasoline and sell their excess TGRs to high-volume consumers such as businesses that use trucks.

While I’m all in favor of utilizing market mechanisms in regulatory programs (e.g., the Clean Air Act’s sulphur dioxide program), I’m not convinced Feldstein’s idea is a good one.

Most importantly, Feldstein never tells us why we need government intervention here at all. High gasoline prices already provide an incentive to reduce gasoline consumption, and households that conserve are already rewarded for doing so. As our current situation “worsens� (i.e., as gasoline prices increase further), these incentives and rewards will grow without government intervention.

Now, Feldstein may believe the price mechanism doesn’t provide strong enough incentives to conserve. That would be true if gasoline consumption involved negative externalities that are not already accounted for by existing gasoline taxes (more about this below). But federal and state gasoline taxes, though smaller than those in Europe, are pretty sizeable, and Feldstein offers no evidence that they are too small to account for any externalities involved in gasoline consumption. Thus, Feldstein’s proposal seems to lack a justification.

But even if we assume that gasoline consumption involves negative externalities that are not already addressed by existing taxes, is Feldstein’s proposal the best way to reduce consumption to optimal levels? Maybe not.

First, consider the goal of a regulation governing fuel consumption. Like most other economic activities, consumption of gasoline involves decreasing marginal benefits (i.e., the per-gallon benefit of gasoline consumption decreases as individuals consume gasoline for less important purposes) and increasing marginal costs (i.e., the per-gallon cost of gasoline consumption increases as gasoline becomes more difficult to produce). The optimal amount of gasoline consumption would be that at which the marginal cost and marginal benefit of consumption are equal. Consumption of each gallon beyond that point would create costs in excess of benefits; stopping consumption before that point would forego a net benefit. Policymakers’ goal, then, should be to get us to this “bliss point� at which marginal costs equal marginal benefits.

Absent externalities (i.e., if individual consumers bore all the costs and benefits of their consumption decisions), individual economic actors attempting to maximize their welfare would consume to the bliss point without government intervention. If there are negative externalities, though, consumers will avoid some of the marginal costs of their consumption decisions and will thus tend to consume “too much� – i.e., to a point beyond the bliss point.

So how could policymakers motivate consumption to the bliss point? They would have at least two options. One would be Feldstein’s: Set the total level of consumption to equal the bliss point, allocate consumption rights equal (in the aggregate) to that point, and allow individuals to trade those rights among themselves. Another option would be to tax gasoline consumption, setting the tax equal to the cost the consumer is not personally bearing when she makes her consumption decision (i.e., to the size of the externality).

Each regulatory option presents difficulties. The tax option requires regulators to estimate the degree of divergence between individual marginal cost and total marginal cost. Such estimation is obviously difficult and, in practice, would undoubtedly involve a bit of guesswork. Feldstein’s cap-and-trade approach would not require such estimation, but it would require policymakers to make equally – or perhaps more – difficult decisions. First, they’d have to determine exactly where the bliss point occurs (i.e., at what point should we cap total gasoline consumption?). In addition, they’d have to determine how to allocate consumption rights initially. Coase tells us that the ultimate allocation probably doesn’t matter from an efficiency standpoint (assuming that bargaining costs are sufficiently low, as Feldstein suggests they would be), but the initial allocation issue does raise difficult distributional questions that would undoubtedly generate lots of political wrangling and the associated deadweight loss.

So which approach is superior? That’s a tough question. At this point, I’d support neither, for I’m not convinced (and Feldstein did nothing to convince me) that our total consumption of gasoline is beyond the bliss point – or, put differently, that gasoline consumption involves externalities that are not accounted for by the sizeable taxes already in place.

If I were convinced that substantial externalities existed, I might favor Feldstein’s proposal over a tax system. It would likely involve greater administrative costs, for estimating the bliss point and determining how to allocate rights is likely more difficult than estimating the size of the externality. Critically, though, it would not increase the revenue of the government, which tends to respond to every revenue increase with an even greater degree of spending on wasteful social programs.

In the end, I suspect that the revenue-neutral effect of a cap-and-trade system is what ultimately persuades Feldstein, who says his “best guess is that the increased revenue from a higher gasoline tax would be … likely to finance additional government spending, just as it does in Europe.� God forbid.