Why do economists defend fuel taxes even though they cause inflation? – 03/13/2023 – Why? Economês in good Portuguese

Recently, the Lula government decided to increase fuel taxes, zeroed in the Bolsonaro government. This began to make gasoline and ethanol more expensive at gas stations this month.

But, before you worry, it’s important to understand why this decision is correct, not only from the point of view of those who care about the environment and climate change, but also from the economics point of view. In today’s text, we explain why economists defend fuel taxes, even if it causes price increases.

The use of fossil fuels, such as gasoline and ethanol, affects not only those who drive, but society as a whole. Pollution and damage to the environment affect everyone’s quality of life and health. The tax is a way to make those who consume these fuels pay for the damage they cause and encourage the adoption of cleaner alternatives, such as electric cars and public transport.

In economese, we call this “internalizing” an “externality”, that is, making the agent take into account the social cost of pollution in his economic calculation, when making decisions.

Taxes on common goods and services may not be good for economic efficiency, as they raise prices in such a way as to bring the market to an equilibrium that is far from ideal for society. With these taxes, there may be more or less than the “optimal” quantity of goods and services bought and sold in the market, leading to a scenario of economic inefficiency.

Furthermore, these taxes do not encourage changes in behavior that could lead to positive consequences for society. However, for the same reasons that normal taxes are bad, taxes due to externalities are good: they bring the equilibrium closer to the social optimum and encourage positive behavior changes: in this case, less pollution.

It is understandable that the Lula government’s measure is unpopular. There are undesired consequences expected for the short term, such as the observed increase in prices at gas stations. But inflation can be temporary. It is also important to remember that it is expected that those who are most affected by the increase in prices are those who have a car, that is, the middle and upper classes in Brazil. This means that the measure can work as a form of income distribution.

The challenge now is to create complementary policies so that people are not affected in terms of the cost of living in the long run. Investments in quality public transport and urban mobility are examples of this. Other examples are investments in renewable energies and subsidies to facilitate the entry of electric cars in the country, in addition to other structural reforms that facilitate the transition to a low-carbon economy.

In short, the government’s measure is likely to make a substantial contribution to climate policy, but environmental objectives are also strongly intertwined with fiscal, macroeconomic, political and social factors, which explains why it is championed by economists.

If you want to better understand the logic behind taxes on externalities, check out this text published in the Why column? last year.

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