Myth: The only solution to high petrol prices is to cut fuel tax

Myth: The only solution to high petrol prices is to cut fuel tax
Fact: Cutting or freezing fuel tax when oil prices go up might postpone higher petrol prices for a few months, but at the expense of having to find billions of dollars through other taxes every year thereafter. The solution lies not in cutting fuel tax, abolishing CPI indexation or chasing alternative fuels, but in fixing up the alternatives to car use.

In 2005 the pump price of petrol began a long upward climb, from its earlier prevailing level of around $1.10 a litre up to an average $1.30 a litre just one year later. Faced with a backlash from car-dependent voters in the lead-up to the 2007 Federal election, the government was under pressure to ‘do something’ about petrol prices. But prices went on climbing, up to a peak of $1.70 a litre in 2008 before the Global Financial Crisis intervened. Prices dropped back to around $1.30 a litre – still very high by historical standards – and have since crept back to record levels, largely thanks to North American economic recovery.

The road lobby’s recommended solution, naturally, is to cut petrol tax or at least freeze the tax rate like John Howard did in 2001. Between 2001 and 2014 petrol excise was charged at the fixed rate of 38.1 cents per litre (down from 47 cents in 1999), plus the 10 per cent GST that applies to all goods and services except basic food. Various pressure groups, from the RACV and AAA to Family First Senators Steve Fielding and Bob Day, have proposed either removing GST from petrol (making it unique among inedible goods) or reducing the excise rate, so that motorists see a lower price at the pump. They are naturally also opposed to the Abbott Government’s 2014 move to re-introduce automatic adjustments for inflation, to keep up with the rising cost of the transport and other services petrol tax is meant to fund.

The campaign to reduce fuel tax scored a major political victory when the Gillard Government in 2010 decided to exclude petrol from its carbon tax, rejecting advice to the contrary from economist Ross Garnaut. This has the perverse consequence that travel by public transport is subject to carbon pricing while travel by car is not, even though public transport generally has much lower emissions per passenger than car travel.

But far from being the ‘only solution’ to high petrol prices, reducing fuel tax isn’t a solution at all. The reason prices are high isn’t that governments have hiked up the fuel tax: after allowing for inflation, total fuel tax now (even with GST) is actually lower than it was in 1999 when petrol cost 90¢ a litre. Even allowing the tax to rise with inflation only raises prices by an average of 1¢ a litre per year, taking a decade just to rise by the equivalent of the 10¢ by which it fluctuates from one day to the next today.

Petrol prices are high today because global crude oil prices are high, and crude oil prices are high because demand for oil is outstripping supply. This is due partly to political instability in the Middle East and Africa where most of the world’s remaining oil is located, and partly because we’re fast reaching the point where, although there’s a lot of oil left, the rate at which we can pump it out of the ground is barely keeping up with the rate at which we’re burning it.

To reduce the price of a commodity that’s in short supply will only result in it being used up more quickly. Take another big Australian price-rise story of recent years: bananas. Cyclones Larry (2006) and Yasi (2011) each destroyed most, but by no means all, of Australia’s banana crop. But had the price of bananas remained the same in the months afterwards, there would truly have been no bananas left in the country by mid-year. Much as we may have complained about it, the high price at least ensured that bananas remained available (more or less), even if we couldn’t afford to eat as many as usual.

Of course, the big difference between bananas and petrol is that bananas grow back. Sure enough, banana crops were eventually restored and banana prices now are essentially the same as before. We have no such assurance with petrol, because once the easy-to-reach oil is gone, it’s gone forever.

But just as with bananas in the months after the cyclones, reducing the price of petrol by cutting the tax does nothing to counter the factors that are causing the oil price to rise, and if anything makes the situation worse. So if fuel tax is cut by 5 cents a litre, as the Federal Coalition once suggested in 2008, it’s probable that in six months’ time the price will have risen by 5 cents a litre and we’ll be back where we started. Meanwhile the government, to recover the $1.3 billion a year it’s no longer getting from fuel tax, would have to raise income tax instead – which hits everyone no matter how much driving they do, and means that those who drive less would be subsidising those who drive more to an even greater extent than currently.

You do people no favours by making it cheaper for them to use up a product in short supply. It encourages us, when making investments, to assume that the product will remain cheap, when it can’t.

Those cuts to petrol taxes in 2000-01 encouraged Australian buyers to invest in fuel-inefficient vehicles such as big 4WDs. They encouraged our manufacturers to keep producing fuel-inefficient cars. Both would be better off now had the Government left taxes alone, and allowed the scarcity of oil to be reflected in its price.

—Tim Colebatch, The Age, 15 August 2006

It is our money [Brendan Nelson] would give away, taking it from our savings so we can spend it now. It would take money from people with fuel-efficient cars to give to those with gas guzzlers. It would take from those who drive little to give to those who drive a lot. Malcolm Turnbull is right: as policy, it’s ridiculous.

—Tim Colebatch, The Age, 20 May 2008

It is also questionable just how beneficial to consumers a cut in fuel tax would be. Given the very tight margins in the service station industry, and the popularity of discount vouchers that erode margins further, there is no guarantee that the full value of any fuel tax reduction would be passed through to consumers. Even if it is, the people most likely to benefit are not those in greatest need of relief from a higher cost of living. Data from the Australian Household Expenditure Survey shows that from each dollar of fuel tax reduction, just 9 cents would go to the 20% of households with the lowest incomes, and 15 cents to the next 20%; meanwhile, the wealthiest 20% would receive 30 cents.

Spending on fuel by household income
Income quintile Weekly spending on fuel Proportion of total
1st (Lowest 20%) $14.55 9%
2nd $23.65 15%
3rd $34.40 21%
4th $40.65 25%
5th (Highest 20%) $48.16 30%

Source: Australian Bureau of Statistics, Household Expenditure Survey 2003-04

The latest Household Expenditure Survey (from 2009-10) actually shows that despite the hike in oil prices since 2004, households are not generally spending a greater proportion of their income on fuel than before. In fact, they’re spending less. Petrol accounted for 3.36% of household spending in 2003-04, and for 3.09% of spending in 2009-10. A major reason for this is that while petrol prices have increased, household incomes have risen even faster over the last decade. Across the entire population, the expenses that have grown faster than our capacity to meet them are housing costs, utilities, private schools and childcare fees – not petrol bills. Of course, aggregate figures hide a lot of inequity, but as we see above, cheaper fuel provides a disproportionately greater benefit to the rich than to the poor.

Given we won’t be able to keep pumping oil forever, finding an effective solution to high petrol prices means taking steps to reduce the amount of fossil fuel we use in the first place. The former Howard Government’s favoured alternative of giving people handouts to convert cars to LPG never had much effect, given that LPG is a petroleum byproduct and subject to the same limitations, and many cars just aren’t suitable for LPG conversion since they lack space for the gas tank. (LPG isn’t even particularly greenhouse friendly: emissions are less than those from petrol for the same energy output, but only by about 10%.)

The next most favoured alternative is to blend petrol with ethanol, so that the fossil-fuel component is at least reduced. But as we point out on another page, there are severe limits to this strategy. Producing even a 10% ethanol blend on the scale required by Australia’s car fleet would consume over half our entire wheat crop, raising the question of how we are to feed ourselves (and maintain a vital export market) on an increasingly dry continent. While some ethanol is available as a byproduct of sugar refining, its contribution in Australia can only ever be a small one and it does not come for free.

The better solution is to attack the fuel demand problem at its source, by providing travel alternatives to single-occupant cars. Public transport, walking and cycling all use substantially less fuel moving a person from A to B than a car does, and since most of our travel occurs in cities where public transport networks are viable, there seems little reason not to pursue the alternatives. If done properly, the cost to the public purse of shifting journeys from cars to less fuel-intensive modes would be a good deal less than that of freezing fuel tax again, let alone cutting it even by a few cents a litre.

It’s certainly very disappointing to see that most of the media coverage and media discussion is about reducing the price of petrol by a couple of cents a litre. What we really need to do is get people’s transportation bills down. Now, part of that will be through more efficient vehicles, part of that will be using our vehicles more efficiently, and also part of that will be shifting from cars to other forms of transport.

—Rupert Posner (The Climate Group), Lateline interview, 2 June 2008

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Last modified: 14 May 2014