PETROLEUM PRODUCT PRICES AND PRICE REGULATION IN NOVA SCOTIA: A CONSUMERS PERSPECTIVE

Final Report submitted to Service Nova Scotia and Municipal Relations

Roderick Hill, PhD Professor of Economics, University of New Brunswick, Saint John, N.B. E5N 6P9 email: HREF="mailto:rhill@unb.ca" MACROBUTTON HtmlResAnchor rhill@unb.ca 2 April 2011

TABLE OF CONTENTS Page iii 1 1 2 3 4 4 8

Executive Summary INTRODUCTION Background and objectives Outline Caveats and Limitations PART 1: THE RETAIL GASOLINE MARKET AND GAS PRICE REGULATION: AN OVERVIEW 1.1 Gasoline market and consumer interests 1.2 The regulation of gasoline prices in Nova Scotia

1.3 Price regulation and consumer interests 1.4 Gasoline prices: a brief overview PART 2: REGULATION AND BEFORE-TAX CONSUMER PRICES 2.1 Marketing margins before and after regulation 2.2 How competitive are local gasoline and diesel markets? 2.3 Promotions and other discounts available to consumers 2.4 Comparisons with other markets in Canada 2.5 The variability of prices 2.6 Summary and main conclusions PART 3: AFTER-TAX CONSUMER PRICES: THE CONSUMER-CITIZEN S PERSPECTIVE 3.1 Fuel taxes in Nova Scotia and elsewhere 3.2 Why fuel taxes? 3.3 Fuel taxes in practice as a user charge for roads and highways 3.4 Who pays fuel taxes? 3.5 Fuel taxes to deal with external costs 3.6 Concluding remarks PART 4: SUMMARY AND CONCLUSIONS APPENDICES Appendix 1 Appendix Tables Appendix Figures Appendix 2 BIBLIOGRAPHY

12 15 19 19 28 33 35 38 42 44 45 51 54 66 67 67 69 73 75 83 92 94

EXECUTIVE SUMMARY This report examines petroleum product prices and price regulation in Nova Scotia from a consumer viewpoint. It considers the effects of regulation on before-tax retail prices of gasoline and diesel as well as the excise taxes on fuel that help to determine after-tax prices. Before-tax prices. Before-tax prices in Nova Scotia are among the lowest in Canada for both gasoline and diesel. These are the prices that matter most to individuals in their role as consumers because this is what they pay producers for their fuel. The maximum and minimum wholesale plus retail gross margins for gas set in 2006 by regulation were in line with historical experience. Consumers faced higher prices just after regulation began because retailers set maximum prices, which lay above historical trends. However with

competition, gas prices fell to the regulated minimum price in larger urban areas. Retail prices remained at the maximum in Yarmouth and in some rural areas, but these were likely relatively uncompetitive markets before regulation. Diesel markets were less competitive markets than gasoline and so consumers only benefit from regulation was a price cap. Real wholesale and retail margin declined over time since regulation began, reducing the costs of these services to consumers. This happened because inflation eroded the real value of the nominal wholesale and retail margins (and transportation costs) set by regulation. This resulted in net savings to consumers of between $8 and $20 million over the first five and one-half years of regulation. When margins and fuel transportation costs were adjusted upwards as of January 2012, retailers real margins increased and caught up with inflation. However, consumers can expect real margins to fall in the future as they have in the past. Price changes are more predictable with regulation with two benefits for consumers: unexpected large price increases are almost eliminated and there are modest monetary benefits for those who time their purchases knowing the direction in which the price is likely to change. Finally, price differences between different regions in Nova Scotia now are more closely connected to fuel transportation cost differences rather than to fluctuating differences in competitive conditions between different markets. Were price regulation to be removed, the most likely outcome would be a reversal of these effects of instituting regulation: higher prices in uncompetitive markets, and perhaps in competitive ones; less predictable price changes and regional diversity in prices not based on transportation costs. After-tax prices. Excise tax rates in Nova Scotia for both gasoline and diesel are now about the Canadian average. They have been declining and are at their lowest rates in more than 20 years. Because these taxes contribute to publicly-provided goods and services, their justification depends on the views of consumers-as-citizens about public policy objectives. Should users of roads contribute to their cost or should roads be paid for from general tax revenues? Should polluters face prices reflecting the costs of their pollution? If drivers dont pay for the benefits they receive (and the costs they generate), there will be too much driving, resulting in excessive road costs, road congestion and pollution. Fuel taxes have acted as such charges, although potentially better alternatives are possible that are linked more closely to road use. In Nova Scotia, gas tax revenues and other road-related revenues must be used for road spending. Currently, road users are paying about 80 percent of the cost of the provinces roads, but closer to 50 percent if municipal spending is included. Similarly, other provinces road users are not paying the full costs through these kinds of charges. Fuel taxes reduction pollution, but if they do not cover road costs, they are insufficient to reduce pollution to socially-efficient levels. INTRODUCTION

Background and objectives This report examines petroleum product price regulation in Nova Scotia from a consumer viewpoint. It follows several other reviews made both before and after regulation began on July 1, 2006. The first, Economics of the Nova Scotia Gasoline Market (Gardner Pinfold and MJ Ervin, 2005), examined the structure of the market as a whole with particular emphasis on the decline in the number of retail gasoline outlets while examining a variety of approaches that might address that issue. The second (Gardner Pinfold 2007) reviewed the experience of the first six months of the regulations to examine the extent to which regulation was attaining its objectives. Two years after the introduction of regulation, a third review (Gardner Pinfold 2008) was undertaken to assess the regulations in light of further experience. Issues closely related to consumer interests were an important part of the stated objectives in developing the regulations, but they were not the only objectives. Section 2 of the Regulations1 that
accompany the Petroleum Products Pricing Act reads: The purpose of these regulations is to ensure just and reasonable prices for specified petroleum products, taking into consideration all of the following objectives: (a) preserving the availability of specified petroleum products in rural areas; (b) stabilizing prices of specified petroleum products; (c) minimizing the variances in prices of specified petroleum products across the Province. Thus the earlier studies also concerned themselves with the changing structure of the industry itself and how that relates to the first objective of preserving the availability of supply in rural areas.2 This study focusses on questions of consumer interest in the regulation of prices of petroleum products (henceforth, gas , which should be understood to include non-commercial diesel oil). It will briefly update some of the ground covered in the earlier studies, which looked at whether regulation had stabilized prices and minimized the variability of prices across the provinces, two of the explicit objectives noted above, but it will also examine other questions. The central consumer interest is surely the level of prices, both the before-tax (or ex-tax) prices produced by private markets and the post-tax prices that are the result of public policy. Because these involve fundamentally different issues and interests, I treat them separately in this report. Of course, consumers would like prices to be as low as possible, but the phrase in the Regulations about just and reasonable prices (cited above) gets to the heart of the matter. If ex-tax gas prices rise, consumers may not like it, but it will be much less onerous if consumers have reason to believe that the prices are nevertheless just and reasonable under the circumstances. What role does price regulation play in this regard? How competitive are regulated and unregulated gasoline markets?

What effect did gas price regulations have on the level of prices in Nova Scotia? Can we say whether prices would likely have been higher or lower, on average, had regulation not been in place since July 2006? The official objectives of regulation say nothing one way or the other about this question. The previous studies, cited earlier, assume that prices, at least in some places, would have to rise to meet the first objective of regulation, the preservation of sufficient supply in rural areas.

s .

1 2

The current regulations are Petroleum Products Pricing Regulations, N.S. reg. 128/2010. Preserving rural supply also has a consumer interest aspect, noted later in the report.

To address this question, this report examines ex-tax prices of regular gasoline before and after regulation. These prices are closely related to gas prices in the New York Harbour market on which the regulated prices are based. That relationship is of key importance in inferring the likely effects of regulation. Also instructive is to examine the evidence from individual local markets about how retailers have set prices for gas and diesel after regulation. Have they set the maximum prices allowed by regulation or have they competed prices down to the minimum allowed? I also compare ex-tax prices for gas and diesel in Nova Scotia before and after regulation with those in other Canadian markets to see if that offers any further evidence about how regulation has affected ex-tax consumer prices. If the tax-inclusive price of gas is to be just and reasonable, then the gas taxes themselves need justification. This requires justifying not only the existence of these taxes themselves, but also their levels. Different jurisdictions in Canada and elsewhere have made very different decisions about the levels of these taxes. Can we say who has made the right decision? What are consumer-citizens getting for their taxes? To address these questions, I review the evolution of these taxes in recent decades in Nova Scotia, the rest of Canada and (more briefly) elsewhere and describe the current levels of these taxes. As we will see, one of the main justifications for gas taxes is their use as a kind of indirect user charge for roads and highways. What do roads and highways actually cost and what do gas taxes contribute towards that? The other main rationale for gas taxes is to alter behaviour so as to produce less traffic congestion and less pollution such as smog and carbon dioxide. I briefly review this in the final part of the report. Outline Part 1 briefly describes the basic structure of gasoline and diesel price regulation in Nova Scotia. It then gives some context to the remainder of the report by providing a description of some of the main features of the retail market for gasoline that are of particular interest for consumers. Give the nature of retail gasoline markets, what role might regulation play from a consumer viewpoint? The actual regulations in Nova Scotia are then described. Finally, to give some further context, consumer prices of gasoline in Canada and in Nova Scotia are compared with prices elsewhere. Part 2 addresses consumer issues related to the regulation of the before-tax price of gas. The central focus here is on whether regulation raised or lowered before-tax prices, on balance. It also deals with how competitive local gas markets are in Nova Scotia, the variability of prices across the province and the predictability of regulated prices compared with unregulated ones. It also compares prices in Nova Scotia before and after regulation with prices in the rest of Canada. Part 3 examines issues dealing with the post-tax price of gas, an important source of price differences between provinces and countries. It first reviews the evolution of excise taxes on motor fuels in Nova Scotia and elsewhere. It then turns to the economic justifications for these taxes, with emphasis on the idea that these taxes could play an important role in having the users of roads and highways pay for their costs and what the benefits of that would be. Finally, it reviews the extent to which gas taxes actually cover road system costs in Canada and (briefly) in the United States.

Part 4 summarizes the conclusions. Appendices contain details about calculations and data. Caveats and limitations This report relies on publicly available data and documents. It necessarily focusses attention on the data about retail price that are at hand, but it should be borne in mind that these data are incomplete. Retail price survey data, formerly collected by MJ Ervin & Associates and now by Kent Marketing Services are limited to the areas around just four cities and towns in Nova Scotia before regulation (Halifax, Sydney, Yarmouth and Truro) and to six cities and towns after it (Kentville and New Glasgow being included in the spring of 2006). While these provide information about the posted retail prices available to about two-thirds of the provinces residents, there is no information about prices in other areas, particularly small towns and more isolated rural areas, locales where market behaviour might be different from the places surveyed. As well, these surveys can only record posted prices, not the actual prices consumers may pay net of the various discounts and promotions that may be available to them. The MJ Ervin/Kent Marketing Services retail price survey takes place on Tuesdays, so the day to day fluctuations in price that would be important in understanding behaviour (particularly in an unregulated market) are not available. The survey data even just in Nova Scotia are based upon tens of thousands of individual prices and some reporting errors, transcription errors and other mistakes have undoubtedly crept into the survey data which reports average prices for each location. Some of the prices reported there are not credible. Unfortunately, there is no other public source of retail price information available. PART 1 THE RETAIL GASOLINE MARKET AND GAS PRICE REGULATION: AN OVERVIEW 1.1 Gasoline markets and consumer interests The importance of gasoline in consumers spending From a consumers perspective, gasoline is an important good. Gasoline currently has a weight of 5.8 percent in the overall Consumer Price Index (CPI), reflecting its importance in the average consumers spending.3 This weight depends both on how much gasoline people buy and what its price is.
People buy gasoline frequently and, at least in unregulated markets, its price fluctuates unpredictably, making its price highly visible. Figure 1-1 shows the average retail price of gasoline in Truro from 2002-2010, in 2011 dollars.4 The volatility of gas prices, even over short periods of time, is striking.

This reflects a fixed 2009 basket of consumer purchases at April 2011 prices. This weight effectively assumes that consumers did not reduce their purchases as prices rose. See Statistics Canadas Weighting Diagram of the Consumer Price Index - 2009 Basket at April 2011 Prices, Canada, Primary Classification, at http://www.statcan.gc.ca/imdb-bmdi/document/2301_D48_T9_V1-eng.htm. 4 . The adjustment for inflation is necessary so prices can be compared properly at different periods of time.

In 2009, when gasoline prices collapsed (along with crude oil prices) in the worst part of the severe global recession, the same amount of gasoline that now takes up 5.8 percent of consumers budgets then took up 4.4 percent. In other words, the gas price increases since then have absorbed more than $1 of every $100 spent by consumers. Most things that consumers buy are purchased in markets where prices do not fluctuate like that of gasoline. The price of clothing or laundry detergent, for example, does not change from day to day (or moment to moment) in the way in which prices fluctuate in markets such as those for commodities like oil, gasoline, metals, or in stock markets, or in wholesale markets for fresh fruit and vegetables. The retail prices of fresh fruits and vegetables may also be very volatile, but they make up a smaller portion of overall consumer spending (2.5 percent, according to the Consumer Price Index). As well, if the price of one type of fresh vegetable rises sharply because of bad weather in some valley in California, it is possible to substitute it for another type of vegetable. That is not possible with gasoline.

Neither gasoline nor diesel fuel purchases have increased much in the last ten years. As shown in Figure 1-2, on a per capita basis, Nova Scotians demand for gasoline is higher than in the country more generally. Demand in New Brunswick is the highest in Canada, 15 percent above that in Nova Scotia; Quebec and British Columbia also the provinces with the highest gas taxes are the lowest at 1,050 litres/person, 18 percent less than Nova Scotia. Per capita demand for diesel is much lower than for gasoline. Nova Scotian demand is below the Canadian average.

Consumers responses to price changes A lack of responsiveness to price changes, particularly in the short term, is another important feature of consumers demand for gasoline. Consumers tend to find themselves locked in to a particular pattern of consumption as a result of their past decisions about where to live, where to work, and what kind of vehicle to drive. As a result, if the price of gasoline goes up, consumers find it difficult to cut back gasoline purchases significantly. Instead, they are forced either to cut back on spending on other things or to save less. When the price of fuel changes, people can change how much they drive to some extent, but in the short term they cannot and will not scrap their cars unless it they are old and near the end of their useful lives. (If a person sells a car and gets a more fuel efficient one, someone else will have purchased the car. Only when less fuel-efficient cars are removed from the road does fuel efficiency as a whole rise.) Households can also decide whether and how many vehicles to own, but significant changes here can also take time. As oil and therefore gasoline prices oscillate, people generally dont know whether the gas price changes are temporary or permanent. There is no point in undertaking expensive adjustments in gasoline use if the price change is temporary, so they will tend to wait and see, slowing reaction further.5
This observation is relevant in thinking about changes in taxes on gasoline to attain possible policy goals like having users of roads pay for them or reducing pollution. Large sudden changes in taxes may have little effect on behaviour in the short term, and recognizing this, governments phase them in over a longer period so that consumers can use the time to adjust to what they know will be a permanent change in prices. (This is what British Columbia is doing with its carbon tax.) Finally, the ability to respond to price changes varies from household to household. Not everyone is in the same circumstances. In a study of Canadian consumer demand, Nicol (2003) found systematic differences in the responsiveness of consumers to gasoline price changes depending on household size and whether they were renters or had a mortgage (renters being more responsive to gas price changes, as one might expect). A 10 percent rise in gasoline prices can lead to decreases in long-term gasoline consumption ranging from 1 or 2 percent for some types of households to 8 or 9 percent for others. Demand always decreases by a smaller percentage than prices increase, which implies that consumers spend more on gasoline when prices rise, even when they have had time to try to adjust their consumption.6 When households incomes rise, they will tend to buy more fuel, perhaps having more or larger vehicles or more income to take vacations by car. But typically, an increase in income of 10 percent (for example) will lead to an increase in fuel consumption of less than 10 percent. This is typical of goods that can be thought of as necessities. So as real (ie., inflation adjusted) incomes grow, gasoline demand (and thus revenues from a gas tax at a given rate) will grow much less quickly.

. .

Sperling and Gordon (2009), pp.159-60). With the advent of electric cars and hybrid vehicles, new long-term alternatives to gasoline have appeared. As they become more widespread and less expensive, we can expect long-term responses to gasoline price changes to become larger.
6

Gasoline is a special good from consumers perspective. Gasoline makes up a significant part of consumer spending, yet its price is volatile and unpredictable. Worse, for many it is a necessity and they have difficulty responding to price increases by reducing their purchases.

Competition in gasoline markets In the long term, it is in both consumers and producers interests that sellers of gasoline be able to cover their full costs, which includes a reasonable rate of return on the their capital investments. Sellers, however, would prefer to do better than that the ideal would be a rate of profit as high as a monopolist (i.e., single seller with no competition) would be able to get in the market. As a result, there is a zone of conflicting interests between consumers and producers that revolves around prices. Competitive prices would allow producers to just cover their costs, while at the other extreme, monopoly prices would generate monopoly profits. The retail markets for gas are visibly dominated by the brands of large multinational corporations, making consumers suspicious about the competitiveness of the market. How do actual gasoline retail markets behave in practice? Retail gasoline markets are complex and have been the subject of a great deal of research by economists who are interested in such things as how the composition of firms in the market (eg., share of independent retailers in markets dominated by large vertically-integrated firms) and how the changing numbers of retailers in a market affects consumer prices.7
A lack of competition in a market like that for gasoline can come about in several ways. (1) A retailer can have no competition because other retailers are a long way away. This is a so-called local monopoly. The retailer has a captive market and can set a non-competitive price. Whether or not this results in high profits depends on the retailers costs; if volumes are low, average costs per litre may be high. (2) A group of retailers can collude to establish a cartel and to set what would be, in effect, monopoly prices. Their motto could be that of the grain processing company, Archers Daniel Midland: The competitor is our friend and the customer is our enemy.8 The Competition Bureau takes a dim view of this practice. Competition law in Canada make it illegal to collude to set prices or carry out a variety of other anti-competitive practices. The Competition Bureau has recently secured a series of convictions against gasoline station operators in the Sherbrooke, Victoriaville, Magog and Thetford Mines areas of Quebec.9 However, according to the Competition Bureau (2008), price fixing and other anti-competitive practices are confined to "local markets and isolated incidents. To date, no inquiry has ever produced evidence suggesting that there is a national or regional conspiracy to limit competition." (3) A group of retailers can instead carry out tacit collusion. This type of collusion is perfectly legal, but can have much the same consequences for consumers as the illegal type. Retailers can form an unspoken understanding to keep prices above competitive levels. This is thought to be easier to bring about the

. . .

Recent Canadian studies of these questions are Sen (2005) and Sen and Townley (2010). Frank (2004), p.64. 9 See Competition Bureau (2012) for a brief summary. Further convictions have just taken place in Kingston, Ontario, and investigations continue in Ontario. Clark and Houde (2011) offer a technical analysis of this case. More details of the Bureaus investigations in gasoline markets are available at HREF="http://www.competitionbureau.gc.ca" MACROBUTTON HtmlResAnchor www.competitionbureau.gc.ca
8

smaller the number of companies in a local market. Repeated interactions through price setting can lead to a kind of informal communication: you raise your price, Ill raise mine, for example.10 Alternatively, a local gasoline market might have a competitive outcome where prices fall to a level that, roughly speaking, permits those remaining in the market to at least cover their costs in the long term. As we will see later in this report, most Nova Scotian gasoline markets for which we have information have been competitive in the period after regulation. Consumers have a strong interest in markets for gasoline being competitive. But some markets will not be competitive either because retailers lack any local competition or because the local competition has decided not to compete. Other markets will be competitive. Only the evidence can decide which is which.

1.2 The regulation of gasoline prices in Nova Scotia Before considering the possible benefits and drawbacks to consumers of gasoline price regulation, it will help to review briefly the essential features of regulation as it has been implemented in Nova Scotia. The Petroleum Products Pricing Act of 2005 began the most recent period of regulation for petroleum products prices in Nova Scotia.11 It deals with the markets for regular, mid-grade and premium
gasoline and with ultra-low-sulphur diesel oil. The central feature of regulation is the regulation of wholesale and maximum and minimum retail prices, which began on 1 July 2006 and was administered by Service Nova Scotia and Municipal Relations (SNSMR). New Brunswick began its petroleum products price regulation on the same day. Newfoundland and Prince Edward Island already had long-standing price regulation at that point. How regulated prices are set The regulated prices for the three grades of gasoline are based on the recent spot prices of unleaded regular gasoline in the New York Mercantile Exchange, where large volumes of gasoline are traded. Similarly, the regulated price of diesel is based on spot prices in that same market. This market is usually referred to as the New York Harbour (NYH) market because the harbour is where the fuel is actually delivered once it is sold in the market. Because no one buyer or seller has any significant and lasting influence on the market price, the prices in this market are presumed to be determined in a competitive way. Prices in NYH have historically influenced gasoline prices in eastern North America. For example, if prices fall in New York, a buyer of gasoline could buy it there and transport it to another location, such as eastern Canada. This would limit the price at which gasoline could be sold by refiners in eastern Canada to the NYH price plus transportation costs.12 The actual prices at which refiners post (the rack price) are higher than the NYH price by about 3 cents/litre, but these prices do not reliably reflect the actual transactions prices, which typically take place at varying discounts from the rack price.13 This is why the NYH price has been selected as the benchmark by all provinces in Atlantic Canada.

Studies of some Canadian markets find evidence consistent with this kind of behaviour. See Eckert and West (2004, 2005a and 2005b). 11 . An Act Respecting the Price of Petroleum Products, Chapter 11, Acts of 2005. 12 . The process works in reverse; high prices in New York could attract shipments of gasoline from eastern Canada, reducing supply and rasing prices. That limits how low wholesale gasoline prices could get in eastern Canada before it would be worthwhile shipping supply to other markets. World markets for commodities in general are linked in this way. This is the so-called law of one price: prices will be the same everywhere in a well-informed market, except in this case for transportation cost differences. 13 . Gardner Pinfold and MJ Ervin, 2005, p.7.

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Table 1-1 summarizes the way in which price regulation has been implemented in Nova Scotia, using a numerical example with the actual values behind the prices that were set to take effect on Friday 23 December 2011. These prices were based on the average of the NYH prices from the Thursday of the previous week (15 December) through to the Wednesday of that week (21 December). This average is termed the benchmark price. The benchmark price may then be adjusted by an amount called the forward averaging correction. In this case, the adjustment lowered the benchmark price by a small amount. Table 1-1 Determination of regulated prices for the week beginning Friday 23 December 2011 (all values in Canadian cents per litre) Previous benchmark price (announced 16 December 2011) New benchmark price (average of NYH prices from Thursday 15 December to Wednesday 21 December) + Forward averaging correction + Winter blending adjustment for diesel + Wholesale margin + Zone 1 transportation allowance + Federal & provincial excise taxes Wholesale selling price Regular gasoline 71.0 70.3 - 0.2 6.0 + 0.3 [= 76.4] 10.0 + 15.5 101.9 Diesel 78.8 78.1 - 0.8 +3.1 6 + 0.3 [= 86.7] 4.0 + 15.4 106.1

+ Minimum and maximum retail margins + 15% HST = Minimum & maximum self-serve retail prices

4.0 15.9 121.8

5.5 16.1 123.5

4.0 16.5 126.6

5.5 16.7 128.3

This was done because, as Table 1-1 shows, the prices in NHY had been declining. When the maximum and minimum regulated prices had been set the previous week, they were based on a 71.0 cents per litre (cpl) benchmark price and retail prices reflected that. However, as the week went on and prices fell in New York, the wholesale prices at which retailers could buy also fell. But the retailers did not lower their selling prices. Their actual gross margins (the difference between their buying and selling price for a litre of gas) went up and they made more money.14
Consumers paid more than they would have if retail prices had reflected the lower wholesale price. Now, by knocking down the benchmark price a bit, the regulator is lowering the margin that retailers will receive and the price that consumers pay, recouping the consumers losses of the previous week and evening out the margin that the retailers receive.15 A 6 cpl wholesale margin is then added to the benchmark price to cover the costs of gasoline wholesalers. Added to this margin is an estimate of the actual cost of transportation of the gasoline from the refinery in Halifax. The province is divided into six zones, each with its own transportation allowance. These allowances were raised at the beginning of 2012.

The report will use the term margins to denote gross margins as defined here. Retailers and wholesalers have costs which would have to be deducted to determine their net margins, or profit per litre of fuel sold. Regulation only directly influences gross margins. 15 . This works in reverse. If the benchmark price is rising, a positive forward averaging correction is applied.

14

Next, the federal and provincial government excise taxes for these fuels are added on. The result is the maximum wholesale price, in this case 101.9 cpl for gasoline, 106.1 cpl for diesel. 16 To cover their costs, retailers are allowed a maximum margin of 5.5 cpl, but are guaranteed a minimum margin of 4.0 cpl. Once the Harmonized Sales Tax is applied to this, we have the maximum and minimum self-serve retail prices shown in the bottom line of Table 1-1. The maximum and minimum prices remain in effect until the following Friday, unless some large and sustained change in the NYH market occurs in the view of the regulators. In that case, the price can be interrupted and a new maximum and minimum price announced. This happens rarely. The regulator, now the Nova Scotia Utility and Review Board, approved an increase in the minimum self-service and full service retail mark-ups of 0.8 cents/litre and in the maximum self-service retail mark-up of 1.1 cents/litre. The new retail margins are therefore 4.8 cents minimum and 6.6 cents maximum. Increases in transportation allowances also took place (as reviewed later in Part 2 of this report). These changes took effect 6 January 2012. The adjustments to the regulatory regime Gas price regulation, like any regulatory system, is changed as time passes, reflecting the experiences with it. The previous two reports that examined the extent to which regulation was attaining its objectives undoubtedly contributed to that. Prices, initially set biweekly, were set weekly by May of 2007. In mid-2007, the maximum mark-up for full service gasoline of 7.5 cpl (two cents above the self-service maximum) was removed. This was done "to allow the limited number of dealers (mostly rural) still offering full-serve more flexibility to realize higher margins" (Gardner Pinfold 2008, p.6). Given the limited nature of the full-serve market, this likely had little significant impact across the province as a whole. On 30 September 2009, responsibility for regulation was transferred to the Nova Scotia Utility and Review Board (henceforth the Board). This follows the practice in the rest of Atlantic Canada of assigning the regulatory function to an organization at arms length from government. While I have seen no evidence that this changed the nature of regulation (regulated prices being governed by the same rules as before), one of the intangible benefits to consumers of price regulation is the confidence that maximum prices are just and reasonable and have been determined by a process seen to be as impartial and as free as possible from any suspicion of political influence. An independent Board with experience in regulating utilities is probably better able to do that than a government department.

1.3 Price regulation and consumer interests Before delving into the specific experience with gas price regulation in Nova Scotia, we can pause to think about how price regulation in general might promote or harm consumer interests. While the details of how regulation is implemented will obviously be important, some possibilities that follow from the nature of gasoline markets should be kept in mind. How price regulation could be beneficial to consumer interests 1. Limiting uncompetitive pricing by having a maximum price Because of the potential for tacit collusion by retailers, described earlier, setting maximum prices can limit the extent to which sellers of gasoline can enjoy profits in excess of competitive levels through a high-price strategy. Retailers can still charge the highest price possible, but it will be one determined by the regulator, not by the retailer.
16

In the cases of midgrade gasoline, an extra 3 cpl is added and for premium gasoline, 6 cpl.

When introducing regulation, the Nova Scotia government did not try to show that such tacit collusion existed in some markets, or that consumers were victims of monopolistic pricing. It had other objectives, as we have seen. Nevertheless, from the consumers viewpoint, a pleasant byproduct of setting maximum prices in a market is that sellers power to set monopoly prices is effectively curbed as long as the maximum price is set below the monopoly price. We will see some evidence later in the report that this probably has happened in some places in Nova Scotia, to consumers benefit. 2. Consumers gain by wholesale and retail margins being fixed in dollar terms Regulated maximum mark-ups are set in nominal terms (eg. in cents/litre) and remain fixed for a considerable length of time. But as time passes and prices in the general economy creep up, the value of the dollar slowly erodes. When adjusted for inflation, the nominal mark-ups decline in real terms, i.e., in terms of their purchasing power. Regulated mark-ups have indeed behaved like this in Nova Scotia and in Atlantic Canada more generally. However, such fixed nominal mark-ups do not (and could not) persist forever; wholesalers and retailers would eventually not be able to cover their costs, so consumers benefits are temporary, but real. 3. Increased predictability of price changes With regulation consumers know when prices will change. If prices are based on observed past prices in New York, it is not difficult to predict the direction of price changes. For consumers who care, this removes an important part of the aggravation from buying gasoline and can save them a modest amount of money in the long term.17
4. The setting of minimum prices prevents predatory pricing While consumers like low prices, perhaps there can be too much of a good thing. A local price war among retailers can have longer-term consequences that are not to consumers advantage. That is the reason for the existence of competition laws concerning predatory pricing, the attempt by a retailer to destroy competitors during a price war. If some of the predator s competitors are driven from the market, the predator may be in a position to reap the rewards through higher, non-competitive prices. If competition laws are ineffective at curbing this behaviour, minimum price laws can complement them. For example, Quebec "has had a minimum price floor on retail prices since 1996. This law is similar to sales-below-cost laws in the United States and was enacted to guarantee independent retailers a minimum profit. The law was introduced amid concerns that vertically-integrated refiners were using predatory pricing strategies aimed at weakening and reducing the market share of independents. "18 In Nova Scotia, this was not the official rationale for having a minimum price, but it serves this purpose nevertheless. How price regulation could be detrimental to consumer interests 1. The setting of maximum prices in the market could lead to tacit collusion where it did not exist before

How might the setting of regulated maximum prices affect actual market prices? One possibility is that there is no effect. This would happen if the actual market price would have been between the maximum and minimum values anyway and if the existence of the regulated prices themselves did
. "
17 18

I offer a numerical example in Part 2 of this report, based on actual price changes since regulation began. Sen, Clemente and Jonker (2011), p.538, n.17.

not affect actual price setting. But the evidence we will see later suggests that the setting of regulated prices may well affect how actual prices are set. One idea in economics is that tacit collusion can be made easier by having a maximum price posted in the market. Without it, retailers would have to try to find a mutually acceptable price in some way. Perhaps one would be a price leader and the others would follow. But they might be unsuccessful and attempts at co-operation might collapse. But with the posting of a maximum price, everyone in such a co-operatively minded market knows right away what price to set. Thus, in this scenario, the regulator is actually helping retailers to collude. The result could be higher price than consumers would otherwise have faced. (As we will see in Part 2 of the report, this probably did happen for a while across Nova Scotia when regulation began.) 2. The setting of a minimum price in the market could prevent prices from being lower This is the polar opposite of the previous point. In a competitive market, by setting a minimum price in the market, some sellers could be prevented from setting even lower prices. Setting aside the predatory pricing scenario mentioned earlier, this supposes that the equilibrium of the competitive market lies below the minimum price.19
In fact, that is the stated reason behind having a minimum price in Nova Scotia: at least in some places, lower-cost sellers are prevented from competing directly on the basis of price with some high-cost sellers who could not match their prices in the long term. 3. If regulated margins (and thus prices) are set too high sellers get higher profits and consumers get higher prices This could happen, at least for a while, if the prices particularly the minimum price set by regulators depend only on the history of past prices and margins and if those margins reflected excess profits enjoyed by sellers because of uncompetitive pricing. 4. Regulation offers wholesalers and retailers an opportunity to use the regulatory system to their advantage Producers are typically better-organized and have more resources than consumers, and the gasoline market is no exception. Although a Consumer Advocate is appointed for Board hearings, he or she is outnumbered by industry representatives (not all of whom will necessarily have the same interests on all questions, however). Producers also have an informational advantage: they know their own costs and profitability better than anyone and will naturally present their case in the best possible light. The regulator will necessarily have to make decisions based on incomplete information. An obvious counterpoint to this is that the regulator, the Board in this case, understands this situation as well and will make their decisions accordingly, taking these imbalances into account. How price regulation could benefit both consumers and retailers Much of the previous discussion stressed the differences in the interests of consumers and producers: consumers want low prices, producers want high profits which could mean high prices. But there is one area of common interest in which regulation might help. Because of the special characteristics of the gasoline market, described earlier, it is particularly difficult for consumers to know whether the prices they are being asked to pay are just and reasonable. There is no shortage of claims that gas prices are always and everywhere unreasonably high and that consumers are being ripped off, yet again.20

. .

It also supposes that a unique and well-defined market equilibrium actually exists in this setting. See, for example, the Canadian Centre for Policy Alternatives (CCPA) Gas Price Gouge Meter, at HREF="http://www.gasgouge.ca," MACROBUTTON HtmlResAnchor www.gasgouge.ca, or the Atlantic
20

19

In unregulated markets, retailers bear the brunt of consumer complaints and dissatisfaction when prices are rising. Regulation provides consumers with guidelines established by a disinterested third party as to what actually constitutes a just and reasonable price. Retailers have an interest in having good relations with their customers and being able to point to a regulated price as an indicator that their price is, in fact, reasonable given market conditions, might help in that task. Price regulation like that in Nova Scotia can have outcomes that are beneficial for consumers or are detrimental to their interests, or perhaps a combination of both. The details of how regulation is implemented matter. Whether the average consumer is made better off or worse off cannot be predicted a priori. It depends on the empirical evidence. 1.4 Gasoline prices: a brief overview Average prices for gasoline and diesel vary greatly across countries, as shown in Figures 1-3 and 1-4. The figures show both the before-tax prices and the prices after all taxes are included. While there are some significant differences in the before-tax prices, largely reflecting differences in overall costs of production, it is clear that the largest part of price differences between countries reflects different decisions about how these fuels should be taxed. The difference between Canada and the United States is large, but the figures also make it clear that other industrialized countries have chosen much higher tax rates. Part 3 of this report examines these taxes and the rationales for them in some detail. While consumers in Nova Scotia may take some comfort that gasoline prices are higher in many other countries, what is of more immediate interest is how prices in Nova Scotia compare with prices closer to home. Figures 1-5 and 1-6 replicate the previous figures, but now for average prices in 2011 for the capital cities of the provinces (as a simple way of illustrating prices across the country). They show that we get a similar pattern to that seen internationally: price differences between places are largely a result of different taxes rather than different before-tax prices.

Institute for Market Studies (AIMS) Gouged at the Pumps meters at

HREF="http://www.aims.ca/en/home/reportcards/gaspriceregulation.aspx." MACROBUTTON HtmlResAnchor www.aims.ca/en/home/reportcards/gaspriceregulation.aspx. Hill (2009) describes why the AIMS

figures are wrong. The CCPA figures are also not credible, but an explanation lies outside the scope of this review.

Before-tax prices do differ, reflecting differences in costs (including transportation) and in competitive conditions locally. Gas prices in Halifax were relatively low; only Edmonton was lower. Diesel prices were the lowest of any of the 10 cities. It is hard to do better than that, from a consumer perspective. After-tax price differences reflect both different provincial excise taxes and sales taxes. Taxes on a litre of gasoline in Nova Scotia were the second highest among the ten cities; only Quebec was higher. For diesel, Nova Scotia taxes were tied for third-to-fourth highest, after Quebec and New Brunswick. What should count for consumers the before-tax price or the after-tax price? At first glance, one might think that it is obviously the after-tax price. That is the total amount that consumers actually have to pay for a litre of gasoline or diesel. But that conclusion would be wrong. It is the before-tax price that is important for consumers. This is what the consumer is actually paying the suppliers for the gas itself and their services in getting it through the production process and into the consumers gas tank. But when the consumer-citizen pays 83.6 cents/litre for gas and 41.9 cents/litre in taxes on that gas (the average values for Halifax in 2011), he or she gets in return a litre of gas and additional government-supplied goods and services that cost 41.9 cents. Because the link between paying the 41.9 cents in tax and getting those goods and services (eg., road and highway maintenance and construction, snow plowing, and so on) is not nearly as visible or immediate as getting the litre of gas, people can easily forget about that part of the transaction. If taxes go up, people simply see a litre of gas costing more; if taxes go down, they see a litre of gas costing less. The error in this is that it assumes that either (a) taxes pay for nothing of any value or (b) the goods and services produced by government are free and so require no contributions by citizens to enjoy them. Obviously, neither of these assumptions is true. In thinking about after-tax prices, people should adopt two perspectives: the consumer perspective, that considers the before-tax price, and the citizen perspective that considers the tax payment that accompanies it. Because of its central role for consumers, Part 2 of this report looks in some detail at these ex-tax prices and how regulation may have affected them. Part 3 of the report considers the tax treatment of motor fuels from the consumer-citizens perspective to ask whether these particular taxes are needed and what people are getting for their money.

PART 2. REGULATION AND BEFORE-TAX CONSUMER PRICES A major set of issues of interest to consumers revolves around before-tax prices. These are the subject of this part of the report. Among the questions of primary interest are: Have the regulated maximum and minimum prices that have been set during regulation been reasonable ones from the consumers viewpoint? How much have consumers been paying wholesalers and retailers for their services? How have those payments been changing during the last five and a half years since regulation began? Would prices without regulation have been higher or lower than they have actually been? How do prices in Nova Scotia compare with prices in other Canadian markets? Have before-tax prices in Nova Scotia risen or fallen compared with prices elsewhere and what might account for the changes? Regulation has affected things other than the levels of prices that also interest consumers: the variability and predictability of prices over time and their variation across the province. How have these changed with regulation? To address these and other consumer concerns, we have to begin by looking at the relationship between before-tax retail prices in Nova Scotia and the New York Harbour market on which those prices have been based since regulation began. What was the relationship between them before regulation? What was the relationship after regulation began? Can we infer anything from that about the effects of regulation? 2.1 Marketing margins before and after regulation The marketing margin denotes the difference between the ex-tax retail price and the New York Harbour (NYH) price. The marketing margin is of interest both because it is the focus of setting the margins for regulation, but also because other margin measures, such as the difference between posted retail prices and posted refinery prices are possibly less reliable.21
.
As noted in Part 1, refineries posted rack prices are typically not the actual transactions prices, so the NYH price is a more reliable benchmark for comparison.
21

The marketing margin can be measured in nominal terms, that is in current dollars, or it can be adjusted for inflation and expressed in real terms. Ultimately what both buyers (and sellers) are interested in are real margins. These measure the value of the real goods and services consumers have to give up to buy the services of wholesalers and retailers. If the real margins fall, as they indeed have under regulation, then this is good news for consumers.22 The nominal marketing margin, before and after regulation Regulation initially set the sum of minimum and maximum wholesale and retail margins in nominal (ie money) terms, at 10 and 11.5 cpl respectively above the New York Harbour price. Those nominal margins remained fixed from July 2006 until the beginning of 2012, when the minimum margin was raised to 10.8 cpl and the maximum margin to 12.6 cpl. From a consumer viewpoint, a very important question is how those margins influenced the prices that otherwise would have prevailed in an unregulated market. For example, a high minimum margin compared with what one might have expected margins to be would suggest that regulation must have pushed prices up to a higher level than would otherwise have been the case.

Weekly survey data for retail prices (excluding tax) are available for Halifax, Sydney, Yarmouth and Truro from Tuesday 9 June 1998 onwards. I calculated a population-weighted average of their average weekly retail prices. The difference between this 4-city average and the NYH price gives an estimate of a marketing margin for Nova Scotia.23 (A somewhat broader measure is available after June
2006, when Kentville and New Glasgow retail prices become available.) This 4-city nominal marketing margin for the 1998-2011 period is shown by the red line in Figure 2-1. We can start by examining the nominal marketing margin prior to regulation. As detailed in Appendix 1, I estimated the underlying trend from mid-1998 to mid-2006. The margin trended upward at about 3 percent annually, on average. This rate was almost exactly the 2.9 percent average annual rate of inflation in Nova Scotia during that time, as measured by the Consumer Price Index. While wholesalers and retailers of gasoline buy quite a different mix of goods and services than the typical consumer, the rise in the margins could nevertheless be related to gradually rising costs that reflect this underlying rate of inflation. Trends before and after regulation The best statistical description of the trend was the blue curve in Figure 2-1, which shows an increasing rate of growth. (An alternative trend line with a constant growth rate is shown by the black line in the diagram. )24 By July 2006, the value of this trend was 11.0 cents per litre. After regulation the trend completely disappears; the average marketing margin fell slightly at about -0.3 percent per year. This is the green trend line shown in Figure 2-1. The lack of a trend after July 2006 is not surprising because fixed nominal margins determined the regulated maximum and minimum prices and those margins remained constant from July 2006 until December 2011. While the margins set by regulation are not the actual margins experienced by retailers from week to week (which depend on the actual prices at the time at which they buy supplies and the prices at the time they sell that supply), they do constrain what the actual margins can be, on average. A broadly similar pattern exists for the individual cities. Pre-regulation margins increased by an average of 2.7% annually in Halifax, 3.7% in Sydney, 3.6% in Yarmouth and 3% in Truro. After regulation began, nominal margin growth became negative in all locations (including Kentville and New Glasgow), with the exception of Yarmouth (+0.8%).

Whether it is bad news for wholesalers and retailers depends on the levels from which those real margins are declining as well as how their costs have changed. If they are able to take advantage of sales-enhancing or cost-reducing innovations, they can be left with a satisfactory rate of return, even if real margins fall. 23 . Appendix 1 contains details of how the marketing margins were calculated. 24 ) Appendix 1 contains further details on the estimate of the trends.

22

The underlying trends in the growth of nominal margins in each location allows us to estimate what I will call the expected margin at the end of June 2006, when regulation began and to compare that with the margins that were actually set. Given that there are many ways of calculating the marketing margin, the objective here is modest: can we say whether the original margins set when regulation began in July 2006 were broadly in line with past experience?25 Table 2-1 shows the actual wholesale plus retail margins used to set minimum and maximum prices in the zones in which the four cities are located. It also shows my best estimates of the average margins that could have been expected based on the trend in the margin estimated for the 1998-2006 data for each city and for the average of the four cities. With the exception of Sydney, the expected margins of the best estimate lie above the margin used to set the minimum price and all are below the maximum margin that was set. Table 2-1 Expected margins and regulated margins, gasoline, cents per litre, July 2006 Expected margin based on Margins set in July 2006* Range of possible price changes June 1998-June 2006 trends after regulation if prices are set at Minimum Maximum

the...

Minimum

Maximum

Halifax Sydney Yarmouth Truro 4-City Average

10.8 cpl 11.9 11.6 11.4 11.04

(10.2 cpl) (11.3) (12.1) (10.4) (10.52)

10.3 cpl 12 11.2 11.2 10.73

11.8 cpl 13.5 12.7 12.7 12.23

- 0.5 to +0.1 - 0.1 to +0.7 - 0.4 to -0.9 - 0.3 to +0.2 - 0.3 to +0.2

+1 to +1.6 +1.6 to +2.2 +0.6 to +1.1 +1.3 to +2.3 +1.2 to +1.7

Note: The first value in each cell in the first column is for the increasing growth rate trend shown in Fig.2-1. The second value, in brackets, is for the constant growth rate trend also shown in Fig.2-1. * includes transportation amount for each zone. The weighted average is 0.73 for the four cities. Values for the alternative estimate the black line in Figure 2-1 are shown in brackets. These trend values lie about 0.2 cpl below the regulated minimum, on average, but with considerable variation for each location. Walking through an example will help in interpreting Table 2-1. Consider Halifax where pre-regulation trend operating margins were between 10.2 and 10.8 cpl. If retailers managed to set the maximum regulated prices once regulation began, marketing margins would total 11.8 cpl, which is then an increase of between 1.0 cpl (ie., 11.8-10.8) and 1.6 cpl (ie., 11.8 - 10.2). Expected prices would rise by the same amount. If instead retailers prices at the minimum regulated price, then marketing margins change by between -0.5 cpl (ie., 10.3 - 10.8) and +0.1 (ie., 10.3-10.2). Thus, whether prices would tend to rise or fall in Halifax after regulation depends critically on how retailers are able to price within the bounds set by regulation. We will see later in this report that they did both: pricing first at the maximum, then at the minimum.
?
The simple average of NYH prices for the particular days chosen is not the only option; the days chosen would have been varied. Greater weights could have been assigned to more recent NYH prices, and so on.
25

The final pair of columns in Table 2-1 summarize similar calculations for the other cities. These are clearly just rough estimates, but the major point is that the effect of regulation on prices could go in either direction. I conclude from this evidence that the margins set by regulation for gasoline were broadly in line with historical experience. Minimum margins lay close to or below the historical average; maximum margins lay above it. Whether consumer prices went up or down after regulation depended critically on whether retailers were able to price at the maximum or behaved competitively and priced at the minimum regulated price. The real marketing margin, before and after regulation What matters to consumers is the real marketing margin, the nominal margin adjusted for inflation. Because inflation has continued at a low, but positive rate, a constant nominal margin means that the real marketing margin has declined, on average, during the period of regulation. A nominal margin of 10 cents, for example, shrinks in real terms as the general level of prices rises and so the 10 cents will buy fewer goods and services. As a result, all else equal, this means that regulation, by fixing nominal margins, has tended to lower real before-tax prices facing consumers. (All else has not been quite unchanged, something that will be considered shortly.) The behaviour of the real marketing margin in Nova Scotia is illustrated in Figure 2-2.26 The trend
before regulation was virtually flat; nominal margins grew, on average, at the rate of inflation, as noted earlier. But, as shown by the blue line, real margins declined unmistakably after regulation began. Note that the left-hand end of the blue trend line, where regulation begins (at 12.2 cpl), lies above the right-hand end of the pre-regression trend line (11.6 cpl) by 0.6 cents. This suggests that the average real marketing margins increased somewhat just after regulation. But we can see that by the end of 2011, the post-regulation trend line has fallen to 10.8 cents, 0.8 cents below the pre-regulation level of 11.6 cents.

On balance, did consumers benefit from changes in real margins?

The previous analysis of trends suggested that in the post-regulation period, real margins were, on average, initially above their previous trend and then gradually fell below it. How did this come out, on balance, for consumers as a whole? A very simple calculation can give a rough answer. I calculated for each week from July 2006 to December 2011 the differences between the pre-regulation real margin of 11.6 cpl (the right-hand end of the black line seen in Figure 2-2) and the post-regulation trend (illustrated by the blue line). The average of these differences was -0.12cpl, meaning that if we spread the net saving across each week of the five and a half years of regulation, that would be the per-litre saving. Multiplying this by average gasoline sales of 1,188 million litres per year in 2005-2010, gives an average
.
26

All real values are in December 2011 dollars for monthly or weekly data. Real values using annual data are expressed in 2011 dollars. The Consumer Price Index for Nova Scotia is used to make adjustments for inflation, unless otherwise noted.

saving for consumers of $1.4 million/year, giving a total over the five and one half years of regulation of about $7.8 million, a modest amount.27
Figure 2-3 illustrates the data in another way, summarizing the changes in real marketing margins before and after regulation for the Nova Scotia average and for the individual communities. All show the same overall pattern; real margins went from no or positive growth before regulation to negative growth after it. Margins fell the least in Yarmouth, a market that, as we will see, is the least competitive one in the group.

Table 2-2 reports the averages of these real marketing margins before and after regulation for the Nova Scotia average and for the individual communities.28 The population-weighted average fell by 0.2 cents per litre if we compare the five and one-half years before regulation with an equal period after regulation. (If the marketing margin is instead measured using posted rack prices in Halifax, the result is similar. As shown in Appendix Table A4, the weighted average margin falls by 0.3 cents per litre across these two periods. The difference in values between this table and Table 2-2 reflects the roughly 3 cent difference between NHY and rack prices in Halifax.) When compared with the 0.12 cpl estimated average saving, these rough estimates of consumer savings of 0.2 to 0.3 cpl would give a proportionately higher estimate of total savings, roughly $13 million to $20 million in total. Table 2-2 Real marketing margins, gasoline, cents/litre (December 2011 prices), before & after regulation Halifax Sydney Yarmouth Truro Population-weig hted average Before regulation: June 1998-June 2006 Before regulation: January 2001-June 2006 11.5 11.5 12.6 13.1 13.3 13.7 11.6 11.6 11.8 11.9

The calculation is -0.12 cpl x 1,188 million litres/year = 142.6 million cents/year or $1.4m. Then 5.5 x 1.4 = $7.8 million over the five and a half years of regulation. 28 . Appendix Table A2 details the real margins for each year.

27

July 2006-December 2011

11.3

13.1

13.6

11.9

11.7

Note: calculated using differences between weekly retail prices and average NYH prices in the previous week, adjusted by the CPI (all items) for Nova Scotia.

The lengths of the particular periods being compared in this way matter. While there was no trend in the overall real marketing margins in the 1998-2006 period before regulation, real margins immediately after regulation began were generally higher than in the immediately preceding years. A comparison of average real margins before and after regulation would result in different conclusions about the possible impact of regulation if it compared (for example) the first two and a half years before regulation (when they averaged 12.0 cents) with an equal period after regulation began (when the margins averaged 12.2 cents). But as Table 2-2 shows, taking a longer perspective reverses the result. From the consumer viewpoint, on balance, regulation provided some before-tax price benefits as wholesalers and retailers combined nominal margins are limited by the regulatory cap. This slow squeeze on margins also provides some incentive for sellers to implement technological change to reduce costs, but in the presence of a low, but steady, inflation rate, there will inevitably be applications for margin increases. Consumers can expect that the industry will make the case for the largest margin increase it thinks it can attain, anticipating that those margins will be fixed for some period of time. At some point, the margins will be raised, as happened in late 2011, raising both the nominal retail margin and the transportation charges that make up the regulated prices. The recent increases in margins and transportation charges If we consider the margin increase that the industry has just received, how should this be judged from the consumers viewpoint? How do the current margins compare with historical trends and trends of inflation? Consumer prices in Nova Scotia from July 2006 to December 2011 increased by 10.24 percent. The Nova Scotia Utility and Review Board increased the minimum retail mark-up from 4 cents to 4.8 cents, a 20 percent increase, while the maximum retail mark-up rose from 5.5 to 6.6 cents, again 20 percent. Transportation allowances rose from 8.5 percent to 50 percent, depending on the zone. However, the nominal 6-cent wholesale mark-up remained unchanged. The last two columns of Table 2-3 summarize the overall change for each zone, including the cities for which we have retail price data, comparing margins and transportation costs before and after the recent change. Table 2-3 Marketing margins, December 2011 - January 2012
Nominal margins in effect until December 2011* Minimum Maximum Nominal margins in effect starting January 2012, and percentage change in the margin* Minimum Maximum

Halifax (Zone 1) Sydney (Zone 6) Yarmouth (Zone 3)

10.3 cpl 12 11.2

11.8 cpl 13.5 12.7

11.25 cpl (+9.2%) 12.97 (+8.1%) 12.29 (+9.7%)

13.05 cpl (+10.6%) 14.77 (+9.4%) 14.09 (+10.9%)

Truro (Zone 5)** 4-city average Kentville (Zone 2) Zone 4 6-city average

11.2 10.73 10.7 11.2 10.75

12.7 12.23 12.2 12.7 12.25

12.29 (+9.7%) 11.70 (+9.0%) 11.79 (+10.2%) 12.31 (+9.9%) 11.73 (+9.1%)

14.09 (+10.9%) 13.50 (+10.4%) 13.59 (+11.4%) 14.11 (+11.1%) 13.53 (+10.4%)

* including transportation costs; ** New Glasgow is in Zone 5.

I noted earlier that Figure 2-2 shows that the trend value of real margins by December 2011 was 0.8 cents below the pre-regulation trend. In fact, 0.8 cents is exactly the amount by which the Board raised the minimum retail margin as of the beginning of 2012. But because the Board also increased the amount for transportation, averaging about 0.2 cpl across the six cities in the retail price data, the average minimum margin is now 0.2 cpl above the average real trend level in June 2006. This suggests that sellers have caught up with inflation with a small cushion that will soon be eroded by inflation.29
I conclude that real margins have declined over time since regulation began, reducing the costs of wholesale and retail services to consumers. This decline has come about because of the effect of inflation on the nominal wholesale and retail margins and transportation costs that are put in place by regulation. These resulted in net savings to consumers of between $8 and $20 million over the first five and one-half years of regulation. When those margins and transportation costs were adjusted upwards in 2011, retailers real margins increased and caught up with inflation. Consumers can expect real margins to fall in the future as they have in the past. 2.2 How competitive are local gasoline and diesel markets? This leads us to an important question that has not been addressed so far. Regulation sets minimum and maximum prices, but where do prices actually end up? That will surely depend on how competitive the individual local markets are. As the discussion in Part 1 pointed out, in uncompetitive markets, retailers may be able to price to the maximum price much of the time. In competitive markets, they will be unable to, and the minimum price will become more relevant. Which of these outcomes or (more likely) what mix of them occurs is of primary interest to consumers, who would clearly prefer more competition among retailers to less. What does the evidence from the years of price regulation tell us? We can get some strong evidence by looking at how actual before-tax retail prices in Nova Scotia compare with the regulated maximum and minimum prices. For each market for each week, I calculated the average retail price minus the regulated minimum price. In principle, this number should lie between zero (when retailers are pricing at the lowest possible price) and 1.5 (when retailers are pricing at the maximum price).

Gasoline

29

For example, at 2 percent inflation, an 11.7 cent minimum margin will be 11.7/1.02 or 11.5 in one year.

The six panels in Appendix Figure A1 illustrates the results of these calculations for each of the six markets for regular gasoline which we have survey data. When regulation began, prices in every market were set at or close to the maximum. However, with the notable exception of Yarmouth, retailers were not able to maintain maximum prices. In Halifax, six months after regulation began, prices were set at the minimum level and, with a few temporary upward blips, they have remained at the minimum level.30 This is not particularly surprising; Halifax is a larger market where many retailers can be
expected to have large volumes and to withstand relatively low margins. The story for Sydney, New Glasgow and Kentville is broadly similar: prices initially set near the maximum ended up at the minimum within six months to nine months. Retailers in Kentville were successful in maintaining maximum prices for longer, but co-operation collapsed suddenly in 2007 and, while many attempts to restore it seem to have been made in 2007-2008 (as average prices oscillated between the minimum and close to the maximum), the market ended up with minimum prices being set most of the time after the middle of 2008. The data from the market in Truro is harder to interpret because it appears at first glance from the figure that prices below the legal minimum were being charged most of the time, which is hardly plausible. However, Truro is in Zone 5 but close to the line going through Colchester County that separates Zone 5 from Zone 1. Zone 1 has a transportation charge of 0.3 built into the price, while the transportation charge incorporated in Truros prices is the 1.2 cents of Zone 5). It is almost certainly the case that some of the retailers surveyed in the Truro region are actually located in Zone 1. This lowers the average price reported for Truro to below the Zone 5 minimum. If we make allowance for that, the story the data tell about Truro is much like that for the other markets: initial co-operation in setting maximum prices quickly broke down with attempts to restore it giving way to pricing near the minimum. Yarmouth, the smallest urban area in the group, stands out as an exception. Retailers quickly established and maintained maximum prices for gas after regulation began and have maintained them since. Yarmouth is the smallest and most isolated community in the survey sample and it is not too surprising that the behaviour of retailers there is markedly different from what is seen in other, larger markets, at least for regular gasoline. Yarmouth may be representative of some similar smaller centres in Nova Scotia that are not near larger urban areas. For example, Michael Gardner has recently written: "The price in most urban markets drops to the minimum end of the range soon after the weekly adjustment. Prices in rural markets tend to stay at the upper end of the range."31 Given the large gap in the retail price data for small towns and rural areas, this must be borne in mind when we come to make an overall assessment of how consumers in different places have been affected by price regulation .32

To sum up: there is persuasive evidence that with price regulation, larger centres ended up with competitive markets. The maximum prices set by regulators have not provided retailers with a focal point around which they could co-operate in a sustained way. They tried initially and the temporary boost that give to their margins will be partly responsible for the higher initial real margins under regulations, described earlier.33
.
Whether retail prices were actually below the minimum or whether these represent errors in the survey data is discussed later in the report. The reliability of the data and the enforcement process for the regulations is discussed later in this section. 31 " Michael Gardner, Response to information requests by the Consumer Advocate, Nova Scotia Utility and Review Board, 26 July 2011. This was related to the Boards review of retail gasoline margins. 32 . Gardner Pinfold (2008, p.50) reports responses from consumer focus groups around the province concerning the goal of maintaining rural retail station. Those with "few choices claimed to be more willing to support their local station, including paying a slightly higher price to keep them open", however, those who had more local choices were "generally not willing to pay extra" to maintain them, "or to maintain stations elsewhere in the province". Fortunately, the data suggest that consumers across Nova Scotia generally have not had to pay extra to keep some rural stations operating.
30

At first glance it would seem that the maximum price is irrelevant in these markets; if it were removed, perhaps nothing would happen. However that assumes that current retailer behaviour in the market would be the same as the behaviour in the absence of regulation, something for which there is no guarantee. The maximum price in these markets can be seen as a kind of long-term insurance policy for consumers against possible tacit collusion by retailers. Nor does the maximum price appear to be redundant as the case of Yarmouth, where it seems to be actually restraining prices. But an alternative possibility is that the maximum price simply acted as a focal point that was not there before and thus made life easier for Yarmouth retailers, possibly to the detriment of its gasoline consumers . To distinguish between these possibilities, we would need to know how effectively retailers in Yarmouth were able to carry out tacit collusion in the absence of regulation. I cannot give a definitive answer to that with the sparse evidence available, but it is instructive to look at the price differences between uncompetitive Yarmouth and Halifax, which is likely to be always a more competitive market.34 The data are summarized in Table 2-4. As we can see, often, but not always, Yarmouth retailers were able to maintain a high price differential. Recall that Yarmouth has transportation costs 0.9 cpl higher than that allowed in the Halifax area under regulation. Only in two or three of these years was the Yarmouth-Halifax price difference less than this. This pattern, compared to the consistently high pricing in Yarmouth since regulation began, suggests to me that tacit co-operation between retailers was somewhat more difficult to achieve without regulation, but was still common. While that would mean that consumers in Yarmouth might have paid more for their gasoline than they would have without regulation (and the same would be true of similar towns), counterbalancing this is the cap the maximum price puts on average margins. Retailers can collude more easily, but the rewards are limited. With regulation, ex-tax prices cannot be more than 2.4 cents higher than in Halifax (0.9 cpl for the transportation differential and 1.5 cents as the gap between the minimum and maximum price, before the recent margin and transportation cost increase). In two of the years before regulation, the yearly average gap was bigger than that. A regulated maximum price would certainly have saved Yarmouth consumers money in those years. On balance, then, consumers in places like Yarmouth may have been somewhat better off or somewhat worse off with gas price regulation. With the information available, a firmer conclusion seems unwarranted.35 Table 2-4 Ex-tax retail gasoline prices in excess of Halifax prices (Annual average, cents per litre)

1998 1999 2000 2001 2002 2003 2004 2005 .

33

Yarmouth 1.4 0.2 0.5 2.5 2.0 2.7 1.5 0.8

Sydney 0.7 0.5 - 1.1 2.3 1.3 1.2 1.4 0.3

This is consistent with the conclusion of Sen, Clemente and Lu (2011), who found that regulation led to a price increase of about 1 cent/litre. The data they examine went to only 2007. 34 . Competitive conditions likely did fluctuate in Halifax too, making these price differences more difficult to interpret. 35 . Using Table 2-1, we can see that Yarmouth retailers priced so that they shared the maximum operating margin of 12.7 cpl with wholesalers. The 10.24 percent inflation between July 2006 and December 2011 eroded their margin to 12.7/1.1024 or 11.5 cpl, which is below the expected margins in July 2006, as shown in Table 2-1.

2006

1.5

1.5

Note: differences are not adjusted for inflation.

Diesel The six panels in Appendix Figure A2 summarize the comparisons between the reported survey data for self-serve retail non-commercial diesel prices and the regulated minimum. The results appear quite different from those for gasoline. There is no market in which prices are consistently set at the legal minimum and most are far from that. There are strange price spikes, both positive and negative, outside the expected bounds of 0 and 1.5. I will return to the nature of the likely data errors shortly, but lets focus on where the markets appear to have come to a kind of equilibrium. We can see that the Halifax market has settled down to a price around 0.5 cents above the minimum, and Truro is likely at about 0.75 cents (if we take into account the likely presence of Zone 1 retailers in this data). In the rest of the markets, retailers seem to be pricing at the maximum. Clearly, the market for non-commercial diesel is more limited and the legal maximum price plays an important role. But what is that role? Has it brought down prices in an already uncompetitive market (which seems most likely), or has it facilitated collusion? Real marketing margins may provide some clues. Figure 2-4 shows these values for diesel in the six Nova Scotia centres from 1999.36 These fell significantly just a year or two before regulation. Whether this
was due to some increase in competition or to other factors, I cannot say. Since regulation, real margins have shown no significant trend, one way or the other. There is no indication here that regulation raised margins, nor was it associated with any significant decline.

36

The data with details on their calculation are in Appendix Table A3.

Finally, some comment is needed about the many anomalous numbers in the graphs in Appendix Figures A1 and especially A2. The price regulations are enforced through a complaints based system in which complaints from the public are received and then investigated and resolved. If someone is selling at below the minimum price, a competitor has every incentive to complain, as noted earlier. This is not a situation that can be expected to persist. Similarly, consumers have an incentive to complain if persistently high prices are being charged by retailers. The numbers in Appendix Figure A2 suggest that prices were repeatedly above the maximum in Sydney, Yarmouth, and New Glasgow during some periods. It strains credulity to believe that no diesel consumers in any of these places ever noticed that prices were in excess of maximum amounts or that if some did notice, not a single one ever bothered to complain. I think a more plausible explanation is that there have been repeated reporting errors from a gas station in each of these locations (that in most cases was eventually corrected because the more recent data are plausible). Perhaps some reported a full-serve diesel price if that was all that was available at that station, for example. The price of diesel is also a less high-profile price than regular self-serve gas, and so perhaps more prone to a reporting error. Its also plausible that there have been occasional transcription errors during the process of recording information from the telephone survey. It takes only one wrong digit for an apparent outlier to occur. This is the most likely explanation for the occasional spike seen in Appendix Figure A2. Conclusions (1) Consumers faced higher average prices just after regulation was introduced, because retailers were able to set maximum prices, which lay above past historical trends. However in larger urban centres, gas prices fell towards the regulated minimum price fairly quickly. The erosion of minimum margins by inflation has subsequently left consumers with net gains in prices, on balance. (2) For consumers in small, isolated markets, prices have likely remained at or close to the regulated maximum. However, these were likely the most uncompetitive markets prior to regulation as well, because of the small number of retail outlets in the locality. (3) Consumers of diesel face relatively uncompetitive markets compared with consumers of gasoline, at least in larger markets. Regulation cannot alleviate that except to place a maximum price in the market.

2.3 Promotions and other discounts available to consumers The retail price survey data for Nova Scotia, used throughout this the report, are somewhat misleading because they record only the posted prices for gasoline, not what the consumer actually pays. Sellers in many different markets often offer discounts to certain customers, and the gasoline market is no exception.37 These discounts, or promotions as they are called here, often require some effort on
the customers part to seek them out and to take advantage of them. The more price-sensitive customers the sort of customer that sellers would like to offer a lower price to thus sort themselves out from the less price-sensitive customers, who are charged a higher price. In his study of the responsiveness of consumer demand to gas prices, Nicol (2003, p.203, 210) found that the demand of households with low incomes was much more responsive to gas price changes than that of households who had higher average incomes. It is reasonable to suppose that such households are also more likely to shop around for a better price and to take advantage of promotions and discounts .38

The practice is termed price discrimination. Sellers find it profitable to charge different prices to different customers. Typically, customers who tend to be more price-sensitive (who have more price-elastic demand) will be charged a lower price, if the seller can find some way of identifying them. 38 . Note that consumers responsiveness to changes in the price of gas in the market as a whole is a different concept from consumers responsiveness to a change in the price at one gas station, holding the prices at other gas stations constant. In this second case, individual gas stations face much more responsive demand to a price change

37

Note that the prevalence of such discounts is not, by itself, an indicator that the market is competitive. Sellers without any competition at all (monopolists) will also find it profitable to offer discounts to particular types of customers to increase their sales and their profits. Although gas price regulation sets a minimum price in the market, that does not now constrain the use of promotions. Initially, it did; promotions were limited to those already in effect between 1 May 2005 and 1 June 2006, before regulation began. The regulations prohibited any enhancement of existing promotions or the establishment of new ones.39 The current regulations, dating from September 2010, are much less restrictive. Any promotion is permitted as long as 5 business days notification is given to the government and as long as it does not involve a purchase of more than 100 litres of fuel. Information about the promotions is posted on the website of Service Nova Scotia and Municipal Relations .40 As of 4 March 2012, there were 14 retailers (some with multiple locations) offering 26 promotions. Two were temporary, the remaining 24 were on-going promotions, all but two of which seem to have been in effect since before regulation began. Promotions take a variety of forms: rebates on gas purchases; discounts for paying cash; getting a special card from a retailer that gives a discount on all gas purchases; discounts on a future gas purchase based on a current purchase; discounts on other merchandise whose value is determined by gas purchases; discounts for premium gas or full service gas offered on a particular day of the week; bundling of gas purchases with other services (such as a car wash) that offers a lower price for gas. As a result, even in markets where retailers are posting the maximum price, some discounts will still be available. In the competitive markets, many consumers will be able to buy gasoline at less than the regulated minimum price. No publicly available data exist about the extent to which that happens or where it happens, but the prevalence of promotions and their widespread availability across the province suggests that it is an everyday occurrence, at least for those who take the trouble to seek them out.

This does not mean that the regulated minimum price is unimportant. As it moves, many of the promotional prices move too because they are often set as a certain number of cents off the pump price. Price-sensitive consumers will have benefitted from the effective removal in 2010 of restrictions on new promotions. 2.4 Comparisons with other markets in Canada How do before-tax prices for gasoline and diesel in Nova Scotia compare to prices elsewhere in the country? We will compare Nova Scotia prices with some measures of average ex-tax prices in Canada, adjusted for inflation.

than do gas stations as a whole if the market price rises. 39 . N.S. Reg. 97/2006, Schedule A, Regulations Respecting Petroleum Products Pricing, Section 13. 40 . The link is HREF="http://www.nsgaspromos.ca" MACROBUTTON HtmlResAnchor www.nsgaspromos.ca.

Gasoline Figure 2-5 illustrates average Nova Scotia gas prices with two measures of Canadian average ex-tax prices (adjusted for inflation).41 Appendix Table A5 provides more detail, comparing differences in
Nova Scotia prices with various measures of prices in Canada or other regions of Canada. All of these comparisons show that, as of 2011, average prices in Nova Scotia were less than averages in the rest of the country, even in large markets where many gas stations have high volumes and could afford to keep margins low. In 2011, people in Halifax paid lower ex-tax prices for gas than people in 43 of the 54 cities outside of Nova Scotia in the survey. Twice in the 2011 weekly surveys (the weeks of 31 May and 5 July), Halifax actually had the lowest price in the country.42 As well, ex-tax prices in Nova Scotia were lower than in New Brunswick, even though both have regulation based on the same NYH benchmark. Halifax prices averaged 1.2 cpl less than Saint John in 2011; Truro was 1.0 cpl less than Moncton. Yet ten years ago, however, Nova Scotian prices were distinctly higher than prices in a variety of Canadian markets, on average. While regulation in Nova Scotia has happened at the same time as the growing gap between prices in Nova Scotia and those in what have been largely unregulated markets,43 correlation is not causation. It is likely that other events in the rest of Canada have moved prices there and can largely explain these differences. This is indeed what has been suggested in earlier reviews. For example, in his 2011 review of the retail margin, Michael Gardner wrote that marketing margins had fallen in major markets in Canada from the 1990s until about 2006. In part, this was attributed to "intense competition for market share" in some large markets in central and western Canada. However, he argued that more recent data "indicate that the low marketing margins were not sustained (or sustainable). A combination of easing competitive pressures and rising costs would explain the increased marketing margins." Figure 2-6 shows that real marketing operating margins (expressed in 2011 dollars) for gasoline in Canada as a whole were lower than in Halifax and fell somewhat during the first half of the 2000s, before starting to rise to reach Nova Scotian levels in recent years. The slow decline of marketing operating margins for Nova Scotia in 2006 and

. . ,

41

By expressing all prices in 2011 dollars, the gaps at different periods of time can be meaningfully

compared. As calculated from the Kent Marketing Services weekly survey. The Canadian averages include the Atlantic provinces, all of which have fuel price regulation of various kinds, but the weight of these provinces in all of the Canadian averages is relatively low.
43 42

later, visible in the figure, is also consistent with the earlier analysis of declining Nova Scotia real marketing margins based on New York Harbour prices, a decline that I think is at least in part attributable to regulation. It seems reasonable to conclude that the major part of the explanation of why average prices in Nova Scotia have improved so much relative to the rest of the country is because margins (and thus ex-tax prices) elsewhere have grown substantially in absolute terms, leaving a growing gap between prices in those markets and prices in Nova Scotia. This may well reflect a general lessening of competition in those other markets, as suggested by Michael Gardner. Because the Nova Scotia average is dominated by the relatively large Halifax market, and because the Canadian averages will also be heavily influenced by the largest markets, it is worth comparing the smaller communities in Nova Scotia with the average of Canadian small markets.44 Appendix Table A6 shows a more detailed comparison of prices in these smaller markets with the small Canadian market average. The pattern seen with the earlier comparisons persists: average prices in other small market centres are much higher than in Nova Scotian communities that are comparable in terms of population.

Diesel Appendix Table A7 summarizes the comparison of retail diesel prices in Nova Scotia with those in the rest of Canada. As with gasoline, there is a pattern of higher prices in Nova Scotia in the period before regulation and lower prices after it. Again, I would not attribute this pattern to regulation. Figure 2-7 shows that operating margins have risen in the rest of Canada relative to Nova Scotia, although (as with gasoline) a modest decline in operating margins for diesel is visible for Halifax. So as with gasoline, the changes in relative prices between Nova Scotia and the rest of the country seem more attributable to events outside Nova Scotia than to events, such as regulation, inside it.

Here I use the division between large and small markets applied by Kent Marketing Services in their reporting of the Canadian averages. Halifax is classified as a large market; the other communities are small markets.

44

Retail ex-tax prices both for gasoline and diesel are, on average, lower in Nova Scotia than in the rest of Canada. This is a reversal of the pattern seen in the past. Regulation has directly played only a modest role, in all likelihood. In the post-regulation period, real operating margins have risen significantly in the rest of the country, while (under the influence of regulation) they have trended downwards in Nova Scotia. 2.5 The variability of prices While the level of prices is a major concern for consumers, the variability of prices is also important and a potential cause of aggravation. This is undoubtedly why reducing price variability was included as an explicit objective in the regulations implementing the Petroleum Products Pricing Act (specifically, "stabilizing prices of specified petroleum products" and "minimizing the variances in prices of specified petroleum products across the Province"). Because these were specific objectives of regulation, the extent to which regulation has affected these kinds of variability has been examined (at least for gasoline) in earlier reviews.45
Variability over time Regulation does not attempt to keep gas and diesel prices from changing. Everyone understands that they must change from time to time, if only because of changes in the notoriously volatile world price of crude oil, the key input in making petroleum fuels. The objective in reducing variability is more modest: to limit price changes during a week-long period to (at most) the gap between the minimum and maximum retail prices (formerly 1.5 cpl, now 1.8 cpl); to encourage the weekly setting of prices in pace with the changing of the regulated prices. The previous review of regulation concluded that "regulation results in increased predictability in the timing and reduced frequency in the number of gasoline and diesel price changes", based on an examination of daily price data in Nova Scotia before and after regulation.46 It reported that in the two years after regulation, prices had begun changing once a week instead of once every five days in the more competitive markets.47 Without access to such daily price data (that the previous consultant obtained directly from oil companies), I cannot update this finding, but I see no reason to anticipate any change in price setting frequency. When new prices are set on Fridays, retailers may change prices during that day as the market finds a new, sustainable level of prices for the coming week, but such price changes are apparently not included in the data examined in the previous review.48 Predictability over time While regulation may see prices change less frequently, the price changes that do take place then will tend to be larger: "regulation tends to bottle up the daily changes for a week at a time, whereas competition in the unregulated market would cause prices to change more frequently."49 Fortunately for consumers, this weekly price change is likely to be predictable, both in direction and in extent, because of the way in which the benchmark price is determined. While Platts Report data is not publicly available, it is not significantly different from the freely available data on NYH prices provided daily by the U.S. Department of Energy. Forecasts of the prices about to be

. . . .

Gardner Pinfold (2007), pp. 27-34 and Gardner Pinfold (2008), pp.29-38. Gardner Pinfold (2008), p.31. 47 Prices tend to change less frequently in less competitive markets. 48 Gardner Pinfold (2008), p.31, notes that "changes from the maximum to the minimum end of the allowable margin are not included". 49 " Gardner Pinfold (2008), p.34.
46

45

set by the regulator are regularly made and publicized by the media, so the public can know with reasonable accuracy how prices will change.50

This is a distinct improvement for consumers, who found the unpredictability of price changes prior to regulation apparently more aggravating than the frequency of the price changes themselves.51 If consumers take advantage of this predictability by altering the timing of their gas purchases, how
much could they save? A simple calculation can give some idea of whether these potential savings are significant or not. Table 2-5 Weekly price changes in Halifax, current prices, July 2006-December 2011 2006 2007 2008 2009 2010 Average absolute price change 2.06 cpl 2.45 3.49 2.54 1.86 Annual savings (2011 dollars) by timing $17 $42 $59 $42 $30 purchases (30 litres/week) Note: amounts are adjusted by the Consumer Price Index for Nova Scotia.

2011 2.09 $33

Table 2-5 shows the average absolute change in the tax-inclusive price from week to week in Halifax from July 2006 to December 2007. If a consumer who bought 30 litres of regular gas weekly could forecast the direction of price changes and adjusted gas purchases accordingly, she or he would have saved about $222 between July 2006 and December 2011. While this may look like a significant figure, it should not be overstated. It amounts to less than 80 cents per week (for the assumed 30 litre purchases) and many consumers may not bother paying attention to such small per-litre savings, just as the more price-insensitive consumers may pay little attention to promotions and other discounts. But sometimes price changes are large and larger numbers of consumers take advantage of it. The predictability of price changes with regulation has given consumers an informational advantage that was formerly held by retailers. There are two benefits: the psychological benefits of avoiding the annoyance of unexpected price increases and the modest monetary benefits for those who choose to exploit their knowledge of when price changes are coming and the direction of those changes. The latter benefits are most likely to be enjoyed by relatively lower-income consumers who pay more attention to prices. Variability over distance What causes fuel prices to be different in different locations? If prices are to be just and reasonable from a consumers viewpoint, price differences should be attributable only to cost differences. Small retailers in rural locations, however, can have higher per-litre costs because of their relatively low sales volumes, which is something that consumers should understand. But the typical consumer is unlikely to accept in the same way the power of a retailer to charge a high
.
The opacity of the forward averaging process that is used in adjusting the benchmark price complicates the forecast. 51 . Gardner Pinfold 2008, p.31, reported that in consumer focus groups unpredictability of price changes was a universal complaint.
50

price simply because of a lack of competition. Lastly, price differences on a day to day basis can be due to unsynchronized prices changes in the different local markets. This should not be a source of consumer concern, but it can show up in price data and make it harder to interpret. In basing price differences by zone across the province, regulation would reduce price differences in competitive markets to the transportation cost differences that the regulator has determined to be justifiable . This is something consumers can understand and accept. Regulation would leave the price differences between uncompetitive markets and competitive ones at 1.5 cpl plus the difference in transportation costs, still not a just and reasonable price difference from the consumers point of view, but perhaps better than the alternative. The 1.5 cpl gap between the maximum and minimum price could be less than the gap that would prevail without regulation. But regulation can close the gap both by raising competitive prices and by lowering uncompetitive ones. Consumers would obviously favour the latter. To what extent has regulation reduced price differences across the province to a pattern that would be more justifiable from a consumer viewpoint? We saw in the earlier examination of the gap between ex-tax gasoline retail prices and the minimum price that competition in five of the six markets ended up reducing prices to the minimum, leaving the transportation costs to account entirely for the gaps between locations. Again, Yarmouth was the exception, where uncompetitive conditions opened the gap to the maximum allowable by regulation. How does this compare with the pre-regulation period? The previous review in 2008 compared price gaps between the various communities and Halifax before and after regulation.52 I have repeated
this exercise for gasoline and also done it for diesel, covering a longer time period both before and after regulation, wherever it is possible with weekly data. The graphs in Appendix Figures A3 summarize the results as annual average differences in prices, adjusted for inflation. The large swings in price differences cannot reflect changes in relative transportation costs and so can be best interpreted as changes in the relative degree of competition in the two markets. For example, in 1999-2000, gas prices Sydney, Yarmouth and Truro were low relative to those in Halifax, taking transportation costs into account. The Halifax market was likely fairly uncompetitive in those years (rather than the other three centres experiencing a simultaneous burst of ultra-competitive enthusiasm). A year or two later, gasoline and diesel prices were well above those in Halifax in all three places, suggesting an increase in competition in Halifax. Diesel prices, with their less competitive markets, experienced larger swings than gasoline. Table 2-6 summarizes the long-term averages. It strongly suggests that regulation, even with the high retail prices that were reported, was successful in putting a cap on uncompetitive price differences. Table 2-6 Real Average Price Differences with Halifax Sydney Yarmouth Truro Kentville Gasoline, January 2001-June 2006 Gasoline, July 2006-December 2011

New Glasgow

1.4 1.5

1.9 2.0

0.2 0.5

0.8* 0.5

0.4* 0.8

52

Gardner Pinfold (2008), p.35-38

Diesel, January 2001-June 2006 Diesel, July 2006-December 2011

1.7 2.4

3.2 1.6

3.3 0.6

3.7* 0.8

3.5* 2.0

* data for March-June 2006 only.

Source: calculated from Kent Marketing Services weekly ex-tax retail price data.

However, the appendix figures and Table 2-6 show that the picture for gasoline is different. The post-regulation period saw a small widening of Sydney, Yarmouth and Truro price differences with Halifax, but price gaps between those three cities remained constant or declined.53
Price differences for gasoline between different parts of Nova Scotia may have increased slightly in real terms since regulation began. They now largely reflect transportation costs differences, legitimate differences from a consumer viewpoint, rather than swings in competitive conditions. Price differences for diesel have generally declined fairly significantly between different parts of Nova Scotia. Price gaps generally remain above transportation costs, reflecting the different degrees of competition in local markets. 2.6 Summary of main conclusions The evidence from the larger markets included in the retail price surveys, markets that include the majority of people in the province, suggests that, on average, ex-tax gasoline prices have fallen modestly as a result of regulation, on balance over the five and a half years regulation has been in place. However, this conclusion is compatible with prices in some local markets being higher, at least some of the time, than they would have been in the absence of regulation. Prices were undoubtedly higher just after regulation began. From the evidence available, it seems that competition in gasoline markets has generally prevailed in all but smaller and more isolated rural areas. That helped to lead to lower prices in the long term in the competitive markets. Regulation has apparently proven quite efficient leaving prices higher where they could achieve the objective of preserving rural outlets, but at minimum cost to consumers in the province as a whole. Price increases in the relatively uncompetitive markets may not have been great, given the relative lack of competition even before regulation.

The markets for diesel appear to be less competitive, however. For diesel consumers, regulation can limit otherwise high prices, but cannot make markets more competitive. Before-tax prices for both gasoline and diesel are now low relative to other Canadian markets, a reversal of past patterns. However, this seems attributable mostly to events elsewhere. This attempt to assess the likely effects of regulation also implies something about the likely effects of removing it. The situation before regulation provides the best evidence we have for what gasoline and diesel markets would look like were regulation removed.

These can be inferred from the table. For example, in the 5.5 years before regulation, Yarmouth prices averaged 0.5 cpl (ie 1.9-1.4) above those in Sydney. After regulation, they remained 0.5 cpl above (ie. 2.0-1.5). Prices gaps between Sydney and Truro and Truro and Yarmouth fell by 0.2 cpl after regulation.

53

From a consumer standpoint, the predictability of the timing and direction of price changes would be removed, and price differences between different parts of the province would be less likely to reflect transportation cost differences, as the dynamics of market pricing change and the degree of competition in the different local markets becomes less stable. As the situation even during regulation shows clearly, retail fuel markets do not have a single, unique and predictable equilibrium: outcomes can range from competitive to uncompetitive. As well, the removal of the guaranteed minimum margin for retailers could reduce the number of retail outlets further, with effects on retail prices that could not be favourable for consumers. If regulation were removed, we could expect that in areas where markets are relatively uncompetitive, gas and diesel prices would rise with the removal of the maximum price cap. However, there is little reason to expect that prices would fall in those markets where minimum prices now prevail. If prices were to fall, either wholesalers or retailers would have to accept a reduction in their gross margins. Neither seem keen to do so. Retailer recently applied for (and received) an increase in their margins while wholesalers applied for and received an increase in transportation costs (although they did not ask for an increase in their gross margin). With regulation, the existence of minimum prices seems to have changed the dynamics of market pricing. As we have seen, with minimum pricing in the competitive markets, both wholesalers and retailers have, in effect, been persuaded to accept gradual reductions in their real margins to levels below those that existed prior to regulation. If these minimum prices, which seem to act as a kind of focal point, are removed, the market will find a new equilibrium which could well involve higher prices. PART 3. AFTER-TAX CONSUMER PRICES: THE CONSUMER-CITIZENS PERSPECTIVE While regulation has surely influenced before-tax prices, consumers are also interested in the after-tax price that they pay for their gasoline. However, considering taxes raises fundamental issues that require that the consumers viewpoint be augmented with the citizens viewpoint. This is necessary because the most basic consumer interest is to get a product at the lowest possible price, as long as that price that permits a sufficient number of suppliers to cover their costs in the long term and thus remain in business to provide supply in the future. If gasoline producers or sellers can manage to raise prices above competitive levels, the consumer has to pay more for a litre of fuel, which means giving up some income that could be used to buy other things. But taxes are a different matter. When a consumer-citizen pays a tax on a litre of fuel, she is also getting something else in return besides the litre of fuel. She is making a modest addition to the governments capacity to provide more goods and services which she can also consume. This holds for general sales tax revenues, such as the Harmonized Sales Tax (HST), that add to general government revenues, as well the fuel tax. If fuel tax revenues are used specifically to pay for the construction and maintenance of roads, she is making a payment to cover the costs of the benefit that she receives from using the road. All that, however, may well seem vague and intangible compared with immediate benefits offered by the litre of fuel, but it is a benefit that should not be forgotten.

Our specific interest here is in fuel taxes rather than general sales taxes like the HST. The primary purpose of the HST is to raise revenues for a wide variety of goods, services and transfers provided by governments. Whether or not the HST is at an appropriate level is an issue that is essentially unrelated to the gasoline market.54 Instead, excise taxes, like those on tobacco, alcohol and fuels, have a
different purpose: to change the relative prices of these specially-taxed goods with the aim of influencing peoples consumption decisions in socially-desirable ways. For this part of the report focuses only on these taxes. Excise taxes on fuels offer an important benefit from the citizens point of view: by changing the price of fuel relative to other goods and services, it can lead to important long term changes in everyones choices regarding driving and fuel consumption. This benefit everyone through less pollution and less road congestion. But by reducing the amount of driving, it also reduces the demand for roads and thus the total cost of roads themselves, costs that everyone in society ultimately bears one way or another. Ultimately, deciding what fuel taxes should be is not just a technical matter. It requires judgements about what societys goals are, what constitutes a fair tax and revenue-raising system, and what the role of the public sector is in providing roads and other forms of transportation of various kinds. This review cannot answer such questions; they can only be resolved through informed public debate that produces collective decisions through our political institutions. Instead, the goal in this section is to provide some useful background, ideas and context for such a discussion. I begin with an overview of the actual choices that have been made in various places, both in Canada and elsewhere, about fuel taxes. As we will see, the choices vary greatly. This leads us to consider the reasoning behind the existence of special taxes on fuels. To the extent that these taxes serve as an indirect user charge for roads and highways, we can ask: are fuel taxes actually paying for that infrastructure? What does that imply about current tax levels, if one accepts that such user charges are appropriate? Fuel taxes also have other potential uses as green taxes to reduce other consequences of peoples behaviour, particularly pollution. To what extent do fuel taxes in Nova Scotia serve that end? 3.1 Fuel taxes in Nova Scotia and elsewhere Motive fuel taxes in Nova Scotia and in Canada Excise taxes on both gasoline and diesel fuel are collected by both the federal and provincial governments at rates shown in Table 3-1.55 Because the tax is set in nominal terms (ie. in cents per litre) and often remains fixed for considerable lengths of time, the real tax per litre then declines as inflation chips away at its value.56 Figure 3-1 and Figure 3-2 show how the gasoline and diesel excise taxes at both the federal and provincial levels have tended to decline over time when adjusted for inflation. The federal excise tax on a litre of gasoline is 10 cents/litre, the same level it was in 1976!57 Adjusted for inflation, that 1976 tax rate would be about 38.5 cents/litre in todays dollars. In other words, the federal excise tax on gasoline has fallen by about 75 percent in the last 35 years. The excise tax rate on gasoline and on diesel in Nova Scotia has also declined in real terms. Fuel tax rates are now at their lowest levels since about 1989.

The same is true for other provinces where the Goods and Services Tax and possibly the provincial sales tax are applied to fuel sales. 55 . The taxes shown in the Table include all types of excise taxes; British Columbia levies both a Carbon Tax and a Motor fuel tax, both denominated in cents/litre. 56 . In the early 1980s, perhaps because of high inflation, some provinces switched from this kind of specific taxation to ad valorem taxation, but all have now switched their excise taxes back (Treff and Ort 2010, p.5:13). 57 ! The tax did not remain constant in nominal terms; it was reduced and subsequently increased back to the 10 cpl level.

54

Table 3-1 Excise taxes on fuel (cents/litre), Canada, federal and provincial governments, July 2011 Federal NL NS NB PEI QC* ON MA excise
Regular gasoline Ultra-Low Sulphur Diesel 10 4 16.5 16.5 15.5 15.4 13.6 19.2 15.8 20.2 17.2 +3 (Mtl) 18.2 14.7 14.3 11.5 11.5

SK
15 15

* A special transit tax is levied in Montreal for gasoline only. ** Special transit taxes are levied in Vancouver (gasoline only) and Victoria (gasoline and diesel). Provincial excise
tax includes a 4.45 cpl carbon tax (which rose to 5.56 cpl as of 1 Feb 2012)

Table 3-2 Federal and province/state excise taxes on fuel (cents/litre), Canada, and United States, as of 1 January 2012 Canada Nova Scotia US US Maine New (Average) (Average) (Range) Hampshire
Regular gasoline federal tax provincial/state tax total excise tax Diesel federal tax provincial/state tax total excise tax 10.0 15.2 25.2 4.0 15.6 19.6 10.0 15.5 25.5 4.0 15.4 19.4 4.9 6.7 11.6 6.5 7.0 13.5 4.9 2.1 - 11.0 7.0 - 15.9 6.5 2.1 - 12.4 8.6 - 18.9 4.9 8.0 12.9 6.5 8.4 14.9 4.9 5.3 10.2 6.5 5.3 11.8

Verm

4 7 11

6 7 14

Note: United States tax rates from State Motor Fuel Tax Rates, 1 January 2012, Federation of Tax Administrators. Conversion to Canadian cents/litre using Bank of Canadas January average exchange rates. 1 US gallon = 3.38541178 litres. US state excise tax averaged using U.S. Census Bureau 1 July 2011 population estimates by state.

The figures also show how Nova Scotias gas and diesel excise tax levels have compared with those of a provincial average (weighted by population). Only during the last 10 years has Nova Scotias gasoline tax been significantly above the national average, and that gap has now disappeared. The excise tax on diesel has typically been above the national average, but that is no longer the case.

Actual fuel tax revenues also depend on total fuel consumption (described earlier in Part 1). Per capita real fuel tax revenues in Nova Scotia have been declining since the late 1990s both in Nova Scotia and, on average, across all provinces. Nova Scotia tax receipts, at about $280 per person per year, are slightly above the provincial average, reflecting somewhat higher per capita gasoline use. (See Appendix Figure A4.) To put the level of fuel taxes in context, these can be compared to peoples after-tax income. Currently, Nova Scotias fuel taxes amount to about 1 percent of personal disposable incomes (ie incomes after personal income taxes), down from a high of 1.4 percent in the late 1990s. This is higher than the provincial average of 0.8 percent of personal disposable income. Federal gas taxes average about 0.6 percent of Canadian personal disposable income. Its important to point out that Nova Scotians are not the only ones paying fuel taxes in Nova Scotia, of course. So too do tourists who use vehicles in the province, but counterbalancing that, Nova Scotians pay fuel taxes when out of province. The net balance is not known and the previous discussion of taxes per capita ignored this distinction. Similarly, fuel taxes paid by commercial vehicles will ultimately be borne by the consumers of the goods and services those vehicles helped to provide, consumers who could live in Nova Scotia or elsewhere. Fuel tax rates in Nova Scotia are currently about the Canadian average. They have been declining and are now at their lowest rates in more than 20 years. Fuel tax revenues per

person are just above the average for all provinces and constitute about 1 percent of personal disposable income. Nova Scotian and Canadian motive fuel taxes in comparative perspective Other countries and jurisdictions within them have made different choices regarding their tax systems and their fuel taxes in particular. Table 3-2 briefly summarizes the excise taxes on gasoline and diesel in the United States at the federal and at the state levels. Extra detail is included on some of the New England states that are closest to Nova Scotia. In the United States, both federal and state governments levy excise taxes on fuel. The U.S. federal tax on gasoline (the equivalent of 4.9 Canadian cents per litre) is half the Canadian federal tax level. Among the states, excise taxes exhibit far more variation than in Canada, ranging from a low of 2.1 cpl (Alaska) to a high of 11 cpl (California). With the exception of Alberta s 9 cpl fuel tax, every Canadian province has a fuel tax tax higher than Californias. The population-weighted average of the U.S. states gas taxes is 6.7 cpl, less than half the average of the Canadian provinces. The nearby New England states shown in the table have gas and diesel tax levels within two cents on either side of the U.S. national average. These different choices about gas taxes are the primary reason why tax-inclusive pump prices in the United States are below those in Canada. Figure 3-3 shows average tax-inclusive prices in the first two months of 2012 for gas and diesel in Halifax and for New England.58 The differences are large
35.3 cpl for gas and 25.6 cpl for diesel. To see that the differences are largely due to the tax treatments in the two places, I added onto the New England prices the difference between the tax levels in the two places.59 The result shown in Figure 3-3. The price gap for gas is then reduced to 4.7 cents/litre and 2.8 cents/litre for diesel.60

The New England average for conventional regular gasoline is published by the U.S. Department of Energys Energy Information Administration and is collected weekly on Mondays. It is compared here with the average of Tuesday Halifax retail prices collected by Kent Marketing Services. Bank of Canada noon exchange rates are used to convert US prices to Canadian dollars. 59 . I estimated the excise tax differences by constructing a population-weighted average for the excise taxes of the six New England states to get 6.3 cpl for gas and 7.7 cpl for diesel. As well, the Harmonized Sales Tax is levied on gasoline in Nova Scotia, but in the New England states, state sales taxes are not applied to gasoline or diesel (Federation of Tax Administrators 2012). 60 . These remaining differences can be due in part to the different days on which the surveys were taken, differences between the volume weights used for the US price data and the population weights I used for the state excise tax rates, and the shorter distance between New England and New York than between Nova Scotia and New York.

58

Table 3-3 Excise taxes in Europe, February 2012 (Canadian cents/litre)

Country
Austria Belgium Bulgaria Cyprus Czech Republic Denmark Estonia Finland France Germany Greece Hungary Ireland Italy Latvia Lithuania Luxembourg Malta Netherlands Poland Portugal Romania Slovakia Slovenia Spain Sweden United Kingdom EU Average (unweighted) Norway

Gasoline
0.644 0.840 0.410 0.478 0.669 0.819 0.568 0.805 0.800 0.817 0.887 0.541 0.878 0.924 0.549 0.553 0.625 0.602 1.006 0.512 0.818 0.489 0.746 0.647 0.583 0.860 0.959 0.705 0.937

Diesel
0.545 0.629 0.429 0.439 0.571 0.643 0.532 0.589 0.538 0.591 0.555 0.502 0.721 0.761 0.439 0.380 0.431 0.467 0.622 0.452 0.525 0.413 0.532 0.476 0.467 0.732 0.945 0.553 0.775

17 February 2012. Norway, Ministry of Finance, Green Taxes 2011, available at www.regjeringen.no/en/dep/fin/Selected-topics/taxes-and-duties/green-taxes2011.html
Source: HREF="http://www.energy.eu," MACROBUTTON HtmlResAnchor www.energy.eu,

Exchange rates: Bank of Canada, average exchange rates, January 2012,

HREF="http://www.bankofcanada.ca/stats/assets/pdf/nrma-2012-01.pdf" MACROBUTTON HtmlResAnchor www.bankofcanada.ca/stats/assets/pdf/nrma-2012-01.pdf

In contrast, European countries have chosen much higher taxes on fuels, as shown in Table 3-3.61 Even relatively low-income countries, such as Bulgaria, Romania, and the Baltic states, which have
the lowest rates, have tax rates far higher than anywhere in Canada. Only Vancouver, at 39 cpl comes close to Bulgarias 41 cpl. Yet other countries have fuel taxes in between the European and the North American levels. In Australia, for example, the federal government levies a 40.8 cpl excise tax on both gasoline and diesel.62 This tax has been fixed since 2001 and so continues to decline in real terms.

Federal and provincial fuel taxes in Canada are at least twice those in the United States, on average. However the United States has, by far, the lowest fuel taxes among the developed countries. Average European tax rates are almost three times as high as Canadas and Australias rates are 1.5 to 2 times as high. What motivates these very different choices that many otherwise similar countries have made regarding fuel taxes? To try to answer that, we first have to think about why we would want to have fuel taxes in the first place. 3.2 Why fuel taxes? Everyone wants taxes to be equitable, but how that should be accomplished in practice remains a matter of lively debate. Two separate strands of thought concerning equitable taxation can be seen in such debates. The ability-to-pay principle One principle says that people should contribute to collectively-provided goods, such as roads, based on their ability to pay, as measured perhaps by their incomes. This principle is compatible with progressive taxation, where the marginal and average tax rates rise with income, reflecting this ability-to-pay principle. This principle of contribution according to ability to pay is widely applied to the many types of public spending which are paid for by general tax revenues. These include goods and services ranging from the police and justice systems, to public education, to some types of transfer payments and social insurance, such as income assistance, Old Age Security and health care, which are paid for out of general government revenues. Decisions about such spending are not directly linked with decisions about taxation.
.
Another set of countries (such as Venezuela, Saudi Arabia and the principalities in United Arab Emirates) have large fuel subsidies instead of taxes. Their example is not relevant here, however. 62 . The Australian Tax Offices Legal Database reports the tax as A$0.38143 cpl. It is converted to Canadian dollars using the February 2012 average exchange rate reported by the Bank of Canada. Some Australian states used to offer subsidies to fuel purchases (in effect, a negative excise tax), but have given up the practice in the last decade.
61

The benefit principle The other principle maintains that people should pay based on the benefits that they receive from publicly-provided goods and services. Road and bridge tolls or charges for public transit or airport fees reflect this benefit principle. So too does tuition for higher education, although much of higher education costs are also subsidized out of general revenues for other reasons. The benefit principle and the ability-to-pay principle have an uneasy co-existence. Different societies make different choices through their political systems about to how to apply these principles in particular cases. At least a portion of excise taxes on fuel have long been seen as an application of the benefit principle. For fuel taxes to reflect the pure benefit principle, the tax that each person would pay would have to reflect the benefits they received. In practice, two people can drive along the same road but use different amount of fuel and thus pay different fuel taxes. For this reason, as discussed further below, road-use fees based on distance travelled have been proposed as a better alternative. Special taxes levied on motor vehicle fuels such as gasoline and diesel have two major potential uses: to act as a kind of user charge for the infrastructure that the vehicles use and to alter individual behaviour by changing the prices of fuel relative to other goods, with the goal of reducing pollution and road congestion. Changing incentives through changing prices A basic principle of economics states that if resources are to be used efficiently, people must face the right incentives so that they will make the appropriate decisions. Here, the right incentives, means the right prices. For people to make decisions that lead to efficient outcomes, the prices people pay would have to reflect all of the costs of their activities. When this principle is applied to the activity of driving a car, it says that a driver who is thinking of driving another kilometer should have to pay the full costs to society as a whole of driving that kilometer. That cost will include the cost of the fuel required, the cost of the additional wear and tear on the vehicle, and the cost to the driver of the time involved all things paid for by the driver directly. But driving another kilometer also involves costs to others besides the driver of the car. Travel over the roads involves some road wear and deterioration, that adds up and ultimately must be paid for through maintenance work and perhaps ultimately replacement. The driver also imposes costs on others through increasing road congestion and thus the time others require to get to their destinations. The vehicle emits air pollution of various kinds including fine particulate matter that can have harmful health effects for people in the region, adding to the number of heart attacks, strokes, and asthmatic attacks, for example.63 It adds to the stock of greenhouse gasses in the
atmosphere that contributes to the long-term costs of climate change faced by everyone in the world.

63

See Canadian Medical Association (2008).

These costs are termed external costs because they are largely external to the person making the decision. In this case, unless some charge is made for them, the driver does not pay them directly and so has no incentive to take them into account when thinking about how much to drive. But socially efficient decisions about how much to drive should be made in light of the full social costs. Social costs are the private costs that the driver pays directly and the external costs that are not paid by the driver. Together, these are the costs of the activity paid by everyone in society, including the driver. In principle, the rational driver compares the benefits and costs of the various options available when making decisions about such things as how much to drive, as well as related decisions about whether to own a vehicle, what kind of vehicle to have, and where to live.64 If driving another kilometer
does not require paying the external costs it entails, the rational driver will drive further than would be efficient from a social point of view. The result will be socially inefficient: the extra kilometers driven will impose additional costs on society that are greater than the additional benefits. The flip side of this is that if the total number of kilometers driven were reduced, the total benefits of that would exceed the total costs.65 Policy instruments to correct incentives This reasoning does not, by itself, imply that special taxes on fuel are needed. It says only that, to achieve an efficient outcome, some means will be needed to make people pay the full costs of their activities. In principle, we could imagine a device that could be attached to every vehicle that would measure distance travelled on roads of various kinds and qualities, the pollutants emitted, the cars contribution to congestion costs, and so on, to compute the external costs involved. A meter in the vehicle itself could keep track of the charges as they accumulated, reminding the driver of the costs being incurred (and taking all the fun out of driving).66 In fact, technologies are being developed that could do some of these things, if the public decides that it is appropriate.67 Fuel taxes, as well as road and bridge tolls, excise taxes on polluting or heavy vehicles, and explicit congestion fees, are among the array of policy instruments that have been used and are being used in various places to address the incentive problems and the resulting inefficiencies described earlier. Because the focus of this report is on gasoline and diesel prices, I will focus on excise taxes on these fuels and the uses of the resulting revenues. As the previous discussion suggests, fuel taxes are not the ideal way to correct for drivers incentive problems. With the exception of major highways and bridges, collecting tolls for the use of roads and city streets remains too expensive to be practical. So taxing something like fuel, which is used in conjunction with roads, has long been seen as an acceptable second-best solution. Vehicle registration and licencing fees may also have a place, but such fees do not vary with the intensity of road use in the way that fuel use does. Without some special charges to cover the costs of peoples use of roads and highways, drivers will not face the correct incentives in making decisions about how much to drive. There will be an inefficiently large amount of driving, resulting in higher costs to society as a whole in maintaining the road system, excessive congestion on the roads and excessive pollution. Fuel taxes are not the ideal way to charge people for road use, but have been the most commonly-used method for practical reasons.

The rational choice model of decision-making sketched out here does not claim to be a literal description of decision-making. No one consciously works out the optimal number of kilometers to drive each year. But people do take the costs they face into account when making decisions as best they can. The rational choice model claims that, in aggregate, peoples collective choices will respond in predictable ways: if driving becomes more expensive, people will do less of it, and vice versa. 65 . Appendix 2 contains a further explanation of this efficiency argument. 66 . Such meters are now coming into use to allow people to monitor their costs of household electricity use. 67 . Transportation Research Board (2006), Appendix C, Review and Synthesis of Road Use Metering and Charging Systems, surveys the technologies now in development or being tested.

64

3.3 Fuel taxes in practice as a user charge for roads and highways Suppose that we accept the rationale for fuel taxes as a kind of user charge to correct drivers incentives and thus to improve the efficiency of governments use of resources. Then it follows that to achieve that purpose, fuel tax rates must be set so as to cover the long-term costs of vehicle-related infrastructure.68 If other methods of charging are also used, they can help cover the total costs as
well. If these user charges only cover a fraction of the cost, then we have not fully solved the inefficiency problem. It seems that the principle that users of roads should also pay for them through some kind of user charge is widely accepted, at least up to a point. In Canada, as in many countries, fuel taxes are explicitly justified by linking them in various ways to expenditures on roads and highways. Those expenditures include both the capital costs of constructing roads and other related infrastructure, such as bridges and culverts, and for their maintenance, and for related services like snow and ice removal. Because municipal governments have substantial road and street responsibilities, some fuel tax revenues may be explicitly designated for transfer to them. As detailed earlier in Table 3-1, gasoline sold in Montreal, Vancouver and Victoria have special excise taxes (transit taxes) that assist in funding urban transport systems more generally, including public transit.69 What is done with fuel taxes? Table 3-4 summarizes the various arrangements in Canada between fuel taxes (and perhaps related revenues) and road expenses. In some provinces, such as Newfoundland and Labrador, there is no direct link. The federal government itself follows this same practice. Fuel taxes go into general revenues and road spending is financed from general revenues. Other provinces, such as Nova Scotia, Manitoba, and Saskatchewan require by law that fuel taxes be used for provincial transportation spending and the government prepares an annual report to document the use of these revenues.70 Only Nova Scotia and Quebec also require that road-related fees (e.g., for motor vehicle registration and drivers licences) also be directed towards road expenses. However, given that road and highway spending is far in excess of fuel tax revenues (as detailed shortly), such requirements currently have no actual effect on the pattern of government spending. Still others have created special funds in which fuel tax revenues are placed. New Brunswick has created the New Brunswick Road Improvement Fund, but it seems to have no independent existence and road spending is not influenced by the amount of the fuel tax. There is really no difference between this and putting the fuel tax into general revenues. The creation of such funds and other attempts to link fuel tax revenues and public spending on roads in the public mind are probably an attempt to improve the public acceptability of the fuel tax by making the link between the tax and the associated public services more visible.71

Long run marginal and long run average costs may not be equal. Efficiency requires that the cost to the driver of driving another kilometer equal the long run marginal costs of providing the service, but that does not allow total costs to be covered if marginal costs are less than average costs. Things like licence and registration fees, while unrelated to distance driven, can help to cover total costs. 69 . Subsidies for public transit are another complementary way of dealing with congestion and pollution externalities in this case by altering the relative price of driving and taking public transit with a subsidy, not a tax. 70 . The annual report for Nova Scotia is in the annual Transportation and Infrastructure Renewal Accountability Report, available at gov.ns.ca/tran/publications/. Those for Manitoba and Saskatchewan are found in the Public Accounts. 71 . No such direct links exist for the tax revenues going into general funds, hence the attempts to try to create them. For example, Ontario has a payroll tax, the Ontario Health Premium that raises revenues that the public is told are for health care.

68

Quebecs new Land Transportation Network Fund (or FORT, its acronym in French) is a different idea. As explained in Table 3-4, it is a separate entity that receives dedicated revenues from fuel taxes and other road-related sources to fulfill its mandate of carrying out road investments. This kind of arrangement links fuel taxes more directly with road spending. British Columbias BC Transportation Financing Authority seems to be set up along similar lines. Some provinces (Manitoba and Ontario) have chosen to set aside a certain amount of the fuel tax for a specific purpose, such as transfers to municipalities, to cover some of the costs of their road or transit systems. As we have seen, British Columbia does this more directly by having special gas taxes in the Vancouver and Victoria areas that go directly to separate agencies, not to the provincial government. Table 3-4 Fuel Taxes, Road-related Revenues, and Road Expenditure Arrangements, Federal and Provincial Governments
Fuel Tax Revenues, Road-related Revenues, and Road Expenditure linkages To general revenues; no explicit link with road spending. To general revenues. Revenue Act, s.10, requires an annual report by the Minister of Transportation and Infrastructure Renewal on highway construction expenditures. The Finance Act, s.79, requires that these be no less than fuel tax revenues plus all fees and fines (net of costs) collected under the Motor Vehicle Act. New Brunswick Fuel tax revenues to New Brunswick Road Improvement Fund. Expenditures in excess of fuel tax revenues are funded from general revenues and federal transfers. Prince Edward To general revenues; no explicit link with road spending. Island Quebec The 2010-11 Budget created the Land Transportation Network Fund (FORT), a separate infrastructure fund funded by dedicated revenues from fuel taxes, drivers licence and vehicle registration fees and any road-related revenues from the sale of goods and services. It funds road investments and supports public transit. Its deficits are covered by issuing debt. Ontario To general revenues, except for 2 cpl of gas tax earmarked for transfers to municipalities to support public transit. Manitoba To general revenues. The Financial Administration Act (Section 61.1(1) requires that all fuel taxes be used for "the construction, operation and maintenance of transportation infrastructure for motor vehicles" and for "assistance to municipalities for transportation systems and infrastructure for motor vehicles". 2 cents/litre of gas tax and 1 cent/litre of diesel tax transferred to to municipalities to support road and transit services. Saskatchewan To general revenues. A Fuel Tax Accountability Act (2007) requires the government to report "the cumulative amount by which road-use fuel tax revenues have exceeded or fallen short of provincial transportation expenditures since the start of the 2007-08 fiscal year" and, in the event of a surplus, to submit a plan to bring the two into balance. Alberta To general revenues; no explicit link with road spending. Newfoundland Nova Scotia

British Columbia Partly dedicated; partly to general revenues. BC Transportation Financing Authority gets 6.75 cpl of fuel tax receipts. Its mandate is "to acquire, construct, hold and improve transportation infrastructure ... over their entire useful working lives." (See its Consolidated financial statements of BC Transportation Financing Authority, Year ended 31 March 2011, p.9 ) It can also finance its activities with debt. The South Coast British Columbia Transportation Authority, with responsibility for the regional transportation system in the Greater Vancouver area, receives the 9 cpl surcharge on fuel sales in its region; 3.5 cpl surcharge on fuel in the Capital Regional District to fund its regional transportation network. Carbon tax revenues are spent by reducing other taxes. Federal Gas tax revenues go to general revenues. These revenues notionally contribute (ie no dedicated Government funds) to the Gas Tax Fund, Infrastructure Canada transfers to municipalities (via provincial governments) to provide stable funding for infrastructure projects. This can include local roads and public transit, but also things unrelated to transportation (waste water treatment, drinking water, solid waste management, etc.)

These final cases are examples of earmarking tax revenue.72 Instead of going into general government
funds, the revenue is earmarked for a specific purpose, such as road construction and maintenance, and may be put in a separate fund. In turn, the specified expenditures are funded by revenues drawn out of that fund or by debt, which will then be serviced by the fund.73

Whether or not some part of revenues are earmarked in this way is a secondary issue to the one of whether fuel taxes (and other road-use related charges) are set at levels where road users are paying their way. Fuel tax revenue and spending on roads and highways in Canada Nova Scotia fuel tax revenues vs. spending on roads and highways We saw earlier that fuel tax rates have been declining in real terms for some years. However, tax revenues also depend on the volumes of fuel purchased. The first part of this report documented that per-person sales of gasoline in Nova Scotia have been fairly flat for more than 10 years, and diesel sales have not increased much either. The population has not been growing rapidly it increased by only 2.25 percent between 1993 and 2010 and many models of vehicles are becoming more fuel efficient. The combination of all these things results in the declining real revenues shown in Figure 3-4. What of expenditure needs? In Nova Scotia, the Department of Transportation and Public Works has responsibility for 23,000 kilometers of roads and 4,100 bridges. It is responsible for all primary highways in the province, while local streets and secondary roads that are within towns and the urban centres of the regional municipalities are a municipal responsibility.74
According to Statistics Canadas Canadian Vehicle Survey, road use has continued to rise in Nova Scotia. Measured in vehicle-kilometers, it rose from 9.2 billion in 2000 to more than 10 billion in 2009, the most recent year available.75 The combination of growing road use and a slow decline in real fuel taxes is illustrated in Figure 3-5,

. .

McCleary (1991) reviews the arguments for and against earmarking in an international context. In the United States, the federal gas tax is earmarked for the Highway Trust Fund, whose income is used to finance the interstate highway system through matching grants to states. 74 . Treff and Ort (2010), p.11:4, who add that the province shares the costs of maintaining bridges on roads within towns and regional municipalities that are designated as part of the provincial highway system. 75 . Calculated from CANSIM Table 405-0058, but excluding bus traffic, whose data are incomplete.
73

72

which compares an index of each of these from 2000 to 2009. The growing gap between them suggests that we should expect there to be a similarly growing gap between fuel tax revenues and the provinces expenditures on roads and highways, expenditures that must result from growing use, if the roads and highways are to be maintained.

How much is spent on roads, highways, and streets in Nova Scotia? If we know this, we can compare it to the user charges that the province collects. Does Nova Scotias fuel tax act as a user charge in the sense that it covers the provinces expenditures on roads? The answer is no: the fuel tax does not come close to covering those costs. Figure 3-6 shows how much of the province s own spending the fuel tax has covered in recent years. In the 2005/06 fiscal year, it covered a bit more than 75 percent of costs, but this has fallen to just 60 percent in the 2011/12 fiscal year. This does not include the spending on roads, streets and snow and ice removal carried out at the municipal level. Nova Scotia municipalities spent more than $200 million for that in 2008, more than the provinces entire gasoline excise tax receipts.76

76

Treff and Ort (2010), p.11:3.

If we include other vehicle-related revenues such as licence and registration fees, net of collection costs, the total shown in Figure 3-6, this changes the picture somewhat. In 2005/06, these did almost cover provincial road expenditures, but they currently cover just under 80 percent of spending. The remaining 20 percent must come from other revenue sources. Table 3-5 sets out the data on a per-capita basis. In the fiscal year 2011/12, the Nova Scotia government is spending about $590 per person on the road and highway system.77 Fuel taxes will pay for about $260 of that with other revenues contributing $85, leaving about $245 per person to come from other sources. Whether all street, road and highway spending should be paid for directly by the users of those facilities (instead of paying for it indirectly through other taxes) is up to Nova Scotian citizen-consumers to decide. Roads have to get paid for one way or the other. The efficiency argument makes the case that by tying payments more directly to use the total bill would be smaller.

Table 3-5 Per Capita Provincial Government Spending on Roads in Nova Scotia (2011/12 dollars)
2005/06 Highways, Net Operating Highways, Capital Total Highway Spending Gas & Diesel Taxes Net Motor Vehicle Registration (MVR) Gas & Diesel Taxes + Net MVR $204 $179 $383 $296 $81 2006/07 207 251 458 287 92 2007/08 253 162 415 283 99 2008/09 249 213 462 270 95 2009/10 228 263 491 273 94 2010/11 229 239 468 273 89 2011/12 (forecast) 197 241 437 262 85

$376

379

381

365

367

362

346

77

See Appendix Table A8 for the original road and highway spending data on which this is based.

Notes: Highway spending includes direct spending only, excluding overhead. See Appendix Table A8 for details. Motor Vehicle Registration revenue is net of costs. (Source: Department of Finance; SNSMR.) Spending financed from federal transfer payments is not included. Gas and diesel tax revenue excludes fuel taxes from aviation and marine sources. Annual inflation adjustment uses Statistics Canadas Consumer Price Index (Nova Scotia, all items), averaged April-March to match the fiscal year. Price index for 2011/12 includes CPI up to December 2011.

Users of roads in Nova Scotia are paying about 80 percent of the full cost of the provinces roads through road-related use fees. It would be closer to 50 percent if all municipal spending were included. Canadian provincial government fuel taxes vs. spending on roads and highways Nova Scotia is not exceptional if we consider the situation in other provinces. Fuel taxes also do not cover other provinces spending. Table 3-6 attempts to compare the two. Gas tax revenues are relatively easy to measure, although the revenues for all provinces are not strictly compatible because some include revenues from fuels other than for road vehicles (eg. aviation fuel).78
Table 3-6 Provincial and Federal Fuel Tax Revenues and Road Expenditures, 2010/11 (millions of dollars)

Newfoundland and Labrador Nova Scotia New Brunswick Prince Edward Island Quebec Ontario Manitoba Saskatchewan Alberta British Columbia* Federal Government

Gasoline Tax Revenues Provincial Spending on 2010-2011 Fiscal Year Roads and Highways, 2010-2011 Fiscal Year $168.5 million 304.4

Gasoline Tax as percentage of spending on roads and highways 55%

$251.0 429.8 58% $202.8 581.7 35% $41.7 60.0 70% $1,910.0 2,225.8 86% $2,358.3 3,253.5 72% $229.9 443.1 52% $391.7 529.8 74% $715 2,407 30% $946 822 (BCTA) 73% (net of $727 m. carbon + 474 (Tptn & tax) Infrastructure) = 1,296 $4,229 $1,751m. (of $2,000m. allocated) Gas Tax Fund allocated for transfers to municipalities; other transfers to provinces under Infrastructure Base Fund, Building Canada plan, Major Infrastructure Component (eg national highway system) and Communities Component (eg local roads): total $1,065m (but not all to road-related things)

* Excluded from revenues: dedicated fuel taxes for regional authorities in Greater Vancouver and Victoria; excluded from costs: funding for BC Transit, which is partly allocated to fuel taxes.

I have made no attempt to include other road-related revenues. Revenues from vehicle registration, licences and fines, if included, should be net of expenses.

78

Notes: Except for Nova Scotia, Manitoba and Saskatchewan, gasoline tax revenues include non-road related revenues. Provincial spending on roads is net of any federal transfers. Some measures include transfers to municipalities from gasoline tax revenue to assist in municipal road expenditures and possibly public transit. Sources: NL and N.B., 2011-2012 provincial budgets. Nova Scotia: SNSMR; Quebec: 2010-11 Budget, p.43; Public Accounts, 2010-11, Vol. 2, p.208; Ontario, Public Accounts 2010-11, p.1-1, 2-368; Manitoba, Public Accounts, 2010-11, Vol. 3; Saskatchewan, Public Accounts, 2010-2011, vol. 2. Alberta (includes only Provincial Highways Systems and Safety Expenses and Capital Investment); British Columbia, Budget and Fiscal Plan 2011/12, p.80; Estimates, 2011-12, p.162; Canada, Public Accounts, and Treasury Board departmental performance report, Infrastructure Canada. Supplementary Tables - Details of Transfer Programs for 2010-2011.

Comparing provincial spending on roads and highways is more difficult, except in those cases where governments produce regular reports comparing fuel tax revenues with road and highway spending, so these figures are not strictly comparable in definition. Where possible, I have attempted to include only spending directly for on-going maintenance and repair of roads and equipment and for capital spending on roads and related infrastructure, and any related transfers to municipalities for those purposes. The basic point made by the calculations in the table is that no provincial government uses only gasoline taxes to fund its road and highway spending. Quebec seems to rely the most on gas taxes, Alberta the least. Nova Scotia is about in the middle. Only the federal government appears to collect more than it spends on road-related activities. Statistics Canada publishes annual data for 1998-2009 on capital expenditures on highways, roads and streets, by province.79 While these are only a partial measure of the cost of roads, because they exclude
maintenance expenditures and the spending on snow and ice removal that is necessary to keep roads useable, it is one source of consistent data by which provinces can be compared and in which all spending, provincial and municipal, is included.

Capital Expenditures, Highways, Roads and Streets, by province, CANSIM Table 290040. No definitions are provided, but these are likely capital expenditures net of depreciation. It would be misleading to measure capital expenditures gross of depreciation because then capital spending could appear positive when in fact the stock of capital was declining (if gross capital spending were less than depreciation). The use of the word streets in the title indicates that it includes capital spending by municipalities as well as by the provincial government. Despite its size and importance, no data is published by Statistics Canada concerning highway and road repair expenditures. The data exclude expenditures on bridges and overpasses, which appear in a separate category and might include expenditures for railway-related facilities.

79

To make the figures on capital spending more meaningful, I have adjusted the expenditures for inflation (so they are comparable over time) and expressed them in per capita terms. We can see in Figure 3-7 that in both Nova Scotia, and across provinces on average, provincial fuel taxes were more than sufficient to fund net capital spending on highways, roads and streets. 2005 was the year when fuel taxes just covered capital spending, and after that, capital spending continued its upward march, while per capita provincial fuel taxes continued their downward slide. If federal gas tax revenues (also on a downward slide) are added in, so that we have federal plus provincial gas tax revenues on a per-capita basis, as shown by the red line in Figure 3-7 (National Average Gas Tax), that postpones by three years (until 2008) the date by which capital spending overtakes all gas tax revenues. Clearly fuel taxes are a long way from covering the costs of vehicle infrastructure, when we consider all the other relevant costs that are not included here, such as the on-going maintenance and repair costs of roads and bridges, and the very considerable costs of snow and ice clearance. While this section has focussed mostly on the provinces, municipal spending should not be forgotten. It is too easy to focus attention just on the federal and provincial governments that collect what road-use related revenues there are. But municipal governments in Canada spent $12.5 billion dollars on roads, streets and snow removal in 2008, a sum just slightly less than the $13 billion collected in that year by all gas taxes in Canada, federal and provincial .80 The fuel taxes and other road-related revenues across Canada paid by road users are not high enough to pay for the costs of roads and highways. The remaining costs must be covered by other tax revenues. U.S. states fuel taxes and spending on roads and highways As reviewed earlier, all state governments in the United States have significantly lower fuel taxes than all Canadian provinces, except for Alberta. Many of them earmark these revenues for road and highway spending. While a full review of their practices would not be relevant here, a brief description of one New England state might be useful as an illustration of the experience of one such a low-tax jurisdiction. Maine is the first state many Nova Scotians are likely to encounter while driving to the United States. At 1.3 million, its population is larger than Nova Scotias 940,000. Median household income, however, is considerably lower than in Nova Scotia. 81

Maines surface area is 65 percent larger than Nova Scotia, but it has fewer roads.82 (A glance at a map
shows that much of the northern part of Maine is virtually uninhabited.) Aside from Maines 590 km portion of the Interstate Highway System, the Maine Department of Transport has jurisdiction over 2,900 km of arterial highways and 6,100 km of collector highways, about 9,590 km in total, and 2,700 bridges. This is much less than Nova Scotias 23,000 km of roads and 4,100 bridges. Few Canadian tourists visiting Maine overlook the difference in gasoline prices caused by the difference in taxes. The gasoline tax in Maine is 8 cpl (Canadian), 7.5 cpl lower than Nova Scotias, but it is now indexed to inflation, unusual for a gas tax. The Maine Constitution requires that its revenue be dedicated to the states Highway Fund, along with vehicle registration fees, inspection fees, road-related fines and other revenues.83 The Highway Fund is used not only for the cost of construction, maintenance and repair of highways and bridges, but also for the costs of enforcement of traffic laws. The Maine Department of Transportation, which is allocated

. .

On provincial spending, see Treff and Orr (2010), Table 11.3. Nova Scotia median household income was $62,550 in 2009, according to Statistics Canada, compared with an average of US$47,000 in Maine in 2006-2010, according to the US Bureau of the Census. 82 . It has, however, more roads per capita than the other New England states, which are smaller and have higher population densities (Maine Better Transportation Association 2011, p.10). 83 . Maine Constitution, Article IX, Section 19.
81

80

money from the Highway Fund, get no funding from general revenues for its road-related work. However it does receive federal government funds related both to interstate highway-related infrastructure as well as other federal funds for special purposes, most recently funds from the American Recovery and Reinvestment Act (ARRA) of 2009, the stimulus spending that came in the wake of the 2008-2009 recession. It seems fairly clear from recent reports that Maines road infrastructure has not been sufficiently funded by the current and past gas taxes and the other revenues that go into the Highway Fund. Adjusted for inflation, total Highway Fund allocations are less now than they were 20 years ago.84 At the same time, vehicle miles were increasing almost 3% annually.85 This reflects some of the shortcomings of relying entirely on a gas tax compared with something like a tax based on distance travelled, for example, as noted earlier. The Maine Department of Transport (2009) reports that 34 percent of its arterial highways are "structurally or geometrically inadequate" and that almost half of its collector highways have restricted passage for heavy trucks during the spring thaw. A recent law requires the Department of Transport to attain certain long-term goals of improving the states transportation system to bring it up to specified standards .86 In light of these, and other, requirements, a ballooning gap is developing between the required Highway Fund expenditures and its projected revenues. A report states: The current revenue estimates project very modest revenue growth... This has combined with significant unmet capital spending needs in this area and continued high prices for key inputs ... to produce this significant current services shortfall... the structural gap is projected to be roughly 53% (i.e. requiring a 53% reduction in current services allocations to equal revenue estimates.87 This brief review of the situation in Maine is not meant to suggest that all states are in equally difficult circumstances. But the case of Maine is useful to illustrate some of the shortcomings of funding roads and highways entirely with user charges that do not adequately cover long run costs and that do not reflect actual use in a consistent way.

The U.S. federal governments Highway Trust Fund, funded by federal gas taxes, is also facing a large and growing gap between its revenues and expenditure.88 Options include increases in federal gas
taxes or using mileage-based charges. LePatner (2010, p.103) cites a 2007 report that estimated that just state and local additional revenue requirements for investments would require an extra tax of 34-63 cents per gallon.89 Currently, the state-level average is about 25 cents and the federal tax is 18.4. About the United States in general, Sperling and Gordon (2009, p.163) comment: In most other countries, people pay high fees to purchase and drive the most inefficient, polluting cars, but not in the United States. Instead, Americans have preferred only a light tax on gasoline and diesel fuel, which is not even sufficient to maintain the highway network (thus requiring additional sales, excise, and property taxes by local and state government to build and maintain roads and transit services).

Highway Fund Allocations: FY 1989-FY 2013, Prepared by the Office of Fiscal and Program Review, Maine. Available at HREF="http://www.maine.gov/legis/ofpr/highway_fund/alloc_expend/index.htm" MACROBUTTON HtmlResAnchor www.maine.gov/legis/ofpr/highway_fund/alloc_expend/index.htm 85 . Maine. Department of Transportation (2009), p.10. 86 . An Act to Ensure Maines Transportation Future, PL 2007, c. 470. 87 . Maine. Office of Fiscal and Program Review (no date) reports estimates that total expenditure requirements for the 2012-13 and 2013-14 fiscal years are more than twice expected Highway Fund revenues, reflecting large increases in required capital spending. How this will be resolved as the 2012-13 fiscal year is being planned has not yet been determined. 88 . LePatner (2010, p.101), citing a National Surface Transportation Infrastructure Financing Commission 2009 report, available at financecommission.dot.gov 89 . National Surface Transportation Policy and Revenue Study Commission , Final Report, available at transportationfortomorrow.com/final_report/index.htm

84

If gas taxes and other direct and indirect charges for road use do not cover road costs, then other tax revenues, unrelated to road use must be used or road-related spending has to fall. If special highway funds are set up to which gas taxes and other road-use related funds are dedicated and if those funds are the only source of road funding, then the charges for roads must reflect their full costs and revenues must grow in pace with road use. Otherwise, infrastructure will deteriorate. 3.4 Who pays fuel taxes? How does the burden of fuel taxes fall on individuals of different income levels? Is the fuel tax regressive, in that it falls relatively more heavily on lower-income people when the tax paid is expressed as a share of household income ?90 The standard view among economists is that taxes such as excise taxes on fuels are regressive. Reflecting their higher savings rates, people with higher incomes tend to spend a smaller proportion of their incomes than people with lower incomes. So the lower people s incomes are, the higher the proportion of their income they will be spending on heavily taxed products, such as gasoline.91 Consider a simple example. Suppose that Consumer 1 has an income of $30,000 of disposable income per year and buys 1,500 litres of gasoline annually. At the 15.2 cpl Nova Scotia rate, this consumer pays $228 in tax. That is 3/4 of 1 percent of disposable income. Suppose that Consumer 2 has disposable income of $60,000 and buys 2,000 litres of gasoline. That consumer pays $304 in tax to Nova Scotia, which is of 1 percent of disposable income. Because the lower income person pays a greater share of income in tax, the tax is called regressive. Should we conclude that this is an unfair tax that should be reduced or removed? That conclusion does not follow because the gas tax has to be seen in the broader context of the overall tax system. It is not the only tax people are paying; some are progressive, some regressive, some roughly proportional to incomes. It is the net effect of all taxes that matters, if the fairness of overall the tax system is being judged on the ability to pay principle.92

It is important to note that here a goal of efficiency in this case, where road users would pay their marginal costs does not have to conflict with principles of tax equity. Efficiency is about adjusting the relative prices of gasoline and other goods to reflect the true relative marginal costs of their use. Increasing a regressive tax such as user charges for roads must increase the regressivity of the whole tax system. But this can be done while offsetting the regressive effects of such taxes for some households through cash transfers. The refundable Harmonized Sales Tax (HST) credits are a well-known example. Alternatively, some other regressive taxes can be reduced. Using fuel taxes more as a source of funding for road and highway costs or as green taxes does not have to make the overall tax and transfer system less progressive/more regressive.

The assumption throughout this report is that the fuel tax in Nova Scotia is ultimately borne by consumers. This is in line with the results of Chouinard and Perloffs (2004) study for the United States. Part of a federal gas tax is more likely to be borne in part by wholesalers, at least in the short run. 91 . Poterba (1991) claims that household well-being is better measured by expenditures (not income) and that gas expenditures are a smaller share of lower-income consumers budgets than for middle-income people. By that definition, the tax would not be regressive for these income groups. But this approach requires believing that savings (the difference between income and spending) does not affect peoples well-being. 92 . On balance, overall taxes are probably roughly proportional to incomes for most people, but progressive for the top of the income distribution, according to Kesselman and Cheung (2004).

90

3.5 Fuel taxes to deal with external costs Even if user charges of various kinds cover the full costs of roadway construction and maintenance, the earlier discussion of efficiency showed that is not enough to eliminate inefficiency. Road users would still not face the full costs of their actions because of the possible costs of congestion imposed on other drivers in some times and places, air and noise pollution, and the addition of greenhouse gasses to the atmosphere. Fuel taxes in high-tax jurisdictions such as the European Union have these kinds of costs as an explicit justification.93
But because with the possible exception of people in British Columbia, which has a growing carbon tax total fuel tax revenues do not cover road costs, there is nothing left over to act as a green tax to reduce further these additional costs.94 There is no reason to tie such green taxes on fuels to providing motor vehicle infrastructure. In British Columbia, the Carbon Tax has been used to reduce other taxes, for example. Fuel taxes, to the extent that they reduce driving and road use, do reduce pollution, but (at current levels) not to a socially efficient amount. They are insufficient to act as effective green taxes. 3.6 Concluding remarks Fuel taxes, like taxes in general, are not very popular, but their persistence suggests that citizens have recognized their necessity. Consumers like to have things for free and very often, the streets, highways and roads do seem almost free. The amount that we actually contribute relative to their cost, per kilometer driven, is small. In effect, they are heavily subsidized but out of the other taxes that we pay. What fuel taxes or the other feasible user charges should be for roads and how much of societys resources should be devoted to streets, roads and highways, is a matter for public debate and decision. Different societies have chosen different paths. It is not the job of this report to recommend one over the other. Nova Scotians will have to consider the issues and choose which path they want to take. Part 4 SUMMARY AND CONCLUSIONS This report has examined the market for gasoline and diesel in Nova Scotia with the goal of addressing questions of particular interest to consumers. I summarize here the main conclusions to these questions. Why does the gasoline market present special problems for consumers? Gasoline is a special good from a consumers perspective. It makes up a significant part of consumer spending, yet its price is volatile and unpredictable. Worse, for most consumers, it is a necessity. If gas prices rise, consumers reduce their purchases, but not in proportion to the rise in price, so their total spending on gas rises. Consumers have a strong interest in markets for gasoline being competitive. But some markets will not be competitive either because retailers lack any local competition or because the local competition has decided not to compete. In other markets, retailers will behave competitively. The same market may be competitive at some times and collusive at other times.

Can price regulation help or hurt consumers?

. .
See Kosonen and Nicodme (2009). The $727m. carbon tax revenue in British Columbia, mentioned in Table 3-6, is revenue from all sources, not just gasoline and diesel.
94 93

Price regulation like that implemented in Nova Scotia can have outcomes that are beneficial for consumers or are detrimental to their interests, or perhaps a combination of both. It may facilitate tacit collusion among retailers and lead to higher prices (or prevent lower prices from happening). On the other hand, it may limit collusive pricing and erode real margins, while offering consumers fewer and more predictable price changes. In the end, the details of how regulation is implemented matter. Whether the average consumer is made better off or worse off cannot be predicted a priori. It depends on the empirical evidence. How do gasoline and diesel prices in Nova Scotia compare with prices elsewhere? Within Canada, before-tax prices in Nova Scotia are among the lowest for both gasoline and diesel. These are the prices that should matter most to consumers. After-tax prices in Nova Scotia are relatively high. Because of relatively low taxes, after-tax prices in Canada are low relative to those in most industrialized countries, with the exception of the United States. Did regulation tend to raise or lower before- tax prices? Looking at the behaviour of operating margins (ie., wholesale plus retail gross margins) before regulation, I find that the margins set by regulation for gasoline were broadly in line with historical experience. Minimum margins lay close to or below the historical average; maximum margins lay above it. Whether consumer prices went up or down after regulation depended critically on whether retailers were able to price at the maximum or behaved competitively and priced at the minimum regulated price. Real operating margins of wholesalers and retailers have declined, on balance, over time since regulation began, reducing the costs of their services to consumers. This decline has come about because of the effect of inflation on the nominal wholesale and retail margins and transportation costs that are put in place by regulation. These resulted in net savings to consumers of between $8 and $20 million over the first five and one-half years of regulation. When those margins and transportation costs were adjusted upwards, effective January 2012, retailers real margins increased and caught up with inflation. Consumers can expect real margins to fall in the future as they have in the past. Consumers faced higher average prices just after regulation was introduced, because retailers were able to set maximum prices, which lay above past historical trends. However in larger urban centres, gas prices fell towards the regulated minimum price within six to nine months. The erosion of minimum margins by inflation has subsequently left consumers with net gains in prices, on balance. For consumers in small, isolated markets, prices have likely remained at or close to the regulated maximum. However, these were likely the most uncompetitive markets prior to regulation as well, because of the small number of retail outlets in the locality. Consumers of diesel also face relatively uncompetitive markets compared with consumers of gasoline, at least in larger markets. Regulation cannot alleviate that except to place a maximum price in the market.

Posted retail prices do not describe the actual prices that consumers pay, given the presence and frequency of promotions and price discounts. Price-sensitive consumers will have benefitted from the effective removal in 2010 of restrictions on new promotions. How do before-tax prices in Nova Scotia compare with those in the rest of Canada? Retail ex-tax prices both for gasoline and diesel are, on average, lower in Nova Scotia than in the rest of Canada. This is a reversal of the pattern seen in the past. Regulation has directly played only a modest role, in all likelihood. In the post-regulation period, real operating margins have risen significantly in the rest of the country, while (under the influence of regulation) they have trended downwards in Nova Scotia. Have fuel price changes become more predictable? The predictability of price changes with regulation has given consumers an informational advantage that was formerly held by retailers. There are two benefits: the psychological benefits of avoiding the annoyance of unexpected price increases and the modest monetary benefits for those who choose to exploit their knowledge of when price changes are coming and the direction of those changes. How has regulation affected price differences across Nova Scotia? Price differences for gasoline between different parts of Nova Scotia may have increased slightly in real terms since regulation began. They now largely reflect transportation costs differences, legitimate differences, from a consumer viewpoint, rather than swings in competitive conditions. Price differences for diesel have generally declined fairly significantly between different parts of Nova Scotia. Price gaps generally remain above transportation costs, reflecting the different degrees of competition in local markets. What would happen if price regulation were ended? While outcomes in retail fuel price markets are inherently unpredictable, it is reasonable to expect that these markets would resemble those before regulation began. If the previous conclusions about the effects of regulation are correct, then removing regulation would reverse them. Prices would likely rise in the less competitive markets and for diesel, where markets are less competitive than for gasoline. Prices could also be somewhat higher in markets that are now also currently competitive, without the effects of inflation eroding regulated margins. Price changes would be less predictable, both in terms of timing and direction. Does Nova Scotia have high fuel taxes? Excise tax rates in Nova Scotia for both gasoline and diesel are currently about the Canadian average. They have been declining and are now at their lowest rates in more than 20 years. Fuel tax revenues per person are just above the Canadian provincial average and constitute about 1 percent of personal disposable income. Federal and provincial fuel taxes in Canada are at least twice those in the United States, on average. However the United States has, by far, the lowest fuel taxes among the developed

countries. Average European tax rates are almost three times as high as Canada s and Australias rates are 1.5 to 2 times as high. Why are there special taxes on gasoline and diesel? Without some special charges to cover the costs of peoples use of roads and highways, drivers will face incentives that will lead them to decide upon an inefficiently large amount of driving. This results in higher costs to society as a whole in maintaining the road system, excessive congestion on the roads and excessive pollution. Fuel taxes have played the role of such charges, although potentially better alternatives are possible, alternatives in which charges are linked more closely to road use. What is done with gas tax revenues? In Nova Scotia, as in some other provinces, legislation directs that gas tax revenues and other road-related revenues (such as drivers licence fees and vehicle registration fees) be used for road and highway spending. Currently, users of roads in Nova Scotia are paying about 80 percent of the full cost of the provinces roads through these road-related use fees. It would be closer to 50 percent if all municipal spending were included. Similarly, the fuel taxes and other road-related revenues across Canada are not enough to pay the costs of roads and highways. If gas taxes and other direct and indirect charges for road use do not cover road costs, then other tax revenues, unrelated to road use must be used or road-related spending has to fall. If special highway funds are set up into which gas taxes and other road-use related funds are dedicated, and if those funds are the only source of road funding, then the charges for roads must reflect their full costs and revenues must grow in pace with road use. Otherwise, infrastructure will deteriorate. Are gas taxes regressive? Yes, households with lower incomes will likely pay a greater share of their income towards these taxes than higher income households. However, increased use of fuel taxes as a source of funding road and highway costs or as green taxes does not have to make the overall tax and transfer system more regressive, nor does it mean that total taxes have to rise. Their effects can be offset by changes to other taxes or transfers. Are fuel taxes helping to reduce congestion and pollution? Yes, to the extent that they reduce driving and road use, fuel taxes do reduction pollution, but not to a socially efficient amount given current tax rates. If these charges do not cover the costs of streets, roads and highways, they are insufficient to act as effective green taxes. What should fuel taxes be? What fuel taxes or the other feasible user charges should be for roads and how much of societys resources should be devoted to streets, roads and highways, is a matter for public debate and decision. Different societies have chosen different ways of paying for roads. Nova Scotians will have to consider the issues and choose which path they want to take. APPENDICES Appendix 1

This appendix includes some of the details of data sources and calculations undertaken for the report. Nova Scotia averages For many purposes, it is useful to use average values across the various gasoline markets. I used population weights to average them. I used an average of census weights for 2001, 2006 and 2011, shown in Appendix Table A1. Halifax dominates the average with its 70 percent weight. This is far higher than its share of the population of Nova Scotia. Unfortunately, this reflects the nature of the few places where retail prices are collected. Estimating trends in the nominal and real marketing margins The nominal marketing margin, the difference between average current dollar Nova Scotia retail prices and New York Harbour prices. It is calculated using the average of Tuesday retail prices in each location from 9 June 1998 until the end of June 2006, just before regulation began, and the average of NYH prices (converted to Canadian cents/litre) from the previous Wednesday through to the Tuesday on which the retail prices were reported.95 The exchange rate used is the daily noon
exchange rate reported by the Bank of Canada. The NHY prices are those of the United States Department of Energy at HREF="http://www.eia.gov/petroleum/data.cfm." MACROBUTTON HtmlResAnchor www.eia.gov/petroleum/data.cfm. Unfortunately, no data are available for ultra-low sulphur

diesel oil before 2006, because very little was traded in the NYH market. Data for other types of diesel oil is not available, so the analysis before 2006 focussed on gasoline. As Figure 2-1 shows, the nominal margins exhibited considerable week-to-week variation, but there was a clearly discernable upward trend. The average weekly compound growth rate can be estimated from a regression of the natural logarithm of the nominal marketing margin in week t, Mt, on a time trend variable, t. This implies the relationship

Mt = c0 ert

(1)

where c0 is a constant that reflects the expected value of the marketing margin in the initial week, r is the weekly growth rate, t is a weekly time trend and is an error term reflecting the fact that the time trend leaves some of the variation in M unexplained. Because ln ert = rt, taking the natural logs of both sides of (1) gives

ln Mt = ln c0 + rt +ln

(2)

An ordinary least squares regression using the 420 observations before July 2006 gives the following estimate: ln Mt = 2.117128 + 0.000561 t (0.22) (0.00009) where standard errors are shown in parentheses; R2 = 0.085.
.
95

Retail survey data is freely available from Kent Marketing Services, www.kentmarketingservices.com.

The weekly growth rate of 0.0561 percent implies an annual growth rate of about (1+0.000561)521 = 0.03 or 3 percent. This happens to be quite close to the inflation rate during that period; from mid-1998 to mid-2006, the Consumer Price Index (all items) for Nova Scotia rose at an average annual rate of 2.9 percent during that time.96 Other average growth rates are calculated in a similar way.
If this 3 percent growth rate is used to calculate an expected marketing margin by the end of June 2006, we get a margin of e2.117128 + 0.000561*420 or 10.52 cents. Because this is based on the actual before-tax retail price, it also reflects any transportation costs, which would differ between retailers in the four different locations. The population-weighted average of the initial transportation costs for the zones in which these 4 cities are located is 0.73.

However, a constant growth rate is not necessarily the best statistical description of the trend in the nominal margin shown in Figure 2-1. A more flexible form that allows for the growth rate to vary is

Mt = c0 ert + gtt

(3)

where tt is the square of the time trend variable, t, so that g is the amount by which the growth rate of M increases week by week. The log-linear regression yields

ln Mt = 2.161757 - 7E-5 t + 1.5E-6 t2

(0.22) (0.00036) (8.3E-7) with adjusted-R2 of 0.088, which is a slightly higher than the estimate using a constant growth rate. The values from this equation are the trend illustrated in Figure 2-1. Similar results were found for all individual cities; for the pre-regulation period only, the non-constant growth rate was statistically a slightly better description than the constant growth rate, by the adjusted-R2 criterion. In the post-regulation period, the constant growth rate provided the best estimate of the trend. APPENDIX TABLES Table A1 Population data for cities where M.J. Ervin gas survey data available 2001 Share in 2006 Share in 2011 population 2001 population 2006 population Halifax (CMA) 359,183 (0.686) 372,858 (0.698) 390,328 0.625 Cape Breton 109,330 (0.209) 105,928 (0.198) 101,619 (CA) [Sydney] 0.178 Yarmouth (MD) 10,476 (0.020) 10,304 (0.019) 10,105 0.017 Truro (CA) 44,276 (0.085) 45,077 (0.084) 45,888 0.076 Kentville (CA) 25,172 n/a 25,969 0.044 26,359
.
96

Share in 2011 (0.712) 0.640 (0.185) 0.167 (0.018) 0.017 (0.084) 0.075 0.043

Nova Scotia, all items, Consumer Price Index from CANSIM series v46691513. It had a value of 90.5 in June 1998 and 111.0 in June 2006. This 22.65% increase over the 8-year period is a 2.9 percent annual increase.

New Glasgow (CA) TOTAL

36,735 585,172 (523,265)

n/a (1.0)

36,288 596,424 (534,167)

0.061 (1.0) 1.0

35,809 610,108 (547,940)

0.059 (1.0) 1.0

Source: Census of Canada, 2001, 2005 and 2011. Abbreviations: CA = census agglomeration; CMA = Census Metropolitan Area; MD = Municipal district. Note: (1) values in brackets exclude Kentville and New Glasgow. This is relevant for comparing periods before and after regulation. Gas price survey data for Kentville and New Glasgow only began to be collected by MJ Ervin during 2006. (2) Population data for broader areas are used (eg. CA values rather than for just towns, as with Kentville, for example. To do otherwise would underweight the populations in those areas, particularly relative to Halifax. Population for Cape Breton CA is used because no official census population data exists for Sydney.

Table A2 Real marketing margins in Nova Scotia, gasoline, cents/litre (December 2011 prices), 1998-2011
Year Halifax Sydney Yarmouth Truro Kentville New Glasgow n/a n/a n/a n/a n/a n/a n/a n/a 12.5 12.8 12.8 12.6 12 11.8 11.8 4 City Average 12.9 11.3 11.1 12.6 11.4 11.2 12 11.8 12.2 12.3 12.3 12.1 11.5 11.3 11.2 6 City Average --------12.2 12.4 12.3 12.1 11.5 11.3 11.2

1998 1999 2000 2001 2002 2003 2004 2005 2006 I&II 2006 III & IV 2007 2008 2009 2010 2011

12.6 11.2 11.4 12.1 11.1 10.8 11.6 11.7 11.8 11.9 11.7 11.6 11 10.8 10.8

13.6 11.9 10 14.9 12.7 12.2 13.3 12.1 13.5 14.1 13.9 13.5 12.8 12.6 12.5

14.5 11.5 12 15.2 13.5 14 13.4 12.7 13.5 13.2 14.2 14.2 13.5 13.3 13.2

13.7 11 11.1 11.5 11.2 11.2 11.9 11.8 12 12.2 12.5 12.3 11.7 11.5 11.3

n/a n/a n/a n/a n/a n/a n/a n/a 12.9 12.8 13.2 12.4 11.4 11.2 11.2

Note: calculated using differences between weekly retail prices and average NYH prices in the previous week, adjusted by the CPI (all items) for Nova Scotia. n/a indicates that the data are not available. Source: weekly retail prices, Kent Marketing Services; NYH prices, authors calculations from US Department of Energy data on daily NYH prices, and Bank of Canada noon exchange rates, CANSIM series v121716.

Table A3 Real marketing margins in Nova Scotia, diesel, cents/litre (December 2011 prices), 1999-2011

Year

Halifax

Sydney

Yarmouth

Truro

Kentville

New Glasgow n/a n/a n/a n/a n/a n/a n/a 11.7 11.5 12.2 10.1 11.9 11.8 10.9

4 City Average 14.55 12.77 15.12 11.98 12.5 10.26 9.39 9.1 9.72 10.67 8.47 9.79 10.06 9.47

6 City Average -------9.37 9.83 10.73 8.57 9.91 10.16 9.57

1999 2000 2001 2002 2003 2004 2005 2006 I&II 2006 III & IV 2007 2008 2009 2010 2011

15.0 12.8 14.3 11.2 12.0 9.4 8.7 8.5 9.3 9.9 7.7 9.1 9.4 8.8

13.7 12.5 17.1 13.1 13.2 11.7 10.3 9.7 11.2 13.1 11.0 12.1 12.1 11.5

14.1 12.7 17.1 13.8 13.7 13.7 12.7 12.3 11.4 11.9 9.7 10.9 11.3 10.8

13.2 12.8 16.9 15.6 14.8 13.2 12.3 11.9 9.7 10.7 8.5 9.8 10.1 9.8

n/a n/a n/a n/a n/a n/a n/a 11.9 10.1 10.5 8.8 10.0 10.4 10.1

Note: calculated using differences between Tuesday weekly retail prices and the same days posted Halifax rack prices, adjusted by the CPI (all items) for Nova Scotia. n/a indicates that the data are not available. Source: authors calculations from weekly retail and rack prices, Kent Marketing Services and CPI.

Appendix Table A4 Retail and rack prices difference, gasoline, cents/litre (December 2011 prices), before and after regulation
Halifax Before regulation: June 1998-June 2006 Before regulation: January 2001-June 2006 July 2006-December 2011 8.4 8.2 7.8 Sydney 9.4 9.8 9.7 Yarmouth 10.1 10.4 10.2 Truro 8.4 8.3 8.4 Population-weig hted average 8.6 8.6 8.3

Note: calculated using differences between Tuesday before-tax retail prices and Halifax rack price, adjusted by the CPI (all items) for Nova Scotia.

Table A5 Ex-tax retail gasoline price differences between Nova Scotia (4-city weighted average) and various Canadian markets, 1999-2011, cents/litre (December 2011 prices)
Year Canada (volumeCanada (pop. Canada (large Canada (small Ontario weighted weighted market market average) average) average) average) 1.5 1.5 1.8 1.3 2 2.1 -2.5 -2.3 1.6 1.7 Quebec Western Canada 2 1.7

1999 2000

2.3 2.9

2001 2002 2003 2004 2005 2006 I&II 2006 III & IV 2007 2008 2009 2010 2011

1.9 0.7 0.2 1.5 0.8 1 0.7 -0.2 -2.5 -3.2 -1.7 -1.9

1.4 0.4 -0.7 0.3 -0.2 1.1 0.7 -0.2 -2.4 -0.5 0.2 -0.8

2.4 1.2 0.2 1.3 0.8 1.4 1.1 0.1 -2.1 -2.4 -1.1 -1.2

-4.8 -4.4 -5.2 -3.5 -4 -5.4 -7.6 -8.6 -11.1 -8.6 -7.6 -8.5

3.1 1.3 -0.1 2.1 1.1 2.6 3.8 2.4 -1 -5.6 -3.1 -2.7

3.4 3.8 1.9 2.4 2.4 3 3.3 2.5 0.3 -1.8 -0.8 -0.8

-0.3 -1.9 -1.6 -1.3 -1.5 -1.2 -4.1 -4.6 -6.6 -2.6 -1.2 -1.4

Notes: calculated using differences between weekly retail prices in Canadian markets and Nova Scotia cities and towns, as reported by Kent Marketing Services, adjusted by the CPI (all items) for Nova Scotia. Data for Sydney, Yarmouth and Truro began to be reported during 1998, but the different Canadian market averages are reported by Kent Marketing Services only beginning in 1999. Large and small market averages are population weighted.

Appendix Table A6 Nova Scotia, excluding Halifax, real before-tax retail gasoline price differences with average of small Canadian markets, 1999-2011, cents/litre (December 2011 prices)
Year Sydney Yarmouth Truro Kentville New Glasgow

1999 2000 2001 2002 2003 2004 2005 2006 I&II 2006 III & IV 2007 2008 2009 2010 2011

-1.9 -3.4 -2.5 -2.9 -4.2 -2.2 -3.8 -4.2 -5.8 -7 -9.8 -7.2 -6.3 -7.2

-2.3 -1.4 -2.3 -2.1 -2.4 -2.1 -3.2 -4.1 -6.7 -6.6 -9.1 -6.5 -5.6 -6.5

-2.8 -2.3 -6.0 -4.4 -5.2 -3.6 -4 -5.6 -7.7 -8.4 -10.9 -8.4 -7.4 -8.4

-7 -7.2 -7.7 -10.8 -8.6 -7.6 -8.5

-7.4 -7.1 -8.1 -10.6 -8 -7 -7.9

Notes: calculated using differences between weekly retail prices as reported by Kent Marketing Services, adjusted by the CPI (all items) for Nova Scotia. Retail price data for Kentville and New Glasgow is only available beginning during 2006. Canadian small market averages, as reported by Kent Marketing Services.

Appendix Table A7

Ex-tax retail diesel price differences between Nova Scotia (4-city weighted average) and various Canadian markets, 1999-2011, cents/litre (December 2011 prices)
Year Canada (volumeCanada (pop. Canada (large Canada (small Ontario weighted weighted market market average) average) average) average) 1.8 3.2 0.6 0.1 0.9 - 0.1 - 2.2 - 1.5 -1.0 -2.1 - 3.8 -1.8 -2.2 -3.1 2.7 2.4 - 0.2 1.3 5.5 n/a n/a - 1.5 -0.4 -1.8 -3.2 -1.5 -1.6 -2.0 1.5 2.3 - 0.2 1.3 0.6 - 0.2 - 2.2 - 1.8 -1.2 -1.4 -3.9 -1.9 -1.9 -2.1 - 2.7 0.1 - 4.4 -2 - 3.2 - 3.1 - 5.4 - 4.5 -4.3 -3.9 -6.0 -3.9 -3.3 -4.1 4.2 2.0 0.6 1.6 5.7 n/a n/a - 0.5 1.4 -1.4 -3.0 -2.8 -2.3 -2.7 Quebec Western Canada 1.5 6.4 0.0 1.5 1.3 0.3 - 4.1 - 1.6 -3.3 -3.9 -5.8 -0.9 -2.0 -2.8

1999 2000 2001 2002 2003 2004 2005 2006 I&II 2006 III & IV 2007 2008 2009 2010 2011

3.2 1.1 1.1 0.6 1.6 - 1.7 - 2.0 - 1.4 2.0 1.8 -0.6 - 0.2 0.2 0.2

Notes: calculated using differences between weekly retail diesel prices in Canadian markets and Nova Scotia cities and towns, as reported by Kent Marketing Services, adjusted by the CPI (all items) for Nova Scotia. Large and small market averages are simple averages, not population weighted.

Appendix Table A8 Provincial Government Spending on Roads and Highways in Nova Scotia (Thousands of current dollars) 2005/06 2006/07 2007/08 2008/09 2009/10 2010/11 Highways, Total Expenditures less Amortization less Revenues = Net Highway Operating Expenditures Highways, Net Tangible Capital Assets Total Provincial Highway Spending
$215,268.0 (45,132.1) 170,135.9 235,960.3 (60,948.3) 175,012.0 295,897.3 (77,112.7) 218,784.6 318,134.0 (89,245.3) (8,611.6) 220,277.1 319,002.0 (107,239.9) (8,289.5) 203,472.6 344,992.7 (125,544.7) (9,284.4) 210,163.6

20 (fo

33

(1 (9 18

149,010.0

212,900.0

139,881.4

188,194.1

234,942.3

219,674.7

22

319,145.9

387,912.0

358,666.0

408,471.2

438,414.9

429,838.3

41

Notes: Highway spending includes direct spending only, excluding overhead. Source: Department of Finance, Nova Scotia

APPENDIX 1 FIGURES FIGURE A1 COMPARING BEFORE-TAX RETAIL GASOLINE PRICES WITH REGULATED MINIMUM PRICES Panel (a)

Panel (b)

Panel (c)

Panel (d)

Panel (e)

Panel (f)

APPENDIX FIGURE A2 COMPARING BEFORE-TAX RETAIL NON-COMMERCIAL DIESEL PRICES WITH REGULATED MINIMUM PRICES Panel (a)

Panel (b)

Panel (c)

Panel (d)

Panel (e)

Panel (f)

APPENDIX FIGURE A3 PRICE GAPS WITH HALIFAX, 1999-2011 Panel (a)

Panel (b)

Appendix Figure A1-3 (continued) Panel (c)

Appendix Figure A4

Appendix 2 The reasoning behind the need for user charges to attain efficiency illustrated in Figure A2-1. The driver who pays no costs for the use of the roads or for pollution costs will drive so that the extra benefits to himself of driving another kilometer (seen in the downward-sloping blue line) are just counterbalanced by the additional private costs he pays (shown by the upward sloping black line).97
This is shown by point a, where the blue line intersects the black line. Driving another kilometer would incur greater additional costs than additional benefits. But point a is not socially desirable because the driver has not considered the additional (or marginal) road costs that must ultimately be paid for (the gap between the black and red lines) and the additional (or marginal ) pollution and congestion costs (the gap between the red and green lines, labelled for brevity marginal pollution costs). If we add these other costs to the marginal private costs the driver does pay, we can see the true social costs of driving, shown by the green line.98 When the driver ignores these costs of road use and pollution, the last kilometer he drives costs society more than the amount by which benefits. The distance between points a and a in the diagram shows the net costs to society from his driving that last kilometer. With too many kilometers driven (from a social viewpoint), the extra social costs would take the form not just in more time wasted in slow traffic, more deaths and hospitalizations from poor air quality, but also too much spending on road repair, maintenance, and construction. The higher level of general taxes that would result would provide no incentive to drivers to drive less.

The benefits of driving an additional kilometer per year are assumed to be decreasing: the further a person drives in a year, the less important is driving one more kilometer. For purposes of the diagram, I have assumed that the cost of driving an additional kilometer rises the more one drives, if only because the time spent driving could be better used doing other things. This assumption is not important for the conclusions. 98 . The diagram is not meant to be to scale.

97

But if the driver can be made to pay the additional costs associated with the use of the road (shown by the gap between the black and the red lines), then it will pay the driver to cut back somewhat on driving. The costs the driver would then face would be shown by the dashed red line: the sum of the marginal private costs plus marginal road use costs. The driver would now choose the point labelled b while paying a road-use fee of bb per kilometer. But that is still not good enough! Our hypothetical driver has still not paid the pollution costs, so the benefits of driving the last kilometer remain less than the social costs (by the amount shown by the distance bb"). If the driver is also made to pay those costs, shown by the gap between the red and the green lines, he would choose to reduce driving further (as shown by point c). If the costs have all been taken into account and measured correctly (hardly an easy matter), then the amount of driving at point c is also the socially efficient one. The driver will pay a per-kilometer charge shown by the distance cc. FIGURE A2-1

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