Anticipation, Tax Avoidance, and the Price Elasticity of Gasoline Demand
29 Pages Posted: 22 Mar 2016
Date Written: February 18, 2016
Least-squares estimates of the response of gasoline consumption to a change in the gasoline price are biased toward zero, given the endogeneity of gasoline prices. A seemingly natural solution to this problem is to instrument for gasoline prices using gasoline taxes, but this approach tends to yield implausibly large price elasticities. We demonstrate that anticipatory behavior provides an important explanation for this result. Gasoline buyers increase purchases before tax increases and delay purchases before tax decreases, rendering the tax instrument endogenous. Including suitable leads and lags in the regression restores the validity of the IV estimator, resulting in much lower elasticity estimates.
Keywords: IV, price elasticity of demand, gasoline, anticipation, intertemporal substitution, storage
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