Excise taxes and policy incoherence in New Zealand

Ok, I’m coming permanently out of “proper blogging” retirement. Why?

The New Zealand government has decided to cut fuel taxes and RUC due to the “cost of living crisis” in New Zealand – egged on by the opposition and a range of New Zealand thinktanks and “thought leaders”. When a similar spike occurred in 2008 such a suggestion would have been ridiculed for being the ill thought out and incoherent policy it is – now it is the sort of stuff that gets a cross-party consensus and loud repeated cheers from the tens of New Zealand Twitterazzi.

Honestly, what is wrong with policy debate in New Zealand – when did we go from caring about policy outcomes and trade-offs to treating every policy decision as something that must be done urgently as if we are in the middle of an episode of West Wing. I mean, read the analysis in the two front-page articles on Stuff (here and here) – it is all politics and no consideration of trade-offs.

Want to understand why I see things this way – click the tab and read on.

What are these taxes in the first place?

The excise tax and RUC that have been cut are a fee that is intended to pay for costs imposed due to the consumption of fuel – be it a reduction in the quality of the road, environmental costs, or other potential negative spillovers from road use. In this way, the purpose and intent of these taxes is to ensure a user-pays device for road use – and ensure that individuals internalise these costs when making their choice about fuel consumption.

In so far as these taxes do represent these costs, then any reduction implies that individuals do not face the full cost of their decision to consume “the road” or “fuel”. As a result, they will tend to consume more of this item then if they faced the full cost, and the cost of that is bourn by others – the general taxpayer (and non-fuel consumer) who will have to pay more through higher taxes, the individuals that experience higher environmental degradation in their community etc.

How these costs are allocated may be complex and opaque, but if this was truly an externality tax then these costs do exist – and if its not, there is a question about whether the tax should have been there in the first place. So I’ll take it as given that it was at the right level.

The rationale for cutting the fuel tax – distributional concerns

The spike in energy prices due to rising global demand and the Russian invasion of Ukraine reduces the real income of those who consume a lot of energy by more than those who consume little energy.

If this was perceived as unfair, there could be a justifiable desire to support those who are more heavily hurt by the spike in fuel prices. In this way, a cut in fuel taxes feels like a natural solution.

But lets think about this a little more. The spike in fuel prices is occurring because fuel is more scarce – the increase in prices tells us that this item is more scarce and we should ration it. As a result, the higher price is a mechanism for incentivising the reduced use of fuel at a time when it is more scarce.

Removing the tax arbitrarily blunts this mechanism – and as noted in the discussion about the rationale of the initial tax, it does so by simply making other people who are not consuming the fuel pay part of the price of it.

Furthermore, alongside other policies that are trying to price the externality associated with fuel consumption this policy is directly inconsistent – you can’t increase the price and cut it at the same time. Flicking together inconsistent policies that push a price in opposite direction will simply lead to wasteful expenses on bureaucracy and avoidance while achieving nothing.

If we could observe people who have previously consumed a lot of fuel, and if we knew they would have continued to consume a lot of fuel in the absence of the price spike, a better solution would be to send these people a direct deposit for some sum of money and leave prices as they are.

Now we can’t observe that – and it also might not be the distributional concern that we as a society care about. After all someone with significant wealth or income may be able to more comfortably weather an increase in costs (or substitute between activities) than a low income individual. However, what we could do is ask ourselves who is made vulnerable from the spike in fuel prices and ensure that they are supported.

A focus on protecting those at the bottom, rather than trying to generally prevent prices from changing, means we don’t need to ask questions such as “is a fuel tax regressive” (Poterba 1991 is quite interesting on this issue) as it is only part of a package – it just means we need to consider the costs faced by those in the most precarious situations when providing appropriate income support.

The spike in fuel costs is not without historic precedent – however the level of price inflation without wage growth (and thereby the decline in real labour income) is. This also indicates that the issue is broader than fuel – the concerns people have come from facing rising prices in general, which are indicative of the productive capacity of the economy being below current demand for goods and services. A period of lower productive capacity following COVID, and given the constant interruptions overseas, is how it is – and arbitrary changes of individual prices won’t help that.

What to do?

Instead it is questions about the nature and magnitude of government income support, and the related change in monetary conditions that this requires, that determine who is bearing the burden of this income shock. And policy work, and responses, should be focused on that rather than trying to fiddle with the price of individual items.

For those of us in the rest of the wage earning distribution, questions about our next wage round are more live than ever – implying that we need good guidance on where prices could go from here, and to keep an eye on what job opportunities are available if we have an employer who is unwilling or unable to compensate for higher prices.

For economists, if this is a supply shock the appearance of rising wage demands starts to look like a wage-price spiral, where higher wages increase costs, increasing prices, requiring higher wages. The current dynamics is a bargain to try to split the loss of an income shock between capital and labour – this provides a challenge to monetary policy, but it also seems inappropriate to ask wage owners to sacrifice their share of income unless capital earners also are.

The solution for this is monetary policy that appropriately balances demand and productive capacity to manage inflation expectations. Contrary to prior comments I’ve made, NGDP targeting, by providing a clear communication of nominal income over time, does have appeal in this circumstance.

We can’t change monetary regimes, and would need to do more work if we did! So is a fuel tax cut a targeted second best for middle income earners to manage this? No.

As noted above, the price spike represents scarcity, higher general prices are the real issue, and the current wage bargain involves workers and employers distributing the genuine income loss that has occurred.

Fuel tax cuts in this context change who is paying for the externality from the user to other people, distributing the loss to those who don’t use much transport or who are subject to environmental costs.

Furthermore, if they reduce wage demands the benefit of the cut goes to employers – limiting its ability to provide both cost of living relief and limit inflationary pressure. Although, to be frank, it would do little of either.

Conclusion

Lets get real. The world is complicated and sudden changes in prices tell us that something has suddenly become more scarce or less scarce – and that we need to adjust our spending patterns at that time to compensate.

To the number of people reading this who are fired up due to how the fuel prices are affecting you as a “middle income Kiwi” – you are not in a precarious situation and have been insulated from the worst of COVID. Having to take a holiday a bit closer to home due to the cost of fuel is not the end of the world, and it is not the responsibility of the government to make sure you can spend a bit more time in your holiday home. You might find people pandering to you everywhere else, but not here.

Instead good government policy would support those who are most vulnerable – not necessarily those who are most affected – and if it was relatively long-lasting it may support the transition.

With indexed benefits and minimum wages this support of the most vulnerable is already happening.

Meanwhile, the excise and RUC changes do neither and instead shifts the cost of increasing scarce fuel onto those who are not consuming the fuel.

Worst of all it opens the door to increasing arbitrary subsides based on political expediency – with the harder to observe costs seen as acceptable for politicians to keep themselves in power.

If this blog goes out and there aren’t a series of articles and interviews up with New Zealand economists calling this out for the incoherent political opportunism it is, then it isn’t just the political environment that is to blame – it is the unwillingness of New Zealand public facing economists to describe and discuss the simplest policy problems in a way that might be unpopular with the government of the day.