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This Congressional Budget Office (CBO) Memorandum, prepared at the request of then Chairman Jim Sasser of the Senate Budget Committee, calculates the price increases that would occur under four alternative energy taxes if the prices of industrial commodities and consumer goods went up by the full amount of the tax on the energy used to produce them. It also describes how foreign competition, energy conservation, and fuel switching might restrain the price increases.

Jon Hakken of CBO's Tax Analysis Division prepared the memorandum under the supervision of Rosemary Marcuss and Frank Sammartino. Richard Farmer and Roger Hitchner of CBO provided valuable comments. Paul L. Houts edited the paper, and Denise Jordan prepared it for publication.
 
 

SUMMARY AND INTRODUCTION

To their advocates, energy taxes provide a way to raise revenue that also encourages energy conservation and reduces pollution. In its 1994 budget, the Clinton Administration proposed a broad tax on energy use based on heat content measured in British thermal units (Btus). The tax was scheduled to be phased in during the 1994-1997 period and would have raised net revenue by slightly more than $20 billion per year by the late 1990s.

During the Congressional debate on the Administration's Btu tax, questions arose about how much the tax would add to the production costs of specific industries and whether producers would be able to pass on the added costs to the domestic and foreign purchasers of their products.

This memorandum provides an analysis of the price increases that would occur under four energy tax options. The analysis assumes that the prices of industrial commodities and consumer goods would go up by the full amount of the tax on the energy used to produce, transport, and market them. Although the analysis does not include the Administration's Btu tax as an option, it does include a generic Btu tax on the heat content of energy consumption along with an equally broad-based ad valorem tax on the value of energy consumption. The other two options tax the energy used by consumers, businesses, and governments on a more selective basis. The oil excise tax would only tax the use of petroleum products, and the motor fuels tax would only tax motor fuels used by vehicles on roads and highways. Tax rates were calibrated so that each option would have raised about $25 billion in gross revenue in 1992--an amount that, in constant dollars, roughly would match the gross revenue from the Administration's Btu tax after it was phased in.

Assuming that producers add the cost of an energy tax to the price of their products, the price increases for particular goods and services would vary in size depending on which energy tax was imposed. Compared with a tax on all energy, for example, a tax only on oil that raised the same amount of revenue would impose a larger price increase on forestry products and transportation services because their production relies mostly on petroleum products for energy. At the same time, the oil tax would impose a smaller price increase on primary metals because their production mainly uses coal and electricity generated from water, coal, and nuclear power.

An energy tax would clearly make U.S. producers pay more for the taxed energy that they use and more for many of the other intermediate commodities and capital goods that they purchase. At the same time, many U.S. producers would be able to raise product prices enough to cover the additional cost of the energy tax because the tax would also increase the costs of their domestic competitors. Even in industries in which U.S. producers compete with foreign producers, price increases for some commodities could be enough to cover the additional cost of the tax. In those cases, the tax would tend to reduce the exchange value of the dollar, which would increase the price of all imports (denominated in dollars) and decrease the price of all exports (denominated in foreign currencies). The size of the dollar's decline in value would roughly match the size of the average cost increase under the tax for producers of internationally traded commodities.

Competition from producers overseas would restrain domestic producers of some internationally traded commodities from increasing their prices enough to cover fully the additional cost of an energy tax. In general, foreign competition would limit price increases for internationally traded commodities that require more than an average amount of taxed energy to produce, but it would not limit price increases for commodities whose production requires only an average amount of energy or less. Thus, for example, a broad-based tax on energy use would reduce the competitiveness of U.S. producers of mineral ores and primary metals because those domestic producers are heavy users of energy. The same tax would not place U.S. producers of machinery and agricultural products at a disadvantage, however, because those commodities typically require only an average amount of energy to produce.

Energy conservation and fuel switching would also restrain price increases under an energy tax by reducing the demand for goods and services that are more heavily taxed and increasing the demand for goods and services that are less heavily taxed. For example, the price of airline transportation would be restrained slightly under a broad-based tax if consumers limited their travel or if they switched to more energy-efficient modes of transportation such as bus or rail.

This document is available in its entirety in PDF.