Why lower taxes would bring no relief

Yesterday I applauded the Administration’s actions with the Strategic Petroleum Reserve and fuel standards as very sensible and appropriate responses to the current problems. No doubt there will be any of a number of other proposals to “do something” that would cause more harm than good. Cutting gasoline taxes definitely falls in that category.

Tax Policy Blog notes the following story from yesterday’s Buffalo News:

Four Republican Assemblymen called Monday for the State Legislature to return to session this week and suspend the state portion of the sales tax on gasoline in time for Labor Day weekend.

Sounds reasonable, perhaps. But cutting the gasoline tax would give motorists virtually no relief from soaring gasoline costs. The reason is that the high gasoline price is a symptom of the problem, not the cause. The core problem is that we have to face a reduction in the available supply of gasoline. That means that somehow consumers must be forced to use less gasoline. Unless we institute rationing, the way that has to happen is for the total cost of the gasoline to consumers (the tax plus the price received by the seller) to rise high enough to choke back demand. If we reduce the tax but do nothing to increase the available supply, the price received by the seller would just go up by the amount that the tax was cut.

Sometimes that increased price received by the seller might create an incentive for more gasoline to be brought to the market. But in the current situation, there’s not much that anyone can do to produce more gasoline on a short-run basis. All that lowering the gasoline tax would accomplish in the present situation is to provide even bigger profits for those with gasoline to sell, leaving the total amount that the consumer pays for the gasoline exactly where it was.

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35 thoughts on “Why lower taxes would bring no relief

  1. RayJ

    JDH,
    In a post under your blog of yesterday, I raised the issue that some form of tiered pricing may be a better solution than either physical or economic rationing. While I recognize that tiered pricing may not be feasible in the very short term, do you see any merit in the idea?

  2. JDH

    Ray, the basic problem is to get the gasoline to the people who want and need it the most. I’m skeptical that we could really ascertain that some other way than to see what they’re willing to pay.
    I agree with you that there’s no painless solution. People want gas, but some of them can’t have it. That’s the basic reality that any plan has to come to grips with.

  3. MJB

    Then maybe a better solution is to raise the gas taxes? Prices wouldn’t go up any more, and the extra revenues could be used to help people who need help get to work by alternate means, instead of just profiting gas station owners.

  4. spencer

    MJM– why wouldn’t the price of gas go up if an additional tax were placed on it? Your conclusion is not realistic.
    At least with higher prices it will induce additional supplies of refined product from Europe to the east coast. So, with a moderate lag there will be a supply response.
    The extra profits go to the refiners, not he service station owners — they work on extremely small margins of under one cent per gallon.

  5. Bill Ellis

    Raising taxes neither hurts the rich, nor helps the poor. Raising taxes reduces the amount of money available for reinvestment feeding unemployment. As the professor notes, the inevitable impact is that there must be reduced consumption of gasoline.
    I doubt that gas station owners are reaping big rewards. When you sell the gas you have, you have to replace it at a much higher price. It is no more of an asset to have 5000 gallons that cost you a $1 than it is to have the same amount that cost you $2.50 a gallon.
    the resource owners will see more cash flow, but there must be massive amounts of repair work done to get the productive resources back on line. If you detract from the profitability of re-investment the resource will not be restored, and probably more importantly, a lot of roughnecks will be unemployed.
    You can’t make poor people rich by giving them more money. You can make the unemployed, those that are looking for work, self sufficient by giving them a job.
    Government does create an economy, it can only get in the way.
    Bill

  6. Bill Ellis

    Whoops:
    Government doesn’t create an economy. It only gets in the way.
    Bill (Slightly blushing.)

  7. Unpaid Punditry Corps

    Follow Up on Oil and Economic Impacts

    Indonesia could be facing a major currency crisis as the government subsidizes fuel prices there. If we get a repeat of Asia 1997, there is very little reserved liquidity, unless you want to see what a liquidity trap could look like in the United St…

  8. Bill Ellis

    And it is darn hard to use the government courts to enforce a contract.
    I didn’t say that there is no role for government. However, the government is extremely ineffective in setting prices. The product of forcing underpricing is always a shortage of available goods. The Soviet Union tried that angle for over eighty years. Were they an economic success?

  9. JN

    >>You can’t make poor people rich by giving them more money.<<
    Yes you can. Look at Sweden – a liberal’s vision of heaven, a conservative’s vision of hell?

  10. Bill Ellis

    An old friend of mine once opined that the farther from the equator you were, the harder people worked, in order to keep from freezing to death. Maybe Sweden’s blessed by its’ geography.

  11. Bill Ellis

    Gee, this is a testy bunch this morning. Partly, we have a definitional problem. I have been broke several times, but I never thought I was poor.
    The path to wealth accumulation is the same for most everyone. Save, invest, and accumulate. Those who follow that simple path, whether their income is minimum wage or millions succeed in wealth accumulation. Those who spend everything they receive will not change their habits because they receive more, they will still spend it all.
    I have watched many poor people waste inheritances. I have also watched many people that were once broke succeed in accumulating extra-ordinary amounts of wealth.
    Review the histories of lottery winners. Those chronicles illustrate my point.
    Bill

  12. DRDR

    MJB – Your tax hike plan would work only if gas supply were inelastic, but I think a tax hike would cause a much greater rise in the price consumers pay for gas than a tax cut would lower the price. This is because supply locally is going to be more inelastic for higher quantities of gas than it is for lower quantities. Put another way, for a tax cut to lower prices, producers need to be able supply more than they are now, and their ability to do that has been reduced by the hurricane. But a tax increase can raise prices if producers choose to supply less as the price they receive decreases, and that is definitely a more likely scenario.

  13. RayJ

    MJB writes: “Then maybe a better solution is to raise the gas taxes?”
    This is the solution used in Europe which why they already pay $5-6/gal. If the taxes are sufficiently high, they will reduce consumption but the problem is that these taxes are regressive. On CNBC yesterday they showed numbers that indicated that at $4, energy expenses rise from about 5% to about 8% of disposable income of the bottom 20% but only from about 3% to 4% for the top 60% (these numbers are approximate based on my recollection). Bottom line is that incentive to consume is higher on the lower segment of the population whose consumption is likely to be more inelastic.
    On the issue of rationing, Britain is currently considering an energy ration card with tradeable quotas albeit for global warming reasons. It will be interesting to see how things work out with that. http://www.telegraph.co.uk/news/main.jhtml?xml=/news/2005/07/02/nrg02.xml&sSheet=/portal/2005/07/02/ixportaltop.html

  14. Max

    JDH (Hirsch criticism, Aug 9): “How much oil is demanded at any given time depends, among other things, on the price…Supply equals demand today, supply will equal demand in 2025, and supply will equal demand in 2050.”
    JDH (Sept 1): “I agree with you that there’s no painless solution. People want gas, but some of them can’t have it. That’s the basic reality that any plan has to come to grips with.”
    Professor, it’s gratifying to see you acknowledge that economic theory is subject to physical reality.
    Max

  15. Larry

    Taxes already distort the price of gas. I understand that a lower price due to a tax reduction would stimulate demand, but wouldn’t that new price be a better reflection of the actual value per gallon since a significant distortion would have been either reduced or removed?

  16. Bill Ellis

    Value is set by the consumers. Cost is the financial history of the producer. When the value a consumer assigns is less than the cost to the producer the ultimate result is that supply ir reduced.

  17. JDH

    I don’t follow your point, Max. I think I was saying exactly the same thing in the two quotes you produced. Can you clarify for me what you see as the difference between the two statements, and why you feel that one statement respects the constraints of physical reality and the other doesn’t?
    Supply equals demand because the price goes up. The price has to go up to make supply equal demand. Those are my versions of the two statements you quoted. I’m not sure what you see as the difference.

  18. RayJ

    M1EK,
    I am aware of these arguments and, to a certain extent, they are correct. Obviously, if you take a low enough segment of the population where no one owns a car, then they are not subject to a gas tax. Note, however, that according to the CEX only about 8% of US households do not have a car.
    If one graphs the percentage of income used on gas, it would obviously start from zero, rise fairly quickly to some maximum and then fall to almost zero if the last person on the graph is Bill Gates. So, when people talk about the regressivity of gas taxes, they are referring to the part of the curve after the maximum which covers the majority of the population.

  19. M1EK

    RayJ,
    It just starts with the 8% who don’t own a car. Then the next N% own one car that gets good fuel economy compared to the exurban SUVs, and they don’t drive it much. (You see a lot of that around here in east Austin – they own one car but use the bus a lot). This comprises the ‘working poor’.
    The people hurt worst by rising gas prices are the middle and upper-middle-class because they drive far less efficient vehicles and put far more miles on them.
    The benefit of a gas tax is that it could be applied towards the operating costs of mass transit – which would provide offsetting help to the members of the middle-class who DIDN’T choose to move to the exurbs knowing that transit wouldn’t be an option.

  20. Bill Ellis

    A regressive tax isn’t all bad. We aren’t going to change a supply problem if the only economic impact is on the top ten percent of the population.
    The problem with mass transit is low use – or unduly low pricing. As gas cost goes up, mass transit gains value and the supply of mass transit will equal the demand.

  21. eric

    However lowering gas prices would give a greater incentive to suppliers to fix their oil supply problems in the long term.
    So I think lower gas taxes would help, even if it isn’t the short term fix people are asking for.
    (also I agree with everything Bill Ellis says :)

  22. Roger

    Bill Ellis – “A regressive tax isn’t all bad.”
    It certainly is. The only fair tax is one that is one that imposes an equal real burden on all under it.
    What’s the matter with you?

  23. Max

    JDH, I don’t question your consistency but felt that in the first case you were demanding [IMO an unecessary degree of] economic succinctness from a report that was really not economic in nature but an assessment of physical limitations, whereas your second statement seems to recognize that supply/demand is not always determined by price — there really are limits. Sorry if I came off sounding glib or smug and I realize that you were addressing two different topics. As you know the debate about limits is highly contentious and econs are often accused of being out of touch with reality. I’d love to see you take up this topic in a future blog as well as the question about whether econ is a science, whether its standard model is valid, etc.
    Max

  24. Bill Ellis

    Eric
    Thanks for the Kudos -
    Roger
    I don’t have enough time to determine, or list what is the matter with me. However, if everyone uses 600 gallons of gas annually, and they each pay $300 of gas taxes isn’t that an equal burden to all?
    The issue of gas taxes, and the price of gas at this time is simply one of avoiding the situation where gas is not available at any price. This would stimulate recession, and while the rich may have more to lose, the poor will have nothing at all.
    Unfortunately some have decided that a regressive tax is bad. I am always amazed that in the US we make plans while in the UK they develop shemes, and that schemes are good.
    Rog – I am sorry that semantics bother you, but regressive taxes do work as intended.
    Bill

  25. Hal

    Here’s an AP story about exactly what you recommend NOT be done:
    ATLANTA (AP): Georgia Gov. Sonny Perdue said he will sign an executive order Friday to suspend state motor fuel taxes through the end of September to “relieve some of the financial burden” on consumers in the wake of Hurricane Katrina.
    The order will remove the 7.5-cents-a-gallon tax and a 4% sales tax on gas, the governor said, and was set to begin at midnight.
    The move comes as gasoline in some parts of the country has risen above $3 a gallon, triggering thousands of consumer complaints of price gouging.
    Political leaders in several other states, including Massachusetts, Connecticut and Pennsylvania, have either proposed or said they are considering gas tax suspensions in their states.
    Perdue said the tax break in Georgia would cut the cost of gas by about 15 cents a gallon. He also called on gas stations to pass the savings along to customers.
    “This is not an opportunity for our stations or our businesses to reap a windfall for themselves,” Perdue said.

  26. Roger

    “I don’t have enough time to determine, or list what is the matter with me.” – Nor I about me, I assure you!
    “However, if everyone uses 600 gallons of gas annually, and they each pay $300 of gas taxes isn’t that an equal burden to all?” – Can a person with any humanity possibly believe that? Do you genuinely think $300 is an equal burden to George Bush as it is to for example a homeless refugee from New Orleans?
    “The issue of gas taxes, and the price of gas at this time is simply one of avoiding the situation where gas is not available at any price. This would stimulate recession, and while the rich may have more to lose, the poor will have nothing at all.
    Unfortunately some have decided that a regressive tax is bad. I am always amazed that in the US we make plans while in the UK they develop shemes, and that schemes are good.” – Ok, I get it now. You just don’t have a clue.
    “I am sorry that semantics bother you, but regressive taxes do work as intended.” – On this point I would agree. They work as intended: to keep a lower class of people impoverished and down where they belong. At least that’s how I suspect you’d see it.

  27. Deinonychus antirrhopus

    Why Cutting Gasoline Taxes Wont Help

    Prof. Hamilton has the answer. But for those of you who are too lazy to click through here is the short version. Let’s say that the market clearing price with taxes is $3/gallon and that taxes are $0.5/gallon. So the initial view is that cutting taxes …

  28. blogs for industry

    I only took one Econ class…

    …and as I recall I didn’t do that well in it. So perhaps I’m missing something in Alex Tabarrok’s and James Hamilton’s arguments about taxes and prices…but then EconLog’s Bryan Caplan doesn’t seem to be buying it either. Tabarrok:
    Ask the man …

  29. smuggler

    The argument made by James is strictly true only if supply is totally inelastic–if the supply curve is vertical. With an upward sloping supply curve, an excise tax works just like any other cost of production, effectively shifting up the supply curve. If you remove the excise tax, you lower the cost of production for suppliers (they don’t have to pay x amount for every gallon of gasoline they produce), and shift outward the supply curve. It’s the same effect as would be seen with a reduced cost of refining a gallon of gasoline. It now becomes more economical to refine the marginal gallon of gasoline, all else equal.
    Therefore, with a natural disaster and a reduction in the excise tax, you have two effects working in opposite directions. Depending on the supply impact of the disaster, you could end up with a higher price, a lower price, or the same price.

  30. Truck and Barter

    A Gasoline Tax Rebate

    Economists agree — with experience and theory behind them — that reducing gasoline taxes will not lower prices in the short run. But will offering a gasoline tax rebate — refunding all federal taxes paid for gasoline — increase them? If so (noting …

  31. The Dead Parrot Society

    Do Gas Taxes Holidays Cause Lower Prices?

    Georgia recently suspended their gas tax for a month. Tax Policy Blog linked to a story that New York is considering tax relief that would last through New Year’s. There is disgruntlement in Connecticut, as well. Will reducing gas taxes reduce prices? …

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