An Energy Consumption Paradox and Tax Consequences

The New York Times has an interesting article today about how increased energy efficiency of a wide range of products can lead to increased consumption of energy and materials - a paradox.

But a growing number of economists say that the environmental benefits of energy efficiency have been oversold. Paradoxically, there could even be more emissions as a result of some improvements in energy efficiency, these economists say.

The problem is known as the energy rebound effect. While there’s no doubt that fuel-efficient cars burn less gasoline per mile, the lower cost at the pump tends to encourage extra driving. There’s also an indirect rebound effect as drivers use the money they save on gasoline to buy other things that produce greenhouse emissions, like new electronic gadgets or vacation trips on fuel-burning planes.

Some of the biggest rebound effects occur when new economic activity results from energy-efficient technologies that reduce the cost of making products like steel or generating electricity. In some cases, the overall result can be what’s called “backfire”: more energy use than would have occurred without the improved efficiency.

Another term for backfire is the Jevons Paradox, named after a 19th-century British economist who observed that while the steam engine extracted energy more efficiently from coal, it also stimulated so much economic growth that coal consumption increased. That paradox was mostly ignored by modern environmentalists, who have argued that rebound effects are much smaller today.

But economists keep finding contrary evidence. When Britain’s UK Energy Research Center reviewed more than 500 studies on the subject, it rejected the assumption that rebound effects were small enough to be disregarded. The author of the 2007 report, Steve Sorrell, noted that these effects could, in some circumstances, “potentially increase energy consumption in the long term.”

What does this have to do with tax policy?

Everything. Think about how many products are taxed, whether it is motor fuels or energy consumption or tobacco products and alcoholic beverages (sin taxes). Sometimes the taxes are imposed to change behaviors (sin taxes) and other times they're imposed to generate revenues for specific purposes - think motor fuel taxes for funding infrastructure.

Well, now that vehicles are more efficient, the fuel taxes do not generate the revenues they once did. To maintain the same level of revenues, taxing authorities and budget officials have to hope that either drivers drive more or taxes have to be raised to fill the gap. As the price of oil has increased, pressure is exerted on reducing the consumption even further so the revenue generated declines - leaving a gap in budgets.

The same phenomenon occurs with home heating and electricity - increased efficiency of HVAC, appliances, and lighting systems means that tax revenues decline. The only way to offset the declines is to either increase the taxes or hope that users find other ways to expend energy (home theater systems, computers and more gadgets that require electricity).

Some states and even some in Congress are looking at shifting from these forms consumption taxes - although that too is going to cause great consternation. Imposing per-mile driving taxes rather than fuel taxes (such that a driver is taxed based on the miles driven in a given period rather than on the motor fuel consumed - which would greatly decline if electric or near electric vehicles are widely adopted) has led to pushback over how such a system would be managed and how it would lead to greater governmental control.

A curious finding when examining motor fuel tax revenues for the nation over the past 30 years is that New Jersey took in more tax revenue than New York despite having a far lower tax rate. That's pretty much been the case since 2002 - so that would tend to discount the claim that the tax rate is the issue but rather that when users have an option to purchase motor fuel at a lower price, they'll do so at a greater quantity. It's a matter of economics. If you have the option of filling up your tank for 15-20 cents less per gallon by driving a couple of miles into New Jersey, you'll do so since you'll save a couple of bucks per tank filled. That's revenue New York (and Pennsylvania) loses to New Jersey where those states have higher fuel taxes.

The current tax structure highlights the problems with consumption taxes, and how greater efficiencies can lead to lower revenues. Yet, alternatives are themselves a form of consumption tax that may lead to unintended consequences.

Such are the perils of an out-of-date tax policy.