CoPS/IMPACT Working Paper Number G-336

Title: Oil Supply Shocks and Tax Policy Responses in Australia: Insights from a Dynamic CGE Framework

Authors: Xianglong Liu, Jason Nassios and James Giesecke


Recent surges in global crude oil prices, caused by supply disruptions from Russia's invasion of Ukraine and associated sanctions, have increased the cost of living globally. In response, in the 2022/23 Australian Federal budget, the former Coalition government announced a halving of Australia's fuel excise from 44 cents per litre to 22 cents per litre for six months. This paper explores the impact of an oil supply shock on the Australian economy, and the effectiveness of a fuel excise reduction as a policy response. We adopt a single-country dynamic computable general equilibrium (CGE) framework. Because Australia is a net oil-importing economy, ceteris paribus, the rise in world oil prices puts downward pressure on the terms of trade and household consumption. The impact at the macro level on real GDP is damped by a rise in net exports and world LNG prices, a key Australian export. Our analysis unpacks the role played by the linkage between world oil and LNG prices. While this linkage attenuates the macroeconomic effects of an oil price rise in Australia, its capacity to mitigate the economic damage is muted because of the LNG sector's low labour intensity, high foreign ownership, and the associated rise in domestic gas prices, which hurt domestic gas users. We find a 50 percent reduction in fuel excise can help damp the overall fall in real GDP and employment, at the expense of larger budget deficits. Rather than strengthening calls for a cut in fuel tax excise rates, we show that higher oil prices compromise calls for its reduction from an allocative efficiency perspective, because it is a specific tax. Finally, we study an alternative policy response to higher world oil prices in Australia: adoption of a UK-style energy profits levy on LNG producers. We find that such a policy would promote household consumption without compromising the federal budget.

JEL classification: C68, E62, H25, Q43

Keywords: taxation policy; CGE modelling; dynamics; oil prices.

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