Optimal pricing of the externality produced by the fuel consumption

Abstract

The essay is analyzing current pricing of the fossil fuel product in the United States of America and provides a comparison of the estimated efficient level of pricing for the same products. The main points of the essay could be summarized into the following statements. The update of the prices showed that the underpricing of the products remains sufficiently large in 2018. Most of the products are sold for two-thirds of the efficient price; for example, the retail price of road fuel is sold for 80 percent of its efficient value, whereas electricity is underpriced for almost 15 percent. In the broader picture, total subsidies for the products are estimated to be 161 U.S. billion dollars for the pre-tax subsidies and slightly over 450 billion dollars for post-tax subsidies that add up to be 0.78 and 2.17 percent of U.S. GDP, respectively. The numbers are close to the estimates of 2015 in IMF paper (Coady, Parry, Le, & Shang, 2019) (considering the externalities that were taken in this essay). By component, the highest difference in between prices is local air pollution (50 percent in 2018), followed by climate change and forgotten revenues (non-paid taxes). The substantial and consistent underpricing that remains for almost a decade suggests that energy reform should be considered. Moreover, the benefit of the revenue rising and welfare benefits that are mainly local should be the topic of interest for the government of the country. In terms of fuel, the leading product with the highest subsidy percentage remains coal (similarly to the previous estimations), followed by petroleum products, natural gas, and electricity. There would be a lot of benefits in case of implementation of efficient pricing, some of which are reduction of CO2 by more than 33 percent of the current level and decrease of the PM2.5 emission by over 76 percent. Finally, the fiscal and economic welfare gains from the subsidy reform were estimated. The fiscal gain after removal of the subsidies for the energy products would be equal to 1.2 percent of U.S. GDP or approximately 250 billion dollars. Economic welfare gain is lower and stands at 33.4 billion dollars (0.2 percent of U.S. GDP). Regarding fuel, both fiscal and economic welfare have petroleum (gasoline is the highest and diesel is the second largest) as a primary source of benefit (190 billion dollars for the fiscal benefit and 29 billion dollars for economic welfare benefit). For the fiscal benefit, natural gas and electricity go further (52 and 9 billion dollars respectively), whereas for the economic welfare coal and electricity are following suit (2.6 and 1.8 billion dollars). Overview of the policies in 2018 and the initiative of President Obama of the new regulations and guidelines on light duty vehicles developed by The National Highway Traffic Safety Administration (NHTSA) and the Environmental Protection Agency (EPA) presents will of the authorities to acknowledge and internalize the externalities produced due to fossil fuel consumption. Federal register displays some estimates for the optimal emission rates and provides a guideline for the producers of the vehicles, aiming to decrease Greenhouse gas and air pollution emission. Comparison of the results obtained during optimal price and optimal quantity estimations to the current alternative policy of the United States.