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Part 3: Overview of fuel taxation objectives

This part provides an overview of some of the objectives often put forward for imposing specific taxes on fuel and the factors that need to be taken into account in assessing the appropriateness of these objectives.

3.1 Fuel taxation as a source of revenue

The principal reason for governments imposing taxes is raising revenue to fund the provision of services to the public.

This revenue may be raised by imposing taxes on income (such as wages and salaries or company profits) or on consumption through taxes imposed directly on goods and services.

Taxation of fuel, particularly petroleum products, is widely considered an efficient means of raising government revenue because fuel is widely used by the community and compared with many other goods, its level of consumption is not generally affected by changes in price. This makes it a relatively stable and reliable source of revenue to fund the range of services provided by governments. Furthermore, the administrative framework required to collect specific fuel taxes is relatively less onerous than for other taxes. Typically, there are only a small number of manufacturers legally required to remit the majority of fuel taxes, reflecting the concentrated nature of the industry.

The characteristics of fuel use that make fuel taxation a reliable source of revenue reflect the importance of fuel as an input to the production and distribution of goods and services and therefore to the economy and economic activity more generally.

Governments may seek to reduce the costs of fuel use in particular sectors, such as primary production or transport, or the costs of particular forms of fuel use such as off-road use. This may be achieved through rebate, subsidy or grant schemes.

3.2 Other possible objectives of fuel taxation

In raising revenue, governments also use taxation to achieve other policy objectives such as income redistribution, or influencing taxpayer behaviour in the consumption of particular goods and services.

Most modern economies rely on the market mechanism to determine economic behaviour, with individuals' choices determining the production of goods and services. This is because the market mechanism, operating efficiently, should ensure that goods and services are provided by producers in response to the diverse and changing needs of consumers.

The market should also ensure that prices charged for goods and services reflect their value to consumers. When this occurs, resources available in the economy for the production of goods and services would be allocated by the market to their most highly valued uses.

However, freely functioning markets will not always operate in a fully efficient manner and the outcomes desired by the community may not be achieved without some intervention from government.

For example, while prices should reflect the full cost of production and consumption, some prices do not always take into account all the positive or negative effects of producing or consuming goods. These `spillover' effects, called externalities, are the impacts of consumption on others, which are not reflected in the price paid for the good or service consumed.

A range of costs often identified with fuel use is borne by the general community. In road transport, for example, the community mostly bears the cost of road construction and maintenance and reduced air quality from exhaust emissions, but individual fuel users gain the economic or social benefits of moving goods or people.

For example, the use of petrol in a motor vehicle pollutes the air enjoyed by the community, but there is no market value for air. In a freely functioning market without government intervention, the motorist does not pay the cost of polluting the air when using petrol. Rather, the community as a whole pays through reduced quality of life, possibly including impaired health and mortality.

In these circumstances, a freely functioning market may not produce the combination of goods and services most desired by the community. If a way could be found for the price of petrol to fully reflect the costs it imposes on the community from its use, consumers may choose other goods and services over petrol (for example, public transport).

There are several mechanisms available to governments to address the spillover costs of fuel use. These include:

• fuel taxes to increase the price of fuel;

• regulations, such as vehicle emissions standards; and

• other mechanisms, such as road tolls or charges imposed on people travelling in congested areas.

Importantly, a number of factors need to be considered in assessing the appropriateness of fuel taxation, or other policy measures to address the spillover costs of fuel use. These factors include:

• advances in technology (such as hybrid electric vehicles) or substitution of fuel that change the impact of fuel use (for example, impacts on air quality);

• the application of taxes directly linked to the cause of the spillover costs

    - for example, fuel taxes might not be the best response to road damage, because such damage is more closely related to the size of a vehicle and the distance it travels, rather than the amount of fuel it uses; and

• the net benefit of addressing spillover costs through government intervention, as intervention itself can impose costs:

    - governments need to take into account the possible costs of intervention, and ensure they are outweighed by the benefits.

In considering these factors, the Inquiry welcomes comments on the extent to which the community considers that fuel taxes are an appropriate mechanism to address the spillover costs of fuel use, or whether these costs should be addressed by other policy instruments. This is further discussed in Part 7.

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