Fuel Tax Incidence and Supply Conditions

Both federal and state diesel and gasoline taxes [are fully passed on] to consumers... [and] are reflected immediately in retail prices.

The division of the burden of fuel taxes between producers and consumers, commonly referred to as "tax incidence," is a key element in current debates about energy policy. In Fuel Tax Incidence and Supply Conditions (NBER Working Paper No. 16863), authors Justin Marion and Erich Muehlegger examine the effect of diesel and gasoline taxes on retail fuel prices. They find complete pass-through of both federal and state diesel and gasoline taxes to consumers. They also find that these taxes are reflected immediately in retail prices; in some cases, retail prices even may rise by more than the tax increase. The pass-through rate for diesel fuel is amplified in cold months, particularly in states with a high fraction of households using heating oil, because heating oil and diesel are chemically equivalent.

Refinery capacity constraints and wholesale inventory levels also affect the pass-through of diesel and gasoline taxes. However, the authors point out that seasonal differences in refinery capacity utilization may be correlated with differences in elasticities of demand for fuel, making it difficult to interpret these findings. Low inventory levels are associated with higher tax-inclusive prices for both gasoline and diesel fuel, and with a greater tax pass-through for gasoline.

The authors also find a positive and significant relationship between the stringency of state gasoline content regulations and tax incidence. In a state like California, which requires the use of a single gasoline formulation throughout the state, the degree of pass-through is greater than in states that permit some variation in such formulation.

The authors' results suggest that under normal market conditions the benefits of fuel tax holidays are likely to accrue to consumers, but those benefits are likely to be shared by both consumers and producers during times when fuel supply constraints exist. Because the burden of fuel taxes falls primarily on consumers, and the demand for diesel and gasoline is not elastic, producer profits are not likely to fall as these taxes rise.

--Lester Picker

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