In a recent piece in the Indian Express, Atanu Dey argues that keeping fuel prices low is effectively delivering subsidy to the rich, by subsidising the cost of car transport. In response to this, he says there should be an annual fuel surcharge imposed per-car. This way, he says, fuel price hikes can be prevented for buses, scooters and trucks, which are common man’s vehicles, and burden only the rich.
I have a fundamental problem with this kind of tax in that it might lead to some kind of tragedy of the commons. The basic point here is that there is no problem with car ownership. Even if each of the one billion people odd people in India buys a car, it would be ok. In fact, it would be fantastic that so many people can afford to buy a car, and it? will also be a huge boost to the automobile and related industries.
However, what needs to be ensured is that people don’t use their cars much. Cars are ok as long as they stay inside the garages. Unfortunately we don’t have too many toll roads in India and we don’t yet have enough technology to make every road a toll road, so the only way we can disincentivize people from driving is by taxing fuel consumption.
The flat per-car tax that Atanu proposes will have no negative impact on the amount that people drive. It is a fixed cost every year. Thus, at the margin, the driver doesn’t know the true cost of the extra kilometer he drives. Thus, he will tend to drive more than what is optimum from the point of view of subsidies, etc.
Another problem with Atanu’s plan is that it creates perverse incentives. Light users of the road end up subsidizing heavy users of the road. Yes, there is still a substantial cost of driving which prevents a “true” tragedy of the commons from occurring. Still, this kind of incentive is likely to only increase the amount that people drive.
To reiterate something I’d said in an earlier post, the government has an incentive in ensuring that people drive less – that way the subsidy bill will remain reasonable. I’ve heard the argument that the Indian market is too small for the elasticity here to have an impact on global prices. Point taken. However, the elasticity in the Indian market does have a major impact on government finances, due to the huge subsidy burden. And it is extremely extremely unlikely that the subsidy bill on oil will come to zero anywhere in the near future.