Opinion: Free Market Minute

Federal Gas Tax: A Break or A Brake?

Policy imperatives a'plenty

The current discussion of a possible summer holiday on federal gasoline taxes is one that is has become extremely muddled. The reason is that advocates and opponents of a holiday tax break are each arguing their case from a different perspective. Because they have very different objectives, each raises different issues and problems. The range of arguments over a federal gasoline tax holiday is broad: costs vs. benefits, long run vs. short run, overall macroeconomic growth vs. family welfare. It’s no wonder that no one analysis will satisfy all questions. The result is a confusing jumble of analysis and policy prescrptions, with nary a market option among the suggestions.

The federal gasoline tax is an excise tax, a tax that is levied per unit sold. It can be imposed either on the supplier or the consumer. Either way, an excise tax typically raises the price of the product at the point of sale, though the burden of the tax doesn’t necessarily fall equally on the buyer and the seller (it can be unequal in either direction).

At present, the federal gasoline tax adds 18.4 cents to the price of every gallon of gasoline sold in the U.S., so it is being imposed on the demand side of the market. It’s a law of economics (meaning it’s a behavioral law within the realm of market exchange) that when you make a product more expensive, less is purchased, and conversely when you make it less expensive, consumers demand more. If your objective is to reduce gasoline demand, whether out of inflationary, environmental, or energy independence concerns, for example, lowering the tax is the wrong strategy.

First, there is evidence that consumer demand for gasoline, at least in the short run, has not been extremely responsive to increases in the price of gasoline. This suggests that a temporary price drop will add to demand, but perhaps not drastically so. That’s not to say that drivers don’t mind paying upwards of $3.50 per gallon of gasoline—of course they do. But in the face of the more familiar price hike, consumers’ short-term willingness or even ability to drastically reduce miles driven, due to work or family obligations, doesn’t drop immediately with rising gas prices. The price elasticity of demand, as economists call this price sensitivity, is fairly low when it comes to gasoline.

That’s where longer-term planning comes into play. Given children and schools, shopping, recreational sports and extracurriculars, and work demands, families might not dramatically reduce the distance and frequency driven as a first resort. Personal transportation is still needed, so family choices may well shift toward more fuel efficient vehicles—in the longer run. Whether a gas tax holiday will generate benefits or costs for families, then, depends in part on the time horizon we are thinking of.

Some analysts argue that the immediate size of the dollar savings to families is monetarily insignificant and, at the same time, that the federal tax revenues foregone are overwhelmingly large. The most meager estimates of consumer cost savings assume 30 mpg as an average for U.S. cars and trucks, suggesting a savings of round $1.83 per week under the assumptions of one cost-benefit calculation.

Since the actual average mileage per gallon for the American fleet is around 25 mpg, consumer savings are understated in the argument. Some worry that a lower per gallon price, arriving at the beginning of the high-demand summer driving season, will tend to drive prices back up, in any case.

A related fear is that lowering the price of gas at the pump in the high-demand summer season will encourage greater use rather than conservation, sabotaging environmentalists’ efforts to discourage auto use per se.

But earlier policy discussions of a hike in the federal gasoline tax, in the interest of generating highway repair and maintenance funds, garnered criticism from some of the same sources that argued against the drop, stating that the tax reduction would be trivial from the point of view of the family. Still, given that excise taxes like the gas tax are regressive, one could still argue in favor of the tax break based upon the disproportional benefits to drivers in lower income strata in the economy, including the enhanced ability to earn income that typically accompanies automobile ownership.

When the unhampered market operates to coordinate plans, the choice of which goals to pursue is sorted out cooperatively by private owners of resources and by private citizens’ choices and priorities. When we try to sort out energy policy through regulatory dictates we are obliged to substitute the goals of the winning policy for the goals of families and consumers in the market. Occasionally these are perfectly in synch. If not, disagreements are settled via the political rather than the market process.

So—would a federal gasoline tax holiday produce a net benefit, or a cost? Ultimately, the policy decision about whether to enact the tax break will have little to do with the economics. It will instead be based on winning the political argument about the value of competing alternatives among groups with competing objectives in the economy.

Moreover, the popular if arrogant manner in which this debate has been framed reveals a general bias in favor of political ‘solutions’; additional punitive (as opposed to protective) regulation, interest group politics, and central planning, eschewing the very market mechanisms that allow for wealth creation and prosperity in any industry or field.

Unfortunately, it’s a good day to be a bad economist.