Gasoline Tax Rates from the Perspective of Optimal Taxation Theory

The question of how best to set desirable gasoline tax rates that take externalities into consideration is one that needs to be investigated. In this article, I use the framework of Parry and Small (2005) and the external cost parameters used in Kanemoto (2007) to explore desirable tax rates for Japan. Specifically, I assume a world in which the only taxes are the gasoline tax and labor income tax, and I calculate tax rates for gasoline and labor income that will maximize economic welfare at a certain level of tax revenue. The results of my analysis show that the first-best optimal gasoline tax rate is ¥118.3/liter(l) and that the second-best rate, when a labor income tax exists, is ¥142.4/l. These rates are approximately 2.2 to 2.6 times higher than the current rate of ¥53.8/l. Because of the substantial uncertainty of the parameters, such as the estimates of external costs, the estimated results must be interpreted as having substantial variance. However, the results also show that from the perspective of the burden of external costs, policies to abolish the provisional taxes, such as the petrol tax, and to lower the gasoline tax rates cannot be justified.