Driving change: Carbon pricing and the transportation sector | Ecofiscal

Driving change: Carbon pricing and the transportation sector

Climate and Energy

North American transportation systems have been shaped by cheap and abundant fossil fuels, and so too have our travel habits. Unlike other sectors of the economy that have viable low-carbon alternatives, fossil fuels are still the dominant fuel source for how we move around. And let’s face it, some people need to drive and don’t have ready alternatives. So, to what extent will carbon pricing incentivize people to reduce GHG emissions by using less gasoline? The answer to this question is straightforward, but kinda wonkish. Sorry? (#notsorry).

Carbon pricing changes the way we view different transportation options

Canadians make countless travel decisions each day. We decide how we commute to work, run errands, or to get to the next job site. Most of us rely on cars and trucks powered by fossil fuels for at least some of these trips. A smaller number of people use low-carbon alternatives, such as electric vehicles, public transit, cycling, carpooling, car-sharing, or walking.

Carbon pricing—either through a carbon tax or cap-and-trade system—changes the relative prices of these different transportation choices. Carbon-intensive modes of transportation suddenly become more expensive, which make low-carbon options relatively more attractive. The higher the carbon price, the greater the incentive for choosing a low-carbon option.

The evidence suggests that drivers do respond to prices. But how much?

The theory is clear. What about the data? In practice, to what extent do drivers respond to changes in prices?

A brief technical sidebar: In economics jargon, we’re talking about a concept called the elasticity of demand. If people respond to an increase in gasoline prices by making a drastic switch to low-carbon alternatives, then demand is considered relatively elastic. If the increase in price barely puts a dent in fuel sales, demand is relatively inelastic.

Several factors influence the extent to which drivers respond to prices. But in general, evidence suggests that they clearly do respond, especially over time.

Most research suggests that our response to changes in fuel prices is relatively small in the short-run (which excludes longer-term responses like buying a new vehicle). Research by the U.S. EIA and the OECD, for example, estimates that consumer demand for gas and diesel are virtually unchanged when the price of fuel changes—estimating that a 10% increase in fuel prices only results in a 0.2–0.4% decrease in fuel purchases. This means that it would take a 25–50% leap in gasoline prices to achieve a 1% reduction in fuel purchases.

Emerging evidence from Newfoundland and Labrador suggests that people may be more responsive to changes in fuel prices than these previous estimates. Here, Nic Rivers, an economist at the University of Ottawa, assesses the provinces’ recent doubling of fuel taxes to deal with its widening budget deficit. Rivers found that the 19% increase in the cost of gasoline was accompanied by a 10% drop in gasoline sales after three months. This means a 10% increase in price resulted in a 5% percent drop in the demand for gasoline.

Prices can change behaviour significantly, especially in the longer-term

Although our response to higher fuel prices may be somewhat constrained in the short-term, transportation choices become more flexible in the long-term. Over time, carbon pricing (through higher fuel prices) encourages people to carefully consider long-term decisions. I may not buy a new car every day, but when I do, that choice has big implications for my emissions; as does the decision on where to live and how long I want to commute by car. And we now have access to a wider and more affordable range of choices: more efficient vehicles or alternative vehicles like hybrids or electrics.

Another sidebar: keep in mind that higher fuel prices also provide an incentive for businesses to create cleaner fuel and vehicle technologies. This is called the elasticity of supply, and is an important factor for whether consumers have low-carbon transportation alternatives. We’ll save this topic for another blog.

Walking the walk: carbon pricing can reduce transportation emissions

The examples so far have covered the consumer response to changes to fuel prices generally. What about the effects from carbon pricing?

Evidence from BC’s carbon tax is instructive. A number of studies find that the $30/tonne tax—which increased gasoline and diesel prices by 7 and 8 cents, respectively—resulted in a 7–17% drop in fuel purchases. More specifically, research by Antweiler and Gulati (at UBC) find that consumers responded to the carbon tax by buying more fuel-efficient vehicles.

The permanence of a carbon price also reinforces the signal for drivers: people react more strongly to carbon pricing—and fuel taxes more generally—than to the normal fluctuations in fuel prices. One study, for example, found that consumers are nearly three times more sensitive to price changes that are more permanent (i.e. taxes) compared to more temporary price movements. Research by Rivers and Schaufele find similar conclusions.

The idea that drivers respond to carbon pricing should seem intuitive. Even if most people rely on their gasoline and diesel cars in the short-run and have few other options, higher prices encourage people to make small adjustments. Instead of driving to work each day, some may choose to take the bus one day a week, bike, or find a carpool group to save fuel costs. Maybe even more importantly, we make bigger spending decisions and travel choices over time. Each of these responses from a carbon price—big and small—helps reduce transportation emissions.

2 comments

  1. Stephen McClellan

    Interesting read. It has been a while since I worked on energy or climate change policies but when I did the evidence certainly did point to very inelastic demand for gasoline. This new work suggests it may be time to rethink those assumptions particularly as they relate to modeling exercises in support of policy making. That said it is essential to ensure that any analysis to support any estimates of elasticity be careful to isolate other dependent factors not the least of which is income and is based on solid and lengthy time series data

    • Jonathan Arnold
      Jonathan Arnold

      Hi Stephen,

      Thanks for your response. I apologize for the delay in getting back to you.

      Your comments about ensuring that modelling assumptions are appropriately updated is a salient one. I think this is indeed being done by organizations like the International Energy Agency that have done lots of work in this field. As substitutes for fossil fuels (and fossil fuel vehicles) become cheaper and more accessible, this will undoubtedly change the elasticity of demand over time.

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