Demand Destruction and Carbon Taxes

May 5th, 2022 by Potato

Oil prices have gone through the roof with the war in Ukraine, but even before that, gas prices in Toronto were about 25% higher than pre-pandemic. Despite that, gasoline consumption appeared to be hitting new highs in the fall of 2021. New cars are hard to come by, and the prices of used ones are up a lot following the pandemic for other reasons (supply chains, etc.), but still I was not seeing the interest in hybrids that we saw the last time gas prices spiked.

I was staring to think that maybe people forgot that it’s one of those things I spent way too much time learning way too much about, or maybe instead of accosting random Prius drivers in parking lots people had learned to research things on the internet themselves. I was starting to think that the price of gas didn’t matter.

Then gas prices hit ~$1.75 and it was like a tsunami of hybrid interest hit me. And it wasn’t just me and BbtP: Google trends shows that searches for Prius doubled from baseline in March of 2022, and those for PHEVs tripled. So there was a point where gas would get expensive enough that more people would get interested in burning less of it. I also noticed more people on the 404 and 400 driving the speed limit — slowing down is a good way to burn less gas (and much more immediate).

While I was expecting more to happen at $1.30 or $1.40/L, people did seem to get to a point where there was interest in change. It’s just that people seem to be able to tolerate much bigger changes in prices before getting to the point of demand destruction than we ever would have guessed before.

Which brings us around to the idea of the carbon tax. A carbon tax is an attractive idea for reducing GHG emissions: give carbon a price, and let the free market figure out solutions to reduce consumption. While I still think the approach is a good idea, after seeing how resilient demand can be in the face of sharp price increases, I think we need to increase it by about an order of magnitude a factor of ~3 to have any effect — the ~11 cents/L carbon tax is not moving the needle at all on people’s driving habits and consumer choices.

It may also be a good idea to re-think how we apply carbon taxes in a market with rapid swings in natural pricing: rather than a static carbon price, would it be better to set floor and quasi-ceiling amounts for gasoline directly? When the market is already setting a price that’s high enough for demand destruction, does an additional tax help further drive behaviour, or would it be better to cut it back as gas approaches $2/L to provide a modicum of relief? And vice versa, if gas prices start going back under $1.50/L, should a new responsive carbon tax make up the difference to keep the price high enough to maintain that reduction in use and behaviour change, or do we really think a $0.11/L carbon tax will do anything if the oil market corrects and gas drops back under $1/L?

One Response to “Demand Destruction and Carbon Taxes”

  1. Michael James Says:

    Sadly, few politicians care about the important considerations you’re discussing. The current Ontario government has already promised to cut gasoline taxes. I’m hopeful that battery technology will keep improving so that electric cars prices will come down enough that people are more open to understanding the low operating cost and low maintenance cost.