Defining an Optimal Tax Rate for Petroleum Products
By Debo Alonge
By Debo Alonge
The Ramsey rule has been widely used as a principle of taxation. While this rule provides a good basis for income generation, it breaks down when attention is given to income redistribution. The rule proposes an inverse relationship between the tax rate and elasticity of demand which makes it regressive in nature by taking more from the poor whose consumption tilts towards necessities with low elasticity.
Similarly considering revenue generation, it will appear desirable to keep raising the tax rate, but as pointed out by Laffer curve, there is a limit to which tax rate can be raised beyond which revenue begins to decline. This is another definition of optimality in tax. The optimal tax rate by this definition will be one that maximises tax revenue.
t* Tax rate
where t* is the optimum tax rate
We also know that taxes create excess burden which is the welfare loss beyond the revenue collected. The Harberger triangle is an accepted measure of the excess burden of a tax. If the welfare loss can be effectively measured, then it is possible to define optimality in terms of minimizing the excess burden. A limitation of only trying to minimize excess burden is that it will suggest that zero tax rate is efficient. However, this means no money will accrue to the government.
In order to overcome this limitation, this paper will attempt to minimize excess burden of a tax subject to a given level of government revenue. To achieve this, we rely on the mathematical construct by Nan (1995) to define appropriate tax rate for petroleum products in Nigeria. This effort is considered appropriate at this time as Nigeria is on a gradual phase out of energy subsidies and the next phase could as well be introduction of appropriate system of taxes that will improve the level of efficiency.
OBJECTIVES OF ENERGY TAXATION
Energy taxes are imposed for various reasons; hence it is often difficult to single out a specific purpose for any particular energy tax. Energy taxes have been proposed as a means of achieving macroeconomic objectives of output and employment as well as an efficient vehicle for fiscal deficit reduction. Environmental benefits of energy taxes have been advanced as a supplementary argument for their use (Nellor, 1995). In a similar development, Bhattacharyya (1998) identified five Objectives for taxing energy products including; revenue generation for the government, ensuring energy security, managing demand, internalization of externalities and income redistribution. Each of these is in turn discussed below.
Revenue Generation
Government raises revenue through a number of sources among which taxation is the most important in most countries. Given that taxation is the major source of government revenue, a simple inference can as well be drawn to suggest that the principal reason for levying taxes is to raise revenue for the government Bhattacharyya (1998). Developed countries rely on direct form of taxation as the main source of government revenue. On the other hand, developing countries lack the administrative capacity required for the optimal use of direct taxation, hence they are heavily reliant on indirect forms of taxes. In particular, petroleum products dominate the tax environment. Three key reasons are proposed for the huge burden placed on petroleum products and especially gasoline as a source of revenue. They include: Bhattacharyya (1998)
• The tax base is large, inelastic and certain, ensuring a steady source of revenue to support government activities.
• The number of economic agents participating in the production and distribution are few therefore making it less costly and easy to administer
• Relative to other taxes, it is less transparent and less sensitive from the political point of view.
These characteristics make energy products attractive for tax purposes. Moreover, the dominance of oil in the economies of developing countries is evident. In Nigeria for example, Oil accounts for a whopping 96.3% of export earnings and about 86% of total federal government revenue.
Ensuring Security of Energy Supply
The global distribution of energy resources are not even. There exist a huge concentration of oil in the Middle East and pockets of reserves in some other countries. This pattern of distribution, by default, makes many countries importers and exposed to shocks in the international oil market as we have observed in the three major oil shocks. Resource rich countries are mostly politically unstable, a situation which poses significant threat to supply. For example the Gulf war in the early 90’s caused supply disruption; the present crisis in Libya also has impacted supply. Apart from the political instability, producers may also deliberately interrupt supply to exercise their market power. In order to overcome this problem, it is common for countries to impose an import duty which creates a wedge between local price and international market price. This form of taxation serve two important purposes: first, the revenue generated may be channelled to the creation of strategic reserve to mitigate supply disruption and second, the higher local price could serve as an incentive to search for alternative sources of energy.
Management of Demand
Energy consumption has witnessed an unprecedented growth in recent times. On the contrary, conventional energy sources are generally non-renewable. Hence, in order to ensure that the limited available energy is efficiently utilized and avoid wasteful consumption, taxes are imposed on energy products. This system can prove effective in managing demand as consumers will receive appropriate signals and will behave in a rational manner by cutting their energy use accordingly.
Internalize Negative Externalities
The production and consumption of energy for industrial use, household as well as transportation generate a substantial amount of water and air pollution which are typically not included in the private cost to either the producer or consumer. This is a classic case of environmental externality . The damage caused in terms of health, loss of life and property and deterioration of the environmental quality leads to an increase in government expenditure in the bid to correct the conditions (Bhattacharyya, 1998). As such, there is a difference between private marginal cost (cost to the agent involved) and social marginal cost (cost to the society). A higher cost is borne by the society. The Pigouvian tax is designed to internalize this kind of externality. The argument about externality or environmental protection is one of the major tools used in drumming support for taxing energy products. However, if the argument is tenable, why is diesel with higher level of emissions taxed less than gasoline?
Income Redistribution
Energy taxes can also deliver a redistribution of income within the economy. The issue with achieving this objective is that the poor spend a larger proportion of their income on certain fuels and taxing such fuels with the objective of income redistribution may be counter-productive because it is regressive in nature (Bhattacharyya, 1998). However, a proper definition of energy taxes by taxing appropriate products such as gasoline which has positive income elasticity (Iwayemi, et.al, 2009) will be useful.
NUTSHELL:
Following the recent debates on petroleum subsidy in Nigeria, here is Debo’s timely analysis of the situation, advocating for energy subsidy removal, by employing the minimization of excess burden of a tax subject to a given level of government revenue to define optimal tax rates for petroleum products in Nigeria. This is the introduction to this explicit analysis. Find out more about his analysis and explanations behind his recommendation in the coming weeks. Until then, your comments and observations on this general topic would be appreciated. To learn more about this article and to read the author's professional profile please click here -->
No comments:
Post a Comment