An oil importing country can protect itself from the adverse effects of price volatility and encourage energy conservation by implementing a tax that varies inversely with the global oil price, thereby smoothing the domestic price.

1. Economics for your Classroom from
Ed Dolan’s Econ Blog
The Economics of a Price-
Smoothing Oil Tax
Revised Nov. 13, 2014
Terms of Use: These slides are provided under Creative Commons License Attribution—Share Alike 3.0 . You are free
to use these slides as a resource for your economics classes together with whatever textbook you are using. If you like
the slides, you may also want to take a look at my textbook, Introduction to Economics, from BVT Publishing.

2. Oil Prices Crash—Should We Celebrate?
 Oil prices have fallen below $100 for
the first time in more than two years.
 Consumers are dancing at the gas
pumps, but economists and
environmentalists have reservations
 Big fluctuations in oil prices cause
uncertainty that undermines
investments in energy conservation
 What could be done to protect
against oil price volatility?
Nov. 13, 2014 Ed Dolan’s Econ Blog

3. How Oil Producers Protect Themselves
 Oil producers like Norway, Russia,
and Saudi Arabia have learned to
protect themselves from the curse of
oil price volatility
 They do so using national wealth
funds that build up when prices are
high and run down when prices are
low
A Norwegian Oil Platform Under Construction
Photo source” Ranveig
http://commons.wikimedia.org/wiki/File:Oil_platform_Norway_new.jpg
Nov. 13, 2014 Ed Dolan’s Econ Blog

4. How consuming countries can protect themselves
 Strategic oil reserves can give
consuming countries some limited
short-run protection against supply
interruptions
 To encourage energy efficiency, they
can use a price smoothing oil tax
 Such a tax would put a floor under
energy prices and encourage
investment in conservation
measures like fuel-efficient cars,
better home insulation, and more
efficient industrial processes
Posted Mar. 1, 2011 on Ed Dolan’s Econ Blog http://dolanecon.blogspot.com

5. How a Price-Smoothing Oil Tax Would Work
 A price-smoothing oil tax would begin
by setting a floor oil price X
 When the world price P falls below X,
a tax of P-X would make up the
difference
 When the world price rises above X,
the tax would be zero
Photo source: http://commons.wikimedia.org/wiki/File:Gas-pump-Indiana-USA.jpg
Posted Mar. 1, 2011 on Ed Dolan’s Econ Blog http://dolanecon.blogspot.com

6. An Oil Tax would Enhance National Security
 When world oil prices are high, money
flows producers may of whom are
corrupt, undemocratic, or anti-
American
 An oil tax would insert a wedge
between the US price and the world
price
 Pushing the US price higher would
encourage conservation and
investment in alternative energy
 Pushing the world price lower would
deprive hostile countries of revenue Photo source:http://commons.wikimedia.org/wiki/File:Marines-with-sniper-rifle-2.jpg
Nov. 13, 2014 Ed Dolan’s Econ Blog

7. Protecting the environment is not all about climate change
 High prices encourage investments in
conservation and alternative energy
 That is important for people who are
concerned about climate change, but
that is not the only environmental
benefit
 Energy efficiency also has immediate,
tangible benefits on local air quality,
health, and road congestion
Photo source: Massimo Caratinella
http://commons.wikimedia.org/wiki/File:LosAngelesSmog.jpg
Posted Mar. 1, 2011 on Ed Dolan’s Econ Blog http://dolanecon.blogspot.com

8. A Variable Oil Tax Could Help Protect Against Recession
 Oil price spikes have often be followed
by recessions in the United States
 High oil prices reduce spending on
other goods and services and
undermine consumer confidence
 A tax-smoothing oil price would help
reduce the volatility of oil prices
Economist James Hamilton has written
extensively on the effects of oil price
shocks on the US economy. See his
recent blog post on Econbrowser for some
data and references
Nov. 13, 2014 Ed Dolan’s Econ Blog

9. Energy Taxes are Good Fiscal Policy
No one likes taxes, but taxes of some kind are an
unavoidable part of public finance. If introduced
on a revenue-neutral basis, a price-smoothing oil
tax would improve incentives for energy efficiency
while permitting a reduction in other corporate or
personal taxes that distort incentives elsewhere in
the economy
Nov. 13, 2014 Ed Dolan’s Econ Blog

10. The Bottom Line
The bottom line:
 We do not have to accept the damage to
national security, the environment, and
the economy caused by extreme oil
price volatility
 A variable, price-smoothing oil tax could
mitigate extreme swings in oil prices and
improve incentives for investment in
conservation and alternative energy
Nov. 13, 2014 Ed Dolan’s Econ Blog

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