How Do Governments Set Fuel Excise Levies? A Testable Theoretical Framework and Evidence from Australia

This paper addresses the important question of how governments set fuel excises. A theoretical framework leads seven possible nested hypotheses to explain fuel excise setting: (1) inflation adjustment, (2) fuel price relief, (3) coordination with GST revenue, (4) sterilisation of oil price shocks, (5) attenuation of the business cycle, (6) public debt financing, and (7) environmental action. Its reduced-form empirical counterpart is estimated with an asymmetric ARDL model with time-varying dynamics on quarterly data for Australia covering 1990 to 2023. It is found that all hypotheses but one are relevant in explaining policymaker’s actions, and their influence is quantified. Importantly, evidence suggests that business cycle and public finance are significant driving factors, each with asymmetric dynamics that depend on the direction of the shocks. These findings help understand the patterns observed in fuel taxation decisions and inform the evaluation and public discourse on the motives of fuel taxation. JEL Classification: Q41, Energy: Demand and Supply; Prices; Q48, Energy: Government Policy