How a Price-Smoothing Oil Tax Could Help Make This the Last Oil Price Shock

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Oil price volatility is highly disruptive to the economy. The disruption could be minimized by a variable oil tax that prevented the price from falling through a given floor, but did not apply when oil prices approached a peak.

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How a Price-Smoothing Oil Tax Could Help Make This the Last Oil Price Shock

  1. More Slides from Ed Dolan’s Econ Blog http://dolanecon.blogspot.com/ How a Price-Smoothing Oil Tax Could Help Make This the Last Oil Price Shock Posted March 1, 2011 An updated version of this presentation was posted November 13, 2014 Terms of Use: These slides are made available under Creative Commons License Attribution—Share Alike 3.0 . You are free to use these slides as a resource for your economics classes together with whatever textbook you are using. If you like the slides, you may also want to take a look at my textbook, Introduction to Economics, from BVT Publishers.
  2. Oil Prices Spike Yet Again  Events in Libya and elsewhere in the Middle East have sent oil prices above the $100 mark yet again  Does the cycle of oil price shocks have to repeat endlessly, or is there a way for consuming nations to protect themselves? Photo source: William Murphy, http://commons.wikimedia.org/wiki/File:Libyans_In_Dublin_March_In_Pro test_Against_Gadaffi.jpg Posted Mar. 1, 2011 on Ed Dolan’s Econ Blog http://dolanecon.blogspot.com
  3. How Oil Producers Protect Themselves  Producers like Norway, Russia, and Saudi Arabia have learned to protect themselves from the curse of oil price volatility  They do so using national wealth funds that build up when prices are high and run down when prices are low  Consuming countries have no such protection Strategic oil reserves only provide short-term protection against physical supply interruptions They do little to mitigate price volatility A Norwegian Oil Platform Under Construction Photo source” Ranveig http://commons.wikimedia.org/wiki/File:Oil_platform_Norway_new.jpg Posted Mar. 1, 2011 on Ed Dolan’s Econ Blog http://dolanecon.blogspot.com
  4. How a Price-Smoothing Oil Tax Would Work  A price-smoothing oil tax could reduce swings in oil prices for consuming countries  Such a tax would begin by setting a floor oil price X  When the world price P falls below X, a tax of P-X would make up the difference  When the world price rises above X, the tax would be zero Photo source: http://commons.wikimedia.org/wiki/File:Gas-pump-Indiana-USA.jpg Posted Mar. 1, 2011 on Ed Dolan’s Econ Blog http://dolanecon.blogspot.com
  5. An Oil Tax would Enhance National Security  When world oil prices are high, money flows to many producers who are corrupt, undemocratic, or anti- American  An oil tax would insert a wedge between the US price and the world price  Pushing the US price higher would encourage conservation and investment in alternative energy  Pushing the world price lower would deprive hostile countries of revenue Photo source:http://commons.wikimedia.org/wiki/File:Marines-with-sniper-rifle-2.jpg Posted Mar. 1, 2011 on Ed Dolan’s Econ Blog http://dolanecon.blogspot.com
  6. An Oil Tax would Protect the Environment  High prices encourage investments in conservation and alternative energy, but there is a risk  If prices fall again, the investments might not pay off  By putting a lower limit on the price, a variable, price-smoothing oil tax would reduce the risk of green investment by consumers and businesses Photo source: Massimo Caratinella http://commons.wikimedia.org/wiki/File:LosAngelesSmog.jpg Posted Mar. 1, 2011 on Ed Dolan’s Econ Blog http://dolanecon.blogspot.com
  7. A Variable Oil Tax Could Help Protect Against Recession  Oil price spikes have often be followed by recessions in the United States  High oil prices reduce spending on other goods and services and undermine consumer confidence  A tax-smoothing oil price would help reduce the volatility of oil prices Economist James Hamilton has written extensively on the effects of oil price shocks on the US economy. See his recent blog post on Econbrowser for some data and references Posted Mar. 1, 2011 on Ed Dolan’s Econ Blog http://dolanecon.blogspot.com
  8. An Oil Tax Could Help Solve Deficit Problems No one likes taxes, but given the large US budget deficit, some taxes are necessary. A variable, price-smoothing oil tax would raise revenue that could be used, in part, to reduce the deficit, and in part to lower tax rates on personal or corporate income taxes Posted Mar. 1, 2011 on Ed Dolan’s Econ Blog http://dolanecon.blogspot.com
  9. The Bottom Line The bottom line:  We do not have to accept the damage to national security, the environment, and the economy caused by extreme oil price volatility  A variable, price-smoothing oil tax could mitigate extreme swings in oil prices and improve incentives for investment in conservation and alternative energy  The best time to introduce such a tax is now, when prices are already high Posted Mar. 1, 2011 on Ed Dolan’s Econ Blog http://dolanecon.blogspot.com
  10. The Bottom Line The bottom line:  We do not have to accept the damage to national security, the environment, and the economy caused by extreme oil price volatility  A variable, price-smoothing oil tax could mitigate extreme swings in oil prices and improve incentives for investment in conservation and alternative energy  The best time to introduce such a tax is now, when prices are already high Posted Mar. 1, 2011 on Ed Dolan’s Econ Blog http://dolanecon.blogspot.com

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