“Passing Costs On” to Consumers

Whenever anyone raises the prospect of anything that would raise producers’ costs, the specter of the costs being “passed on” to consumers comes up. So, for example, the American Petroleum Institute’s Jack Gerard is pretending to favor the idea of a “carbon fee” rather than cap-and-trade because he seems to think this would be easier to attack:

Gerard said that the carbon fee approach would yield net environmental benefits, while giving consumers the most transparent signal they can get about what the costs are from the program. Unlike the House bill’s cap-and-trade system, oil companies would pass through the costs with signs at the gas pump letting people know they’re paying more because of U.S. efforts to deal with climate change.

This is really just nonsense, as there’s obviously nothing stopping oil companies from putting signs up at the gas pump if cap-and-trade raises their costs.

More generally, you need to be suspicious of the entire form of the argument. After all, if it were true that producers could just “pass the costs on” to consumers, this would raise the question of (a) why the new tax or regulatory burden bothers producers so much, and (b) why they don’t just raise prices now. The answer, of course, is that the current market price maximizes profits. If you raise prices, you’ll lose customers and make less money. That exact same logic applies if new taxes or fees come into play. What actually happens is a mix of higher prices, lower profit margins, and reduced consumption.

Estimating exactly how the mix will play out is difficult. But Brad Johnson offers this analysis:

One can bet they won’t mention that even a very strong price on carbon only marginally affects consumer gas prices. Modeling by the Massachusetts Institute of Technology in 2007 of a scenario equivalent to emissions reductions to 1990 levels by 2020 and 80% cuts by 2050 found that oil producers would pay most of the pollution fees, not consumers. In fact, after an initial rise in consumer prices in the first decade of implementation that could be offset by increased fuel economy standards, MIT projects consumer gas prices would decline:

Now when it comes to looking at a carbon charge as environmental policy, rather than as tax policy, the crux of the matter is that the point of levying the charges is to result in less pollution. If the government were credibly committed to a path of economy-wide carbon emissions reduction, then this would raise consumer gas prices in the short run but the long and medium run effect would be to reduce gasoline consumption. It would take time for new generations of more efficient vehicles to be designed, built, and sold but it would happen soon enough. And the companies who currently profit over America’s high gasoline consumption would end up taking a substantial hit in the form of reduced consumption of their product which in the long-run would likely reduce fuel expenditures.


That said, there’s no getting around the fact that in the short-term unless you’re pushing consumer prices up you’re not going to accomplish anything. Even here, though, it’s important to look at the net effect. If you put a higher tax on gasoline and rebated the money on a flat per capita basis, on net most people would end up with more money in their pockets since the median person consumers a below-mean amount of gasoline (the distribution is bounded at the low end, but not at the higher end so most people are below average). Alternatively, if you take the funds garned from the fee and light them on fire, then even if “most” of the cost is borne by producers, consumers will still feel a pinch.