April 6, 2023

The possible increase in the specific tax on fuels has returned to public discussion after the Minister of the Environment mentioned that progress is being made on the green tax project included in the government’s program. The reactions to her statements highlight that this is a complex and controversial measure. To contribute to the debate, we present various perspectives on the issue from academia, industry, and politics.

The controversy surrounding a potential increase in the specific fuel tax (IEC) has once again raised the question of whether this tax is effective in discouraging the use of fossil fuel-powered cars and consequently reducing pollutant emissions. The debate arose after Minister of the Environment Maisa Rojas stated that the proposal for tax reform regarding green taxes is “practically ready” in response to a question about an increase in the IEC, a measure included in President Gabriel Boric’s government program.

Although the minister later clarified that she was referring to green—or corrective—taxes in general rather than specifically to the IEC, various sectors criticized the possibility of an increase, mainly citing the potential impact on the middle class.

The government program includes four main categories under the concept of “green taxes”:

  • A gradual increase in the CO₂ tax from 5 to 40 USD per ton of CO₂.
  • A gradual increase in the specific fuel tax to an average of 7 UTM/m³ nationwide and the elimination of exemptions for industries and transportation.
  • Expanding the tax on the first sale of automobiles.
  • Introducing an ad valorem tax on plastic packaging and disposable plastic products.

Currently, the IEC is set at 6 UTM per cubic meter for gasoline and 1.5 UTM/m³ for diesel (Law 18.502), accounting for approximately 46% and 23% of the final price, respectively. The key question is: Would increasing the IEC to 7 UTM influence car use and effectively reduce emissions?

A Political Perspective: The Impact on the Middle Class

Félix González, a congressman from the Green Ecologist Party representing District 20 in the Biobío region, argues that raising the IEC will not significantly change people’s behavior because they lack viable transportation alternatives.

“Taxes typically have two purposes: revenue generation and behavior change. Since the tax is already high and international fuel prices are also high, a 100 or 300-peso increase in fuel prices won’t alter behavior,” he explains.

He points out that in many cities, public transport is inadequate and overcrowded, making it impossible for people to stop using their cars.

“The Biotren is packed to capacity, buses are overcrowded, and people will continue to travel as they do now because they have no other choice. An increase in fuel taxes won’t lead to lower fossil fuel consumption; it will just increase tax revenue and burden the middle class,” González asserts.

He also criticizes the existing exemptions for freight transport and the mining industry, noting that these sectors have more flexibility to switch to cleaner energy sources, such as rail transport or green hydrogen.

The Academic View: Externalities and the Tax Gap

Claudio Agostini, an academic and researcher at the Center for Energy Transition (CENTRA) at the Universidad Adolfo Ibáñez (UAI), explains that the primary goal of the fuel tax is to address the negative externalities caused by fuel consumption, including pollution, traffic congestion, and road accidents.

“Oil consumption is directly linked to higher pollution levels, increased congestion, and more traffic accidents. Therefore, fuel taxes are a necessary measure to reduce these negative impacts, which users don’t typically account for in their decisions,” Agostini states.

He highlights a major discrepancy in taxation between gasoline and diesel in Chile:

“On average, 20% of diesel vehicle emissions equal 80% of gasoline vehicle emissions, meaning diesel cars pollute more but pay lower taxes.”

Agostini argues that increasing taxes closer to the proposed government levels would help achieve the desired outcomes. He cites a study by Parry and Strand (2010), which estimates that the optimal tax rate for Chile should be 7.22 UTM/m³ for gasoline (currently 6) and 6.71 UTM/m³ for diesel (currently only 1.5).

Public Transport as a Key Factor

Katherine Brintrup, Director of the School of Energy and Sustainability at Universidad San Sebastián, agrees with Congressman González that improving public transport is crucial before raising fuel taxes.

“Middle-class and lower-middle-class families would be the most affected by an IEC increase, especially those living in isolated areas where cars are essential for daily life,” she explains.

Brintrup highlights that in Santiago, public transport is relatively efficient, but in many regions, there is no fast or well-connected system.

“When there’s no reliable public transport, families are forced to cut back on other expenses to afford higher fuel costs,” she warns.

She argues that comprehensive measures—not just fuel taxes—are needed to reduce car use.

“In Europe, public transport is not cheap, but it’s high-quality, punctual, and predictable. People willingly switch to public transit when these conditions are met,” she says.

Behavioral Economics: Fuel Demand Elasticity

Luis Rizzi Campanella, a professor at the Pontificia Universidad Católica (PUC) Department of Transportation and Logistics Engineering, explains how an IEC increase could influence car use by applying the concept of demand elasticity—how sensitive consumers are to price changes.

“If demand is very sensitive to price, increasing the IEC will lead to a decrease in fuel consumption. But if demand is inelastic, a price increase won’t significantly impact fuel sales,” he explains.

In the short term, he says, most drivers won’t change their habits, but over time, they may:

  • Switch to more fuel-efficient vehicles.
  • Use their car less frequently.
  • Carpool or combine trips.

He contrasts Europe and the U.S.:

  • Europe has high fuel taxes and limited space, leading to fewer, smaller cars.
  • The U.S. has low fuel taxes and abundant parking, leading to larger, fuel-hungry vehicles.

He concludes that fuel taxes do affect consumer behavior, but governments need to balance economic and social impacts when implementing them.

Industry Perspective: Redesigning the Fuel Tax

Aldo Cerda, CEO of the Santiago Climate Exchange (SCX), argues that fuel taxes should be redesigned to be more effective.

“Since electric vehicles are still rare in Chile, direct fuel taxes would mainly generate revenue rather than reduce emissions,” he explains.

He proposes a progressive taxation system, where only emissions above a certain threshold are taxed, rather than a blanket tax on all emissions.

“If we apply the tax as planned, transport and logistics costs will rise, affecting consumers. Instead, we should gradually increase the proportion of cleaner fuels in the mix,” he suggests.

Final Thoughts: A Complex Challenge

Fuel taxation is a powerful tool for reducing emissions but must be implemented carefully to avoid disproportionately harming the middle class while ensuring real environmental benefits.

Experts agree that raising the IEC alone won’t solve the problem—it must be part of a comprehensive strategy, including:

  • Improved public transport.
  • Incentives for electric and fuel-efficient vehicles.
  • Redesigned fuel taxes with a focus on emissions intensity.

As policymakers debate this issue, the challenge remains striking a balance between environmental goals, economic realities, and social equity.

See full article at: País Circular.