Oil price volatility is highly disruptive to the economy. The disruption could be minimized by a variable oil tax that prevented the price from falling through a given floor, but did not apply when oil prices approached a peak.

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How a Price-Smoothing Oil
Tax Could Help Make This
the Last Oil Price Shock
Posted March 1, 2011
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November 13, 2014
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2. Oil Prices Spike Yet Again
 Events in Libya and elsewhere in the
Middle East have sent oil prices above
the $100 mark yet again
 Does the cycle of oil price shocks
have to repeat endlessly, or is there a
way for consuming nations to protect
themselves?
Photo source: William Murphy,
http://commons.wikimedia.org/wiki/File:Libyans_In_Dublin_March_In_Pro
test_Against_Gadaffi.jpg
Posted Mar. 1, 2011 on Ed Dolan’s Econ Blog http://dolanecon.blogspot.com

3. How Oil Producers Protect Themselves
 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
 Consuming countries have no such
protection
Strategic oil reserves only provide
short-term protection against physical
supply interruptions
They do little to mitigate price
volatility
A Norwegian Oil Platform Under Construction
Photo source” Ranveig
http://commons.wikimedia.org/wiki/File:Oil_platform_Norway_new.jpg
Posted Mar. 1, 2011 on Ed Dolan’s Econ Blog http://dolanecon.blogspot.com

4. How a Price-Smoothing Oil Tax Would Work
 A price-smoothing oil tax could reduce
swings in oil prices for consuming
countries
 Such a 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

5. An Oil Tax would Enhance National Security
 When world oil prices are high, money
flows to many producers who 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
Posted Mar. 1, 2011 on Ed Dolan’s Econ Blog http://dolanecon.blogspot.com

6. An Oil Tax would Protect the Environment
 High prices encourage investments in
conservation and alternative energy,
but there is a risk
 If prices fall again, the investments
might not pay off
 By putting a lower limit on the price, a
variable, price-smoothing oil tax would
reduce the risk of green investment by
consumers and businesses
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

7. 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
Posted Mar. 1, 2011 on Ed Dolan’s Econ Blog http://dolanecon.blogspot.com

8. An Oil Tax Could Help Solve Deficit Problems
No one likes taxes, but given the large US budget deficit, some taxes are
necessary. A variable, price-smoothing oil tax would raise revenue that could be
used, in part, to reduce the deficit, and in part to lower tax rates on personal or
corporate income taxes
Posted Mar. 1, 2011 on Ed Dolan’s Econ Blog http://dolanecon.blogspot.com

9. 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
 The best time to introduce such a tax is
now, when prices are already high
Posted Mar. 1, 2011 on Ed Dolan’s Econ Blog http://dolanecon.blogspot.com

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
 The best time to introduce such a tax is
now, when prices are already high
Posted Mar. 1, 2011 on Ed Dolan’s Econ Blog http://dolanecon.blogspot.com