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COLUMNISTS
TODAY'S STORIES
06.01.2009
Breaking The Boom-Bust Oil Cycle

Jason E. Bordoff is Policy Director of the Brookings Institution's Hamilton Project and Gilbert E. Metcalf is Professor of Economics at Tufts University.

Gas is cheap again, and that's a mixed blessing. On the one hand, the drop in gas prices from their summer peak of more than $4 per gallon has put about $300 billion back in the pockets of U.S. consumers. But lower prices, projected to drop to $40 per barrel by the spring, also mean more driving and more oil consumption. That will, in turn, send more dollars overseas, bolster nations that are hostile to U.S. interests, and increase our economy's vulnerability to oil price shocks. Not to mention that oil consumption contributes one-third of U.S. greenhouse-gas emissions each year.

Low oil prices also take the wind out of the sails of alternative-energy ventures, which would be unfortunate because, while oil prices are low right now, they won't stay that way. Once we move past the current global recession, prices will shoot back up, thanks to the demand shock from rapid economic growth and supply constraints caused by underinvestment. Tighter supplies will also mean greater price volatility down the road.

Faced with this reality, policymakers need to take measures now, while prices are low, to encourage both conservation and development of alternative energy sources. But what are the options? A gasoline tax is a hard sell politically and ignores the 35 percent of oil consumed in the United States in forms other than gasoline. Moreover, a gas tax won't directly reduce price volatility-it will only add to the pain of the next oil price spike. Others have proposed a price floor on oil, but that has an element of arbitrariness to it: There's no reason consumers should enjoy all the benefits of market price declines until some random price point, and none of the benefits beyond that point.

As an alternative, we propose a variable oil security charge that's phased in gradually over four years. The charge would rise when oil prices go down and decline when they go up. The precise formula could be negotiated, but we suggest a 40-40-40 approach: a charge of $40 per barrel (roughly $1/gallon at the pump) if the price of oil goes $40 per barrel or less, which declines by 40 cents for each dollar increase in the price of oil until the market price reaches $140 per barrel (just shy of last summer's record price). After that, the charge would be zero.

A sliding security charge provides several benefits. Once it is phased in, the variable approach mitigates the economic pain of an oil security charge by rising only as oil prices go down. (Research into what economists call "loss aversion" shows that the pain of foregoing a dollar's gain is significantly less than the pain of giving up a dollar.) A variable oil security charge would also act as an automatic stabilizer for the economy. Rising oil prices tend to slow economic growth, while falling prices act as a stimulant to the economy. Our oil security charge declines when prices rise and so acts as a fiscal stimulus to offset the negative impacts of oil price increases. And the oil security charge increases as oil prices fall, preventing the sharp increase in oil consumption that can contribute to an overheated economy.

A variable charge would also smooth oil price volatility and enable consumers and firms to better plan for the future. The Big Three automakers are suffering, in part, because they built profitable but fuel-inefficient cars when gas was cheap. When prices rose, demand for those cars plummeted. Automakers could develop products with greater confidence if they knew that gas prices wouldn't fall so rapidly when oil prices plummet, as they have in the past few months. The oil security charge would also provide a strong, stable price signal to encourage both conservation and alternatives to oil. And reduced oil demand in the United States would lower prices worldwide—as a result, we estimate that 15 cents out of every dollar of the charge would actually be paid by oil producers through lower prices. In turn, reduced demand would mean fewer U.S. dollars sent overseas, and more revenue generated here at home. It's just the policy we need to break the vicious cycle of oil boom and bust.

--Jason E. Bordoff and Gilbert E. Metcalf

Posted: Tuesday, January 06, 2009 8:21 PM with 5 comment(s)

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ataylor said:

Glad to see it's taken us only 20+ years to suggest the Danish plan - raise gas taxes when the price of crude drops, level off the taxes when the price rises.  They could have simply said, "Cheap gas for everyone!" when the Scandinavian countries hit the jackpot in the North Sea.  Instead, now, their roads and bridges are in decent shape, their cars are very fuel efficient, people think twice about driving, there are no wild price gyrations, and they have greatly reduced their dependence on foreign oil.  (Not to mention their windmills.)

January 7, 2009 1:08 PM

gshiwenwu said:

I don't think you have to worry about low oil prices.  They will rise again shortly to $70 to $100 per barrel as a minimum.  Over the next decade they will rise more due to the abrupt decrease in investment in new and secondary production that will follow the current bust in oil prices.  Furthermore, production is declining, and will continue to decline, in Russia, Venezuela, Mexico, Iran and Nigeria because the governments of those countires are siphoning off the money from oil production to satisfy other needs or to line the pockets of the rulers and their cronies. If you want to reduce usage, a simple carbon tax would be much more effective and easier to administer.  

January 7, 2009 11:11 PM

jwl2672 said:

Stop stealing the Weekly Standard's ingenious idea for a net-zero gas tax that increases gas prices by $3 per gallon and refunds the difference to workers and the aged through an immediate weekly tax break or increase in Social Security.

www.weeklystandard.com/.../949rsrgi.asp

January 9, 2009 3:08 PM

Brad Plumer said:

jwl2672--Krauthammer is hardly the first person to discuss a gas tax/payroll tax swap, and in any case, Bordoff and Metcalf are proposing something different, as you'd see if you read the post.

January 9, 2009 3:42 PM

Environment and Energy said:

Just five months ago, as the global economy was crumbling, oil prices plummeted to $30 per barrel. And

June 4, 2009 4:01 PM