8 September 2005

Cullen Releases Reports On Petrol

Finance Minister Michael Cullen today released two pieces of expert advice showing that there is no tax windfall to the government from higher petrol prices.

The Treasury report, prepared in August 2000 during a previous petrol price peak, says the price rises are likely to lead to little change in tax revenue in the short term and an increasing reduction in tax revenue in the longer term.

And an analysis prepared by a research analyst at the Parliamentary Library suggests that while it is possible government revenue may rise by $14 million, it is also possible that it may reduce by as much as $42 million depending on how much people compensate for the price rises by reducing their expenditure elsewhere.

Attached:
Treasury report.
Report from Parliamentary Library.

29 August 2000 TX/1/3/3/6
Treasury Report: Petrol Price Increases
Executive Summary

Petrol price increases are likely to lead to little change in tax revenue in the short term and an increasing reduction in tax revenue in the longer term. Excise and customs duties on petrol are based on volume, not price, and so will decrease as consumption falls in the longer term in response to price rises. GST revenue is unlikely to rise and may actually decrease, because the gain in GST from higher petrol prices will be offset by two factors. These are reduced consumption of petrol, and less GST from other sources as people and businesses meet higher petrol costs by reducing spending on other, less essential goods.

Petrol price increases will increase the CPI, leading to increased government expenditure on benefits and NZ Superannuation. Increased spending on petrol, at the expense of domestically produced goods, could also have negative, flow-on effects for tax revenue and the economy in general.

Recent media reports on the extent of gains in GST from petrol price rises appear to have ignored the decline in non-petrol spending in their calculations.

There is no evidence oil companies have used increases in crude oil prices to inflate their margins. In fact, margins are currently significantly tighter than they were in 1996.

A reduction in taxes to offset a change in petrol prices would reduce the burden of the price rises on petrol-users. However, the strategic context of the Government’s management of the economy, and tax and fiscal strategy suggest that a tax reduction to reduce the petrol price-rise would have major disadvantages.

Recommended Action

This report is for your information. We recommend that you refer it to the Minister of Economic Development, the Minister of Energy, the Associate Minister of Energy and the Minister of Transport and any other interested Ministers.

Minister of Economic Development
Minister of Energy
Associate Minister of Energy
Minister of Transport and any other interested Ministers

Referred: Yes/No

Hon Dr Michael Cullen
Treasurer/Minister of Finance

Treasury Report: Petrol Price Increases

Purpose of Report

1. Your Office asked for a report on the revenue effects of petrol price increases. This report discusses the likely revenue effects, both direct and indirect, of petrol price rises on tax revenue. It also briefly discusses the effect on government spending, the source of the petrol price-rise, and problems with offsetting the price rises by a reduction in the tax component of petrol.
Analysis
Direct Revenue Effects on Petrol Excise Duties and GST
2. Tax revenue from petrol arises from three sources:

- excise duty on domestically refined petrol;

- customs duty on imported petrol; and

- GST, both on these duties and on the pump price minus the duties.

3. Excise and customs duties on petroleum fuel are charged on a per litre basis, not as a percentage of the selling price. The current excise rate, which is also used for the customs duty, is 34.3 cents per litre. This was set in the 1998 Budget and, unlike excise duties on alcohol or tobacco, is not annually CPI-adjusted. The duty on fuel is apportioned between ACC levies (2 cents), roading funds (13.5 cents) and general taxation revenue (the remaining 18.8 cents).

4. Petrol price increases lead to consumption decreases. Therefore, as excise and customs duties are based on volume, rather than price, increasing petrol prices reduce revenue from these duties. Based on present levels, each percentage point decline in consumption equates to a loss of around $12 million in excise and customs duties.

5. GST on the excise or customs duty lifts the rate to nearly 38.6 cents per litre. Like the duty it is tied to, the total value of this GST falls as consumption drops. GST is also charged on the price of petrol before excise duty (and GST on that duty). This source of GST does increase as the price per litre rises. However, for two main reasons, overall revenue from GST may not rise as petrol prices increase.

- Firstly, while higher prices mean more GST from each litre of petrol sold, overall GST revenue from petrol will increase to a lesser extent, or even decrease, depending on the downturn in consumption. Petrol is a necessity for many individuals and firms and so, in the short-term, the decline in consumption is likely to be small.

If petrol prices remain high, the long-term downturn in consumption will be more significant. In the longer term individuals and businesses will find ways of reducing their use of petrol, e.g. firms contracting rail or shipping rather than trucks to transport goods, replacing vehicles with more fuel-efficient models, or conversions of vehicles to run on LPG.

- Secondly, most consumers are on a fixed budget. They are likely to meet the higher cost of buying petrol by reducing their purchases of other goods. While many consumers may not be in a position to cut petrol consumption by much in the short term, most will be able to reduce spending in some other areas and hence this will probably have the bigger impact on GST. As GST is charged at 12.5% on all goods, it makes no difference to the overall GST revenue if the average consumer spends $15 more each week on petrol but $15 less on other goods.

6. In short, the likely scenario, especially in the long-term, is that GST revenue will not change much, but may actually decrease. This is because people and businesses will lower petrol consumption and switch spending from other goods they find less essential in order to stay within their budgets.

Indirect Effects on Government Spending and Revenue

7. There will be many indirect effects on the Government’s budget arising from petrol price rises, some of which could be positive and others negative. Two, in particular, stand out as probable and, unfortunately, negative.

- Petrol price increases will affect the CPI, both directly through the price of petrol itself and indirectly through the price of goods which have petrol as part of their cost structure. Since the end of June 1999, petrol has risen in price by about 45%. This will raise the CPI by approximately 1.3 percentage points. Social Welfare benefits and NZ Superannuation (NZS) are CPI-adjusted each April. If the increase in the CPI really is 1.3 percentage points, the Government will face around $110 million in extra annual net expenditure on benefits and NZS.

- Petrol is essentially an imported good, even if the majority is refined domestically. To meet the higher cost of petrol, people and businesses will decrease their spending on domestically produced goods to some degree. The flow-on effects of this reduced spending on domestically produced items are lower profits for NZ firms and hence less corporate tax revenue. This could also lead to job losses, which not only results in reduced personal tax but also higher benefit payments.

Claims about Increased GST Revenue for the Government from Petrol Price Rises
8. Recent newspaper articles have reported various claims on how much extra GST the Government has received since petrol prices started to go up in July last year, including, for example, BP spokeswoman Jane Diver stating the figure was $60 million. The table below gives estimates of the extra GST from petrol.

Quarter Average price rise per litre since June 1999 quarter
(NZ cents) Extra cents of GST per litre Total extra GST since June 1999 quarter
($NZ million)
Sep 99 6.4 0.7 5
Dec 99 12.1 1.3 16
Mar 00 16.5 1.8 29
Jun 00 20.8 2.3 48
Present 37.5 4.2 63

It is crucial to realise that these calculations make no allowance for compensating the higher expenditure on petrol by reduced spending on other goods.

9. There have also been media comments which link the petrol price increase to increases in overall GST revenue. While it is true that GST receipts have grown in the 1999/2000 fiscal year, they grew by nearly twice as much in the previous year when petrol prices were fairly steady. GST is affected by numerous factors, such as income and profit growth, Government and consumer spending, and interest rates. Consequently, the effect on GST of price increases in one good cannot be reliably measured by comparing growth between years.

The Source of Petrol Price Rises

10. The two major factors underlying the recent rise in petrol pump prices have been the rising cost of crude oil on the world market and the recent weakness in the NZ dollar. Two other factors also influencing pump prices are the rising cost of refining crude oil and the cost of shipping the fuels to New Zealand.

11. Data collected on the cost to oil companies of producing refined petrol and the price charged at the pump indicate that both have closely tracked the cost of crude oil. There is no evidence that oil companies have used the hikes in crude oil prices to raise their margins on pump prices. In fact, the data supports the opposite scenario, which is that margins have been significantly tightened compared with their levels in 1996 and 1997.

Should the Government Offset Petrol Price Rises by Reducing the Petrol Excise?

12. A reduction in excise taxation to offset a change in petrol prices would reduce the burden of the price rises on petrol-users. However, it is desirable to put this policy option in a strategic context of the Government’s management of the economy and tax and fiscal strategy. These broader considerations suggest that a tax reduction to reduce the petrol price-rise would have major disadvantages, as discussed below.

i. Prices play a key role in allocating resources in the economy. An increase in the price of petrol shows that certain activities have become more expensive. This will lead people to change their behaviour. Offsetting petrol price rises by reducing taxes on petrol would mute this change in behaviour and accordingly lead to a reduction in New Zealand’s overall economic welfare.

ii. Cutting excise rates to offset petrol price increases would reduce Government revenues. Other taxes would have to be increased in order to maintain the current fiscal position.

iii. It is unclear how long high prices will last, how large future price changes (up or down) will be or what other inputs would be “eligible” for tax offsets if their prices rise. Therefore changing the excise tax to offset petrol price-changes would risk creating an unstable tax system.

iv. Cutting the excise would require the Government to know what the “correct” price of petrol is. However, the comments under (iii) above suggest that it is not possible for the Government to know this.

v. Offsetting petrol price increases could send a signal to the business community that it can obtain favourable tax treatment to offset rises in particular production-costs, leading to lobbying for such treatment.

vi. A policy of reducing the excise in response to petrol-price increases may prove to be “asymmetric”, since petrol consumers and lobbyists would probably vigorously oppose offsetting future petrol-price reductions with excise increases.

vii. Cutting excise rates could encourage petrol companies to inflate their margins via the Government buffering the price.
Consultation

12. The Ministry of Economic Development has been consulted on, and agrees with, this report.

ENDS

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