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Can a Gas Tax Actually Lower Our Driving Costs? An Interview with Richard Thaler

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At the second presidential debate, moderator Candy Crowley asked Barack Obama and Mitt Romney what they would do about the price of gas, as it’s hovering around the 4-dollar mark. As you likely noticed, neither answered the question—instead each used it as a platform to talk about energy more broadly. Their squabble quickly became a question of domestic oil production. But don’t be fooled—American production does little to affect the price of gas.

We may have the largest economy and emit the most greenhouse gases, but, in the oil market, we’re one of many small players in a global game. The president can, however, reduce costs by other means, particularly in reforming not oil production but our oil consumption. And so, Obama is attempting to soften the blow on consumers with revised fuel-efficiency standards, which he introduced at the end of August.

With his new regulations on automakers, in 2025, Americans will select from fuel-efficient cars, with 54.5 mpg. That’s more than double that of the average American car, which offers just 24 mpg.

In a previous Nerdwallet study, we outlined four factors that affect the price of gas:

  1. The price of crude oil,
  2. The price of refining,
  3. Distribution and marketing, and
  4. Taxes.

The first three factors, unfortunately, are out of the people’s control. Greater production from companies like ExxonMobil will not lower our prices. In the oil market, barrels will go to the highest bidder, American or not. There’s little you can do about business in Big Oil. Even if you can’t reduce the price of gas, though, you can reduce your costs with fuel-efficient cars. And with the Obama administration’s new policy, you’ll soon have more extensive choices.

Three cars, three very different expenses

To break down costs, NerdWallet compared the total cost – gas and purchase – of three cars:

  1. The average American car of today, which costs, on average, about $30,303, and has an average fuel efficiency of 24 mpg,
  2. A currently available, environmentally friendly model: the Smart ForTwo, which gives 39 mpg and has a suggested retail price between $12,490 and $17,690, or an average of $15,090. (This is a relatively cheap option among today’s environmentally friendly cars—the next best bets run between $20,000 and $30,000.)
  3. A car of the future – 2025, to be precise – that meets the administration’s efficiency standards of 54.5 mpg and comes with economists’ expected average price of a $2,500 a unit.
Car Purchase Price Fuel Economy
Average American car $30,303 24mpg
Smart ForTwo $15,090 39mpg
2025 fuel-efficient car $2,500 54.5mpg

We further assume:

  1. The car’s lifetime is 8 years, the current average.
  2. Gas costs $4 a gallon. It is likely to rise in price, so this assumption favors less fuel-efficient cars.
  3. The car is driven 12,000 miles per year, the current average
  4. The car is purchased in cash, with no interest payments. We amortize the cost of the car over its lifetime.

Even if we assume that the price of gas stays the same – which, given current trends, seems rosy at best – fuel-efficient cars soundly trounce the nationwide average.

Car Purchase Cost
Annual Fuel Cost Annual Total Cost Savings Over Current Average
Average American car $3,788 $2,000 $5,788
Smart ForTwo $1,886 $1,231 $3,117 $2,671
2025 fuel-efficient car $313 $881 $1,193 $4,595

It’s true that many of today’s greener cars are smaller than gas-guzzlers. But, in this writer’s opinion, the more limited space is worth the dramatically smaller cost. And in just 13 years, autos will be all the more affordable.

Gas taxes as incentive for fuel efficiency

Right now, most Americans are behind the green-auto trend, which is all the rage in Europe. The road to greater fuel efficiency still looks to be a long one, but there may be a way to shorten the journey and motivate Americans to look at today’s greener options.

One possible route of action: Raise the tax on gasoline, says American economist and University of Chicago professor Richard H. Thaler. Yes, it sounds awfully counterintuitive. But as Thaler suggests, higher taxes will lead to lower consumption, which would in turn bring lower costs to consumers. Because, as he predicts, such a policy change would push Americans to embrace fuel-efficient cars sooner.

In an e-mail to NerdWallet, Thaler said, “If we had a big enough gas tax we would not need those regulations. Just look at the cars people drive in Europe. Personally I would prefer the big gas tax but I don’t have to run for office.”

As Thaler hints, as a professor and not a politician, it’s easier for him to talk about sensitive policy issues without losing his job. There’s not much urge in Washington to levy a tax; gas prices are such a thorny issue that most politicians wouldn’t touch it with a ten-foot pole. Yet, put into practice, Thaler’s proposal could work out. Say a gas tax raised prices to $6 per gallon. This would only make environmentally-friendly cars more attractive:

Car Purchase Cost
Annual Fuel Cost Annual Total Cost Savings Over Current Average
Average American car $3,788 $3,000 $6,788
Smart ForTwo $1,886 $1,846 $3,732 $3,055

A reformed gas tax would have positive externalities, too. Our current tax helps fund transportation infrastructure. Yet the tax, in place since 1993, has failed to keep up with road-repair costs. So, if we overhaul the tax, we can fix up roads as well as put Americans in greener autos.

If you believe in Thaler’s proposal, then there is something you can do: Call up your congressman. Yes, they do listen—they record the number of calls in support of an initiative.

When you’re not out politicking, there are several things you can do to lower your own personal gas expenses. To find the best prices at the pump, try NerdWallet’s gas price comparison tool. And while you’re at it, check out our feature on gas cards.

The small things make a difference. Pump your tires and you can increase mileage by up to 3.3%. Some more small changes: turn off your car if you’ll idle for more than 30 seconds, close your windows, reduce your car’s weight, carpool, and turn off your air conditioning. Heating is fine, though—to warm up, your car diverts excess heat from the engine.

For the time being, a couple thousand a year in gas and auto expenses is still a dream. Until then, it’s worth weaning yourself off the pump with today’s green options, and pushing your friends, neighbors, and politicians to follow.