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May 1, 1993

Federal Reserve Bank of Cleveland

The Energy Tax: Who Pays?
by Mark E. Schweitzer and Adam D. Werner

An his State of the Union address, President Clinton called for a broad-based energy tax to help reduce the federal budget
deficit. The tax is expected to generate
$21.1 billion in 1997 when it is fully
phased in — one-quarter of all new revenue in the overall budget package. However, the motivation of the tax is not solely
revenue generation. The administration's
favoring of an energy tax over other potential revenue sources is clearly rooted in its
desire to further the social goals of protecting the environment, conserving energy,
and reducing our dependence on foreign
oil. In addition, the Treasury Department
indicated that the tax had to be structured
so that it would be borne "fairly and equitably across the country.,,2
While the energy tax may or may not
survive concerted efforts to kill or reshape it, it nonetheless offers an interesting look at the difficulties that arise
when lawmakers try to craft economic
policies having multiple, sometimes
conflicting, goals. In the case of the current proposal, the dilemma is how to
reduce the nation's energy consumption and the attendant social costs
while simultaneously ensuring that no
particular region or income group bears
more than its fair share of the burden.
To address the social costs of energy
use, an energy tax must favor those
who use less or cleaner fuels.

Under a narrower set of goals, a more
focused energy tax might have been
chosen. For instance, taxing the carbon
content of fuels would implicitly tax
the production of carbon dioxide, the
primary "greenhouse gas" associated
with global wanning. Or had the
government wished to focus on pollution
and our dependence on foreign oil, a
gasoline tax could have been levied to
raise the cost of driving. In fact, both of
these approaches, along with oil import
fees and an across-the-board tax on
petroleum products, were considered but
ultimately rejected as being unfair to certain states or low-income families.3
In light of its varied goals, the White
House opted for a general tax on energy
usage based on the heat content of fuels,
with rates varying by fuel type. Coal,
natural gas, hydroelectric power, and
most other fuels are assessed at a base
rate of 25.7 cents per million British
thermal units (BTUs).4 Petroleum-based
energy sources other than heating oil and
liquefied petroleum gas (LPG) are taxed
at a premium rate of 59.9 cents per million BTUs. Alternative energy sources,
such as alcohol and geothermal energy,
are not taxed at all. Thus, the proposal both
raises the cost of most energy sources
and alters the relative prices of different
types of fuel. In particular, it discourages
the use of petroleum.
This Economic Commentary examines
the narrow issue of whether the BTU tax
meets the administration's goals of equal
distribution among consumers across
states and income levels. We focus the
analysis on consumers' direct energy purchases, since this is the portion of the tax

ISSN 0428-1276

President Clinton's proposed energy tax
is aimed not just at cutting the budget
deficit, but also at encouraging fuel conservation, reducing pollution, and lessening our dependence on foreign oil.
This Economic Commentary takes a
look at the problems that arise when the
government attempts to formulate economic policies having multiple objectives
—in this case, reducing the nation's
energy consumption and its associated
social costs while making sure that no
particular region or income group bears
a disproportionate share of the burden.



$29 to $45

$46 to $50

$51 to $55

$56 to $65

NOTE: U.S. mean = $49.20.
SOURCE: Authors' calculations based on the Department of Energy's 1990 State Energy Data System files.

most likely to vary among regions and
to place a disproportionate burden on
low-income families.' Climatic differences, existing investments by consumers and utilities in fuel-consuming
technologies, regional housing patterns,
and availability of public transportation
are the major reasons why consumers'
share of the tax could vary substantially
by region and income level. We do not
analyze the business portion of the expected revenue by state because much of
this burden will be shifted to consumers
nationwide and will be borne roughly in
proportion to their income level.
While we make no attempt to justify
the imposition of an energy tax, our
comparisons indicate that the current
proposal does indeed generate revenue
evenly across states and does not burden low- or middle-income families
more than would alternative consumption taxes (particularly if the administration's proposed increases in aid to
low-income households are included).
However, readers should consider other

factors when judging the proposal's
overall merit.
• Incidence across States
Despite the administration's recent
revisions to the BTU tax proposal,
which were intended to distribute the
burden more equitably across states,
many opponents argue that it still has
an unequal incidence. One need only
contrast the Department of Energy's
total fuel usage figures for the West
South Central region with those for
New England to find the oft-quoted differences in expected per capita revenue
collections. Based on total energy consumption data for 1990, residents of
the West South Central states would
have paid nearly twice as much per capita as New Englanders, $154 versus
$84. However, most of this gap is traceable to the regions' differing industrial
compositions. The West South Central
area is a large producer of oil and has
attracted oil-intensive industries that
serve consumers throughout the nation.
Energy consumption in Texas alone

would generate revenue equal to $150
per resident, but 63 percent of this
amount would be picked up by the
state's business community.
Differences in industrial energy consumption patterns across states do not
translate directly into differences in
consumer tax burdens, however. Because a substantial number of goods
are marketed nationally, companies can
pass along their additional costs to customers throughout the country. The
primary sources of consumer tax differentials based on location are the assessments on residential power and
gasoline. Thus, we focus on these two
components of the household budget to
determine whether residents of certain
states would bear a disproportionate
share of the new tax.
Based on aggregate state data, the BTU
tax would cost the average consumer $49
on direct purchases of energy, with 36
states falling into the narrow range of $46
to $55 (see figure 1). While the largest
per capita revenue would be collected in


(Dollars per year)





New England
East North Central
West North Central
South Atlantic
East South Central
West South Central








SOURCE: Authors' calculations based on the Department of Energy's 1990 State Energy Data System files.

Alaska ($261 with business assessments factored in), its citizens would
each pay only $6 more than the national average. The majority of Americans
would bear a comparable burden.
Most of the states expected to fall below the $46 mark have gasoline consumption rates well below the national
average. These include New York, Rhode
Island, Pennsylvania, and Massachusetts.
California, Hawaii, and Utah benefit
from unusually low residential power
consumption, a result of their relatively
mild climates. States with tax rates above
$55 typically combine high gasoline consumption with above-average residential
power usage. For example, Wyoming,
the only state with per capita taxes exceeding $60, had the highest gasolinebased tax ($46) and the eighth-highest
residential energy tax ($19).
Generally, states with low population
densities would have higher per capita
tax burdens, with the major exception
being those southwestern states blessed
with mild climates. Using the Department of Energy's survey data and controlling for the number of drivers in a
household, we found that suburbanites
would, on average, pay 18 percent
more than city dwellers with regard to
the BTU tax on gasoline. Facing an
even greater burden are rural residents,
who would pay 22 percent more than
their urban counterparts.

Regional variations would have been different had the administration opted for
either a gasoline or a carbon tax (see
table I). 10 A gasoline tax would generally boost the payments faced by rural and
suburban residents while lowering the incidence on urban dwellers, who have
greater access to public transportation. It
would also result in a slight increase in
the variance among regional average tax
collections while shifting the burden west
and south. A carbon tax, typically
proposed at a rate of $30 per ton of carbon, would have a lower variance for
consumers than the BTU tax. New Englanders and residents of the West and
East North Central areas would be hit the
hardest by this approach.
Part of the administration's concern for
regional equity is linked to maintaining
the BTU tax's political viability. To appease New England legislators, most of
whose constituents heat their homes
with oil, the rate on this fuel (as well as
on LPG) was lowered from the petroleum rate to the base rate. This subtle
shift moved New England from the
most highly taxed region ($58 per person) to the third least highly taxed ($47
per person), but in so doing eliminated
one of the proposal's main goals: motivating easterners to switch from home
heating oil to a cleaner fuel like natural
gas or electricity.

• Incidence across Income Levels
Energy taxes, like most other consumption taxes, are generally thought to be
regressive. That is, lower-income families pay a higher percentage of their
earnings in taxes than do higher-income
families. The reason for this is that as
earnings rise, the percentage of current
income spent directly on energy (and
thus the average tax burden) falls.
Regressivity is typically evaluated at the
family level, so in this section we report
revenues from direct energy purchases as
a percentage of family income rather than
on a per capita basis.
Not surprisingly, the nation's poorest
families would bear the brunt of the
BTU tax — or a gasoline or carbon tax
(see figure 2). For households making
less than $5,000 per year, the BTU tax
would represent 1.8 percent of their income. This figure falls to 0.14 percent
for families earning more than $75,000
annually. The carbon and gasoline taxes
would show a similar pattern, with the
differences among the three alternatives
declining as incomes rise.
The upshot of these comparisons is
that, based on equity, there appears to
be little justification for favoring one
energy tax over another. One must then
ask whether energy taxes are too regressive in general. That is, do they place
too high a burden on those Americans
who can least afford to pay?
The direct portion of the BTU tax is
not substantially more regressive than
other consumption-based taxes. The
relative regressivity of the proposed tax
can be judged by comparing it to a
broad-based consumption tax like the
value-added tax (VAT).12 The VAT has
often been proposed as a new source of
federal revenue and was recently suggested as a way to help underwrite a
universal health care plan.
Figure 3 compares the percentage of
family income that would be devoted
to taxes under the current proposal versus under the VAT. As the chart makes
clear, the taxes are quite similar in their
incidence, indicating that the broadbased energy tax is not unusually



Percent of family income
| BTU tax
| Carbon tax
Gasoline tax






10-15 15-20 20-25 25-30 30-35 35^10 40-50 50-75 > 75
Income, thousands of dollars

SOURCE: Authors' calculations based on the Department of Energy's 1990 Residential Energy Consumption
and Residential Transportation Energy Consumption Surveys.

Percent of family income

increase in the Low Income Home Energy Assistance Program (LIHEAP), which
channels money to states to help poor
Americans with their heating and cooling
expenses, weatherization, and energyrelated emergencies. This 66 percent
funding jump could fully offset the increase in residential energy costs facing
low-income families. Our estimates of
the total tax receipts for residential power
usage from households that earned less
than $10,000 in 1987 is only $505 million
— half the proposed increase in the
LIHEAP. Unfortunately, exact estimates
of the added benefits that would accrue
to the poor are not easily determined,
since states are allowed to structure their
own energy assistance programs.
Even assuming that the entire homeutility portion of the tax burden is offset
by increases in the LIHEAP for families
currently receiving aid, the regressivity
of the energy tax is only partially offset.
The reasons for this are twofold: uneven
distribution of family assistance and the
fact that 60 percent of low-income consumers' energy tax burden would be devoted to taxes on gasoline. Thus, the
White House has also proposed an additional $3 billion for the food stamp program. Families that receive most of their
income from indexed transfer payments,
such as Social Security, would generally
bear little of the burden, since mandated
cost-of-living increases would cover most
of the energy price rise.'3



10-15 15-20 20-25 25-30 30-35 35^*0 40-50 50-75
Income, thousands of dollars


NOTE: These estimates are based on the Treasury Department's six broader income categories (0-10, 10-15,
15-20, 20-30, 30-50, and >50).
SOURCES: Authors' calculations based on the Department of Energy's 1990 Residential Energy Consumption and Residential Transportation Energy Consumption Surveys; and U.S. Treasury Department, Tax Reform
for Fairness. Simplicity, and Economic Growth, vol. 3, November 1984.

regressive, as some critics claim. The

important factor in the production of

largest gap in the incidences is 0.17 per-

most consumer goods.

cent, found in the Treasury Department's
$0 to $10,000 income category, and the

Because the BTU tax exacts the harshest

differences decline as earnings rise. The

toll on the lowest income group, it is pos-

indirect portion of consumers' BTU tax

sible to correct much of its regressivity

burden would likely mirror the inci-

without severely cutting into revenue.

dence of the VAT, since energy is an

The administration has proposed accompanying the energy tax with a $1 billion


To encourage conservation, cleaner fuels,
and energy independence — all admirable goals — an energy tax must focus on
individuals who are relatively intensive
users of energy, particularly heavily polluting or imported fuels. This raises the
distinct possibility that such a tax will
have a disproportionate impact on specific regions or on low-income families.
The Clinton administration appears to
have carefully formulated the BTU tax to
be equitable in terms of the average consumer's tax burden across states, and with
the planned increase in transfer payments,
much of the apparent regressivity of the
tax will be eliminated.

Nonetheless, some families and regions
will still pay larger shares. For instance,
the average tax burden will be higher
in America's rural and suburban communities, where access to public transportation is limited. Inequities in the tax will
also encourage behavioral changes the administration favors, such as consumers
opting for more fuel-efficient cars.
In sum, the BTU tax represents a delicate balance between social goals and
tax equity. Adjustments aimed at
strengthening its fairness — or its
political viability — are likely to lessen
its ability to encourage positive shifts
in behavior and can only complicate
what is already a relatively evenly
spread tax.

• Footnotes
1. See "Summary of Administration's Revenue Proposals," released by the Treasury Department on February 25, 1993, as published
in the Daily Report for Executives, Washington, D.C.: Bureau of National Affairs, Report
No. 37, February 26, 1993.
2. See "Treasury Department Description of
Proposal for Modified British Thermal Unit
Tax," released by the Treasury Department
on April 1, 1993, as published in the Daily
Report for Executives, Washington, D.C.:
Bureau of National Affairs, Report No. 62,
April 2,1993.
3. Treasury Secretary Bentson describes the
process by which the BTU tax was chosen in
"Clinton Plan's Aim to Balance Pain Regionally Misses Bull's Eye by What May Be a
Crucial Inch," The Wall Street Journal,
February 25, 1993.
4. For purposes of comparison, 1 million
BTUs represents about eight gallons of
gasoline, or 1.1 days of U.S. per capita energy usage in 1990.
5. Relatively homogeneous consumption
patterns across the United States tend to limit
variations in the indirect portion of the tax.
6. Our analysis is based on the proposal
released by the Treasury Department on
April 1, 1993.

7. Tax incidence is defined according to who
makes the final payment. For example, business taxes are bome jointly by investors in
the form of reduced market value of their investment, by employees in the form of lower
wages, and by customers in the form of
higher prices.
8. The primary revision affecting consumers
is the exclusion of fuel oil and LPG from the
higher petroleum tax. Additional revisions
have already been proposed by the House
Ways and Means Committee, and more
changes are likely as the bill wends its way
through the legislative process.
9. The energy consumption figures used in
our analysis are from the Department of Energy's 1990 State Energy Data System files.
10. The carbon tax would raise more than
twice the revenue of the BTU tax ($ 189 billion versus $71 billion over five years). All
figures reported in this article have been adjusted so that the tax alternatives generate
equal revenues from consumers.
11. Based on 1990 consumption data, families making less than $3,000 per year spend
nearly half their reported income on energy,
while those making more than $75,000 pay
less than 2 percent. (These figures do not include government subsidies to low-income
12. A VAT is a general tax on consumption
collected at all stages of production. Businesses pay the tax on their revenues minus
their purchases of capital and intermediate
goods. Ultimately, consumers pay most of
the tax through higher prices for goods and
services. State sales taxes are similar in their
incidence, but do not adjust for capital and intermediate goods used in production.
13. Energy expenses represent 7 percent of
the Consumer Price Index. Other prices
could also be expected to rise as industries
pass on their added costs to customers.

Mark E. Schweitzer is an economist and
Adam D. Werner is a research assistant at
the Federal Reserve Bank of Cleveland. The
authors are grateful to Randall Eberts and
E.J. Stevens for helpful comments and suggestions.
The views stated herein are those of the
authors and not necessarily those of the Federal Reserve Bank of Cleveland or of the
Board of Governors of the Federal Reserve

1993:IQ Economic Review Now Available
Economic Review is published quarterly by the Federal Reserve Bank of Cleveland. Below we present a summary of each of the
three articles contained in the most recent issue. Copies are available through the Public Affairs and Bank Relations Department,
Generational Accounts and Lifetime
Tax Rates, 1900-1991

Has the Long-Run Velocity of M2
Shifted? Evidence from the P* Model

by Alan J. Auerbach,
Jagadeesh Gokhale, and
Laurence J. Kotlikoff

by Jeffrey J. Hallman and
Richard G. Anderson

Unlike the federal budget, which typically
measures receipts and expenditures for
one year at a time, generational accounts
and lifetime tax rates focus on long-term
intergenerational wealth redistribution.
The accounts show that future generations can expect to pay, on average, more
than twice as much to the government as
current (1991) newborns if living generations continue to be treated as they are
under current policy. Lifetime tax rates
on successive generations have increased
from 22 percent for Americans born in
1900 to about 34 percent for those bom
in 1991. Under the basel ine economic
assumptions presented here, future
generations are slated to see that figure
rise to more than 70 percent on average.

Federal Reserve Bank of Cleveland
Research Department
P.O. Box 6387
Cleveland, OH 44101

Address Correction Requested:
Please send corrected mailing label to
the above address.

Material may be reprinted provided that
the source is credited. Please send copies
of reprinted materials to the editor.

The P-Star (P*) model forecasts inflation
by exploiting the stability of M2 velocity
and the tendency of the real economy to
operate near its potential. While originally offered as a link between inflation and
money growth, inverting the model
provides a test of one of its primary assumptions: the constancy of M2's longrun velocity, or V-Star (V*). If V* has increased during the last three years,
predictions of inflation from the original
P* model should be inferior to predictions from a model that incorporates the
new, higher V*. In fact, the deceleration
of inflation through 1992:IIIQ was quite
close to the original model's prediction,
and simulations of the model under a
variety of hypotheses regarding changes
in V* provide relatively little support for
a dramatic shift in that measure.

Examining the Microfoundations
of Market Incentives for Asset-Backed
by Charles T. Carlstrom and
Katherine A. Samolyk
Many view the proliferation of
securitization as a response to competitive or regulatory pressures. But to
what extent would asset-backed lending occur in a less regulated environment? This paper addresses the extent
to which models of credit intermediation have been able to formalize some
of the market-based forces driving this
phenomenon. The authors examine
four papers that model some of the
dimensions of asset-backed markets.
An underlying theme is that under certain conditions, the very information
costs that make financial markets important as conduits of credit can also
create nonregulatory incentives for
asset-backed lending as an efficient
funding mode.

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