How to Bring Oil Prices Down

Richard Koo, chief economist of Nomura Research Institute, says the U.S. and China should sharply boost taxes on gasoline to cut consumption

The high oil prices of the last two years caught many by surprise. This is especially true for those who thought that alternative energy sources and vast reserves in marginal oil fields would keep prices from rising too high for too long. The oil futures market, however, is indicating that oil will remain above $60 a barrel as far into the future as 2012. This suggests that demand for oil is expected to outpace new supply for years to come.

This growing demand is fueled by the U.S.—the largest consumer of oil in the world—and China, the fastest-growing consumer . The rapid increase in China's appetite is in turn causing many to worry, not only about higher future oil prices, but also worsening environmental problems, including global warming. Beijing, however, argues that it should not be singled out when Americans are consuming 16 times more oil (3.2 tons) per person per year than the Chinese (0.2 tons).

Are we then helpless in fighting this drift toward ever-higher oil prices and ever-more-serious environmental degradation? Not necessarily. The key is for the U.S. and China, which have relatively low taxes on oil, to raise those levies over the next 10 years to rates similar to Japan's and Europe's. This means that the tax on gasoline, for example, would have to reach 100% in these two countries over the coming decade.


  That may sound crazy when oil prices are already at historic highs. But the market's reaction to such a tax would lead to a much better outcome. In particular, oil prices would fall following the announcement of the tax. This is because current prices, especially those in the futures market, are based on forecasts for the growth of demand in the U.S. and China.

If the prices that consumers pay were expected to shoot up because of the new tax, forecasts for demand growth would be revised downward, which would mean lower prices. As a result, what consumers would pay for oil, even with the new tax, would be far less than double the current price. And if the tax were introduced gradually over 10 years, the pump price might actually come down sharply.

Higher oil prices so far have meant an ever-greater transfer of income and wealth to oil-producing nations. A new tax and resulting lower prices, on the other hand, would mean that money that previously flowed to oil exporters abroad would stay inside the two countries as government revenue, lowering trade deficits and providing funds that could be used to subsidize fuel costs for low-income families. Plus, increased efficiency spurred by the higher taxes would slow global warming and environmental degradation.


  Japanese cars are legendary for their fuel efficiency. But that's not because the Japanese are smarter than others. It's because consumers there had to grapple with gasoline prices of $4 a gallon long before anyone else. There is no reason that the U.S. and China, faced with the same market signals, could not achieve the same results.

So this would be a win-win situation for everyone other than oil producers. Such a plan would be a tough political decision domestically for the leaders of both countries, but their citizens might find it more palatable if it were simultaneously implemented on both sides of the Pacific.

Even though President George W. Bush has close relations with the oil industry, if he and Chinese President Hu Jintao were to agree on such a proposal, the whole world would not only breathe better but also be forever grateful for their leadership in reversing the runaway rise in oil prices.

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