To tax or to spend? Modelling tax policy responses to oil price shocks

Abstract

Global crude oil prices surged in 2022 due to geopolitical conflicts, raising living costs worldwide. In response, policy measures such as fuel excise cuts and energy profits levies have been adopted by policymakers worldwide. We assess the efficacy of these two fiscal policy responses to temporary supply-side oil price shocks, using a dynamic general equilibrium model with rich fiscal and industry detail. Our focus is Australia, a distinctive country that functions both as an oil importer, and a liquefied natural gas (LNG) exporter. This dual role amplifies the inflationary pressure for Australian households and industries caused by an oil price rise, because the domestic LNG industry is largely foreign-owned and capital intensive. Inflated profits therefore flow offshore, and little of the terms of trade gain stemming from the oil-indexed LNG export price accrues to domestic economic agents. We find a temporary fuel excise cut can limit GDP and employment losses, but its effectiveness in relieving household cost-of-living pressure comes at the cost of increased net foreign debt. Higher oil prices also weaken the case for this policy from an allocative efficiency perspective. In contrast, an energy profits levy can stimulate national income without compromising the budget.