Overreaction to Excise Taxes: The Case of Gasoline

In this paper we contribute new results on the different consumers’ reaction to tax or price changes. We separately compute the compensated gasoline retail price elasticity and the gasoline tax elasticity and show that consumers overreact to taxes as compared to price variations. A novel element in our analysis is that we compare reactions to tax-inclusive retail prices to reactions to information on excise taxes that is made available to consumers. We estimate a complete system of demand for the U.S. population of households using quarterly data from the Consumer Expenditure Survey from 2007 to 2009. Relying on a complete system of demands rather than on single equations avoids imposing an implausible separability restriction, thus allowing estimation of accurate elasticities that take behavioral responses into account, i.e. that account for the way in which consumers reallocate their expenditure on a bundle of goods after a price/tax change in one of the goods. Our analysis shows that the reaction to a gasoline tax change is, on average, about 20% stronger than the reaction to a corresponding price change. We discuss the implications of our findings for the design of energy policies.