Forty-two reasons why fuel tax cuts and price caps just add fuel to the fire
András Lukács is is president of Clean Air Action Group (CAAG), a national association of Hungarian environmental NGOs which has been active for more than 30 years
Cross-posted from The Ecologist
Photo: Andreas Lehner/Flickr/Creative Commons
Keeping fuel prices low causes huge environmental and economic damage while providing no meaningful help for the poor.
A total of 18 European Union countries have reduced transport fuel taxes or introduced price caps on fuel and some have done both in response to the energy crisis.
The Hungarian government fixed the consumer price of petrol and diesel at HUF 480 or about €1.2 from November 2021 while market prices have been much higher and even exceeded HUF 800, for example. The government reduced the excise duty on fuels by HUF 25, or €0.06 even before that.
I have at least 42 arguments for why artificially reducing fuel prices by government intervention is the wrong response. The primary issue is that reducing fuel prices increases fuel consumption.
According to the European Environment Agency, an average fuel price increase of one per cent in the EU reduces fuel consumption by 0.1 per cent in the short term and 0.3 per cent in the longer term. The fuel tax cuts announced so far in the EU are estimated to lead to an additional 3.3 megatonnes of oil consumption.
The effect of the price decrease on fuel consumption is demonstrated by the Hungarian case, too: in the first eight months of 2022, Hungary consumed 14 per cent more transport fuel than in the same period of the previous year, despite the fact that the price of other products, especially food, has increased sharply, limiting the households’ disposable income.
The traffic-boosting effect of price-fixing is also demonstrated by the fact that businesses started to restrict the use of company cars in July 2022 when they were banned from purchasing fixed-price fuel. And in Slovakia, a survey found that 30 per cent of the population drive less since the fuel price hike, and almost six per cent of the respondents said they had switched to public transport either partially or completely because of the sudden price hike.
Ultimately, taxpayers will have to finance the losses from the fuel tax cuts/price-fixing in the form of higher public debt and/or deteriorating public services.
Reducing fuel prices will contribute to at least 41 serious problems by stimulating consumption:
- Carbon emissions increase even more, accelerating the onset of a global environmental catastrophe. At this point, we could end the article, but it is not uninteresting to mention the other problems, too.
- Other environmental problems increase, too, particularly air pollution, causing the premature deaths of more than 300 000 people in the EU every year, for which transport is responsible to a large extent.
- Traffic jams continue to increase, while already causing a loss in the EU equivalent to more than one per cent of its GDP.
- The Russian government’s revenues are increasing, helping to ensure that it can continue its aggression against Ukraine. The fuel tax cuts have increased Russia’s profits by €8.4 million daily. The European Union imported around 30 per cent of its crude oil supply from Russia until recently. Oil is by far the largest source of Russia’s export revenue: more than three times greater than that from gas exports. The EU paid Putin $285 million a day to satisfy its oil hunger. More than two-thirds of the EU’s oil and petroleum products are used for transport.
- If more oil revenues are received by oil producing countries then this often contributes to keeping dictatorships in power: they have more money to buy off their citizens so that they don’t have to democratise.
- The EU’s already very high energy dependence on other countries increases: 96 per cent of the oil used in the EU comes from imports.
- By using more oil, the EU’s energy security is put at a growing risk.
- In an ideal world market, money would flow to where it is best used. But we are far from that ideal, and one sad example is the EU’s encouragement of low-value-added oil extraction, which diverts resources away from higher-value-added economic activities.
- Although governments often justify fuel tax cuts on the grounds of fighting inflation, the fact is that, in the longer term, it is the fuel price cuts that lead to higher inflation. First of all, as mentioned above, they contribute to environmental degradation and the continuation of the war, and there is little else that causes higher inflation than these two factors. Both lead to many illnesses and deaths and the destruction of economic wealth.
- Increased demand for fuel also increases inflation. It is a truism among economists that the best antidote to inflation is price increases, which reduce demand. According to an analysis by the Hungarian National Bank on the effects of the fuel price cap, in Hungary the fuel price cap did result in higher inflation.
- People have more money left over for other products, so demand for these increases, which also fuels inflation.
- Higher demand also leads to higher import prices. The fact that 18 EU countries have already reduced the price of petrol and diesel for a certain amount of time and thus encouraged higher consumption may have pushed up the price of imported oil and oil products to a noticeable extent – only the recent EU embargo on Russian oil has reversed this process.
- Higher import prices mean even higher revenues for the Russian government. During the first 100 days of the war in Ukraine, Russia exported its oil to the European Union at an average price 60 per cent higher than during the previous year.
- Ultimately, taxpayers will have to finance the losses from the fuel tax cuts/price-fixing in the form of higher public debt and/or deteriorating public services. So, in the longer term, citizens will gain nothing from lower fuel prices in this respect either.
- The external balance of payments in EU countries deteriorates, making it increasingly difficult to finance public debt. For example, Hungary has recently run a record trade deficit due to higher energy import prices.
- Cutting fuel taxes worsens public finances: in the European Union, according to some estimates, the fuel tax cuts in 2022 cost EU taxpayers €52 billion. For the reasons explained in this article, the indirect losses to public finances are also huge, although difficult to quantify.
- Tax revenues from fossil fuels used in road transport have so far failed to cover the costs of road transport, according to the study Internalisation of transport external costs published on the European Commission’s website. In fact, the external costs of road transport are huge in all Member States. (External costs of transport are the costs that are incurred by transport users and are not paid for by them – at least not directly.) According to a study by the European Federation for Transport and Environment, in the European Union, the big oil companies have paid only 5 per cent of the €13 trillion in social and environmental damage they have caused so far.
- Cutting fuel taxes/fixing fuel prices gives an undue advantage to some businesses while putting others at a blatant disadvantage: companies that use a lot of fuel receive a lot of subsidies, which harms the market opportunities of more fuel-efficient companies, eg. road hauliers versus railways or local producers versus imports from distant locations). Some businesses might even go out of business through no fault of their own, while others can get rich through no merit of their own.
- Although fluctuations in world energy (and other) prices are often unpredictable, arbitrary state intervention makes economic life even less predictable.
- A voluntarist state economic policy undermines the effectiveness of legal institutions and causes legal uncertainty.
- Companies build in the prices the increased business uncertainties, further fuelling inflation.
- Wrong decisions are being made at state and municipal levels. For example, new roads are being built to accommodate growing vehicle traffic, while this would not be necessary if prices reflected the costs.
- Wrong decisions are made at company level. For example, a company may add extra parking spaces for their employees or customers.
- Wrong decisions are made at the individual level. For example, families move to a place with poor public transport, or if they live in a place with good public transport or cycling conditions, they choose to drive. This situation is illustrated by the fact that according to a recent survey, 30% of the motorists surveyed said that they would refrain from the daily use of a their car at a fuel price over HUF 850 (EUR 2.1) . However, today they do not ride a bike and drive a car instead despite the fact that, in contrast to car use, cycling has significant external benefits. (An external benefit is a benefit gained by an individual, firm, or even the society as a whole as a result of an economic transaction where they are not directly involved in the transaction.)
- Subsidising fuel prices works against innovation because with low fuel prices there is less incentive to develop alternative technologies.
- There are significant opportunity costs, i.e. the losses that arise because the subsidy is not provided for the most useful purpose. And it is hardly arguable that public money is better spent, for example, on health care or education than on subsidising passenger cars or road freight.
- The rich get much more support than the poor. According to household statistics, the richest 10 per cent of the EU population spends eight times more on fuel than the poorest 10% (see the figure). But the reality is much worse, as wealthier citizens often use company cars – with higher fuel consumption and mileage than average – but this is not reflected in household statistics. So, the people who get the most subsidies are those who don’t need them. This is a typical example of so-called perverse redistribution.
- Moreover, those who do not drive hardly receive any support. Although car use is much more polluting and much less fuel-efficient than most of its alternatives, from walking and cycling to public transport and shared mobility, users of these modes of transport in most countries receive little or no extra subsidy to compensate for their increased costs due to the energy price hike. Moreover, for example, in Hungary, public transport companies continued to purchase fuel at market prices, which made them even less competitive.
- If one country cuts its excise duty on fuel, it puts pressure on other countries to follow suit and participate in the race to the bottom.
- Increased price differentials between countries lead to a surge in cross-border fuel tourism: striking examplescould be witnessed during recent months.
- It is not only fuel tourism that takes off, but also smuggling, i.e. the phenomenon of taking much more than the amount permitted to be taken across borders outside the vehicle’s officially authorised fuel tank. During recent months there have been many cases of people smuggling fuel across the Hungarian border in canisters, sometimes even on trailers.
- Consumer prices which are lower than the market price are also a hotbed of the black economy in general. The former socialist countries have ample experience of the extent to which artificially low prices have contributed to the spread of the black economy. The recent fuel price cuts have also led to the emergence of illegal behaviour, including criminal offences, such as the theft of Hungarian number plates by foreign motorists. As another example, we mention that in Hungary since 30 July 2022, when company cars have been permitted to fill up only at market prices, there was a sudden surge in demand for fuel suction hoses and canisters, indicating that many people were filling up private cars at a discounted price and then transferring this fuel to company cars.
- It is practically impossible to enforce rules which contradict the principles of the free market. Already 1800 years ago Emperor Diocletian recognised this: he fixed the maximum prices of more than 1400 products and services, and those who broke the rules were to face the death penalty – however, this penalty could not be enforced, because if it would have been, a significant proportion of the population would have had to be executed.
- Unfounded interference in market processes leads to more and more distortions, which the government tries to avoid with more and more rules, making the whole system more and more complicated. This is what happened in Hungary after the introduction of price-fixing for fuel: the government introduced more and more detailed and complicated regulations to try to eliminate the anomalies caused by price-fixing.
- The newer and newer regulations have caused further problems, including protests abroad and even a row with the European Commission.
- Below-market prices can lead to shortages of the products concerned. This has already happened because of the price freeze in Hungary. As a result, the Hungarian oil company MOL has limited the amount of fuel that can be filled into the same car to 50 litres per day from 24 June 2022. Despite this, more and more petrol stations have been regularly running out of one type of fuel or another. Finally, in December 2022, the government was forced to scrap the cap on fuel prices after shortages sparked long queues at petrol stations.
- The oil companies certainly swallow part of the tax cuts. Since the oil market is dominated by a few giant companies with huge market power, the tax cuts are certainly not passed on in full to consumers. This phenomenon has already been observed when Germany temporarily reduced the VAT rate on fuel during the Covid-19 epidemic, and it has also been observed in 2022.
- It is hard to step back. It is a common experience that those who have benefited from some kind of financial concession expect the concession to continue, and at a political level it can be extremely difficult to return to the old price, even if the government intends to do so. A striking example of this phenomenon is parking fees: although virtually all experts believe that the abolition of free residential parking is a fundamental condition for ending the parking problems in many cities, politicians usually dare not implement it.
- The EU provides substantial support to Member States with climate objectives. Fuel price subsidies make a farce of these subsidies.
- Opinion polls show that the vast majority of European citizens are very concerned about climate change and environmental degradation. With fuel price fixing, this concern will become even more acute.
- Mendacious prices and lying at the state level go hand in hand. While consumers are informed about the reduced price of petrol and diesel in notices and at petrol stations, and the government boasts that it is protecting consumers, the latter are given little or no information about the dire consequences of the government’s measures that make reduced prices possible.
- The fuel price freezes/fuel tax cuts run against basic principles of the European Union as enshrined in the Treaty on the European Union and the Treaty on the Functioning of the European Union, as 24 NGOs have pointed out in a joint letter to the European Commission.
If prices do not reflect real costs, sooner or later this will lead to a severe economic downfall. We have already witnessed this in the case of the former Socialist countries, as Professor Ernst Ulrich von Weizsäcker stated: “Communism collapsed because it was not allowing prices to tell the economic truth.”
There are socially, economically, and environmentally satisfactory solutions. We need to adopt these without delay.