The Gas Tax Holiday Joke And The Hard Truth About Gas Prices

This week marked a milestone for me. For the first time in my driving history, I paid more than $50 to fill my gas tank (16.5 gallons at $3.39 a gallon at Costco). This price reflects a new economic reality in which everything is suddenly much more expensive. Gas prices are due to a number of factors, most importantly by demand driven up in part by fuel-thirsty China and India, supply kept low by an oil cartel that clearly benefits from high prices. The winners are oil companies that reap windfall profits, and oil-producing nations, some of which are entering a "golden age," thanks to $120-a-barrel oil. The losers are consumers, who pay more for gas, as well as for anything shipped long distance or made from a petroleum product.

In the midst of this, both John McCain and Hillary Clinton proposed a summertime gas tax holiday as temporary relief to the beleaguered American consumer. There are two problems with this proposal: The first problem is that the tax holiday is a convenient but, in the long range, insignificant ploy...

To illustrate, it's time for a story problem:



President McClinton signs legislation that mandates a gas tax holiday eliminating the 18.5-cent gas tax during the months of June, July, August, and September. On May 31, one day prior to the tax holiday going into effect, the price of a gallon of gasoline is $3.399. Assuming that the price of gas remains constant through the summer and that Frank fills his 16.5-gallon tank twice a month, how much will Frank save in the months of June, July, August, and September due to the tax holiday?

Let's see...
$3.399 per gallon x 16.5 gallons = $56.08

$3.399 - $0.185 = $3.214
$3.214 per gallon x 16.5 gallons = $53.03

($56.08 per tank x 8 tanks) - ($53.03 per tank x 8 tanks) =
$448.64 - $424.24 = $24.40.

Yup. I'll save $24.40. Admittedly, I drive fewer miles than the average American, and for so many people, every dollar saved does matter. But, in the end, $24, or $48, or (for you SUV drivers or long commuters) $100 over the summer is of marginal economic impact over the course of the year. This scenario assumes that gas prices will remain constant through the summer. That brings us to our second problem: supply and demand.

Anyone who's taken Economics 1010 knows the relationship between supply and demand. In terms of gasoline, it's safe to say that supply will be essentially fixed throughout the summer. Right now, our refineries are at 85% capacity. This summer, they'll be at 100% capacity, as they have been for years. In the face of fixed supply and increased demand (all those people taking road trips added to the constant increase in trip generation and vehicle miles of travel due to low density development), any student not asleep in class will tell you that prices will increase until demand tapers off. Hacking off $0.185 for a few months only induces greater demand. Seeing what appears to be a drastic price cut at the pump will compel people to drive more. In short order, prices will rise, erasing the benefit of the tax cut. Meanwhile, the oil companies and oil producing states (some friendly, some not) will reap an enormous windfall. That's what makes it silly.

The Kingdom of Saudi Arabia is one of the nations that benefits from high oil prices. Bloomberg reports that it is in a "golden era."

What makes the tax holiday dangerous is the potential $9 billion hit to the Federal Budget (it's worth noting that your gas taxes fund highway infrastructure. Have you driven our interstates lately? Can we afford such a hit?) McCain's proposal suggests that the federal government just take the hit. Clinton's proposal replenishes the hit by a windfall tax on oil companies, which turns the tax holiday into a pointless exercise in money-laundering.

(To his credit, Obama has called this scheme for what it is: a sham. In his words, "this isn’t an idea designed to get you through the summer, it’s designed to get them through an election." To his detriment, he's pandered on other stuff, including ethanol subsidies and vaccinations).

The gas tax holiday is a dangerous exercise in populist demagoguery. It will have a negligible impact on the consumer, and will induce long term behaviors that are counterproductive to long term energy savings. How can I say this more clearly? There is no economic benefit to a policy that promotes a demand increase without addressing supply! It is a joke. Nothing more, nothing less.

Some would argue that the real solution is to add refining capacity, to drill for more oil domestically, and to produce more ethanol. These are supply-side initiatives that could provide short term relief to the gas-buying consumer. But as long as China, India, and others demand more gas than we can produce, these are only short term fixes. Besides, the harm to our environment by our continued reliance on fossil fuels is a cost that must be considered in analyzing any supply-side remedy.

So here's the hard truth as I see it: let the gas prices rise. I know it will be painful, but we need to consider demand-side remedies as well, and price increases will naturally guide us toward some of these...call it getting whacked by the invisible hand. We need to drive less -- even if that means living closer to work in higher densities, and investing in and relying on more and better public transit facilities -- and we need to make concerted investments in more fuel-efficient automobiles in the short term, and alternative energy sources in the long term.

At the end of the day, supply side remedies such as increasing refining capacities (incidentally, Keith Olbermann played a clip on his show the other day wherein a bunch of American oil executives expressed no interest in increasing refining capacity during congressional testimony) and drilling for more oil or producing more ethanol will not save us from the point where we flat run out of oil, or(far more likely) when it becomes economically infeasible to extract. It will only move that date back a few years or decades. In the meantime, urban sprawl will continue unabated, and pollution will continue to darken our skies.

Conversely, ponder the collateral benefits that can be attained by focusing on demand: smaller, more compact, and potentially more livable cities, cleaner air, and the preservation of open space. I acknowledge it will be painful getting us there, but it will be worth it in the end.

In the meantime, I don't accept the notion that our nation will crumble under the weight of $5- or $6-a-gallon gasoline. The Canadian and European economies have long ago adjusted to very expensive energy costs, and there's nothing I can see that would prevent us from doing the same.