Mike Moffatt is a chemical industry consultant and a Lecturer in the Business, Economics and Public Policy (BEPP) group at the Richard Ivey School of Business
The Ontario NDP has proposed cutting four percentage points from the provincial portion of the HST on gasoline. The policy has received a great deal of attention for the savings it passes along to consumers, but this policy has a number of other effects which need to be considered.
A straight removal of four percentage points of tax from gasoline would, by itself, lower gasoline prices by 3.7 per cent. Not all of that tax reduction would go into the hands of consumers -- gasoline retailers could capture some of the reduction through raising their pre-tax price. Given how competitive the retail market for gasoline is, I estimate that 95 per cent of the reduction would be passed along to consumers, whereas 5 per cent would be captured by retailers. Taking that into account, consumers should expect the tax-included price of gasoline to fall by 95 per cent of 3.7 per cent, or roughly 3.5 per cent total. Industrial and business gasoline users would see no savings from the move, as any HST they pay is already refunded back to them.
When the price of any good falls, we should expect to see consumption of that good rise. Economists measure the magnitude of this phenomenon through a metric called price elasticity of demand, which measures how much consumption changes, in percentage terms, when the price changes by 1 per cent.
There have been more than 100 studies measuring the price elasticity of demand for gasoline, which were summarized in a meta-study by economist Molly Espey. Ms. Espey found that the average price elasticity for gasoline is -0.26 in the first year, and -0.58 over time. These figures imply that a 1 per cent change in the price of gasoline changes consumption by 0.26 per cent in the first year, and 0.58 per cent over several years. The negative sign indicates the two measures work in opposite directions -- when the price of gasoline rises, consumption is lowered, which is exactly what we would expect. This price effect on consumption is higher in the long-run, because in the long-run consumers have more options on how to respond to higher gasoline prices. If gas prices rise significantly, you are not likely to run out and buy a new car tomorrow. When you do eventually buy a new car a few years from now, however, you are likely to be more concerned about fuel efficiency if prices are higher.
Using these elasticity estimates, we can calculate that the NDP proposal, which would lower gasoline prices by 3.5 per cent, would see an increase in fuel consumption of roughly 0.9 per cent immediately and 2 per cent over time. If we consider a second study by Goodwin, Dargay and Hanly, this change in prices will increase traffic volume by roughly 0.4 per cent immediately and 1 per cent over time.
Given that Canada is trying to reduce greenhouse gas emmissions, and given the health concerns from traffic-related air pollution, I cannot think of a single reason why we should want to increase gasoline consumption by consumers, particularly at a cost of $500-million a year to the government. Stagnating wages and increased commodity costs are placing a burden on Ontarians, but that is best solved through increased HST rebates, not through reducing taxes on fossil fuels.
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