Energy taxes and oil price shocks

This paper examines if an energy price shock should be compensated by a reduction in energy taxes to mitigate its impact on consumer prices. Such an adjustment is often debated and advocated for redistributive reasons. Our investigation is based on a model that characterizes second-best optimal taxes in the presence of an externality generated by energy consumption. Energy is used by households as a consumption good and by the productive sector as an input. We calibrate this model on US data and proceed to simulations of this empirical model. We assume that energy prices are subject to an exogenous shock. For different levels of this shock, we calculate the optimal tax mix including income, commodity and energy taxes. We show that optimal energy taxes are affected by redistributive consideration and that optimal energy tax is less than the Pigouvian tax (marginal social damage). The difference is an implicit subsidy representing roughly 10% of the Pigouvian price. Interestingly, the simulations show that an variation in the energy price only has an almost negligible effect on this percentage. In other words, even a very large oil price increase will only have a small effect on the optimal tax on energy. Nevertheless, it appears that the energy tax is used to mitigate the impact of the energy shock. However, this result is not explained by redistributive consideration but by the fact that the Pigouvian tax (rate) decreases as the price of energy increases. This is a purely arithmetic adjustment due to the fact that the marginal social dammage does not change. Consequently, the marginal dammage as a percentage of the energy price (which defines the Pigouvian tax rate) decreases as the price increases.