Puzzled

I have been puzzled by the proposal for a tax holiday for gasoline purchases running from Memorial to Labor day (see [0], [1], [2]), with the objective of spurring the economy. First, the Federal tax is quite low, either in real or in relative terms. Second, the benefits that would accrue to consumers are probably pretty small, under reasonable assumptions.


Going to the first point, consider the total Federal tax on a gallon of gasoline.


gastax1.gif

Figure 1: Gasoline tax, in cents per gallon (blue) and 1982-84 cents per gallon (red, green), as defined by CPI-all and CPI-ex energy/food. Sources: ARTBA, FRED II, and author’s calculations.

As one can readily verify, in inflation adjusted terms, the tax has been eroded over time to levels not seen since the early 1990′s. This is true regardless whether one deflates by the CPI-all or the CPI-ex. energy and food.


In relative terms, the total Federal tax has been shrinking as a share of gasoline prices, as gasoline prices have headed north (March = $3.293, all grades, inclusive of taxes). As of March 2008, the Federal tax accounted for 5.6% of that price.


gastax2.gif

Figure 2: Total Federal gasoline tax as a share of total price of gasoline. Sources: ARTBA, Energy Information Administration/DoE [a], [b], and author’s calculations.

So this is the measure to jump start the economy? I think this measure would give relief to somebody. But I also think it’s a pretty blunt instrument by which to provide assistance to the driving public, or consumers, for that matter.


Now, I’m not a microeconomist by training. Nor do I play one on TV. But it seems to me that if the supply of gasoline is price inelastic, and the demand is similarly price inelastic, then the incidence of the current Federal gas tax must be about evenly balanced. A tax holiday is then a holiday to both consumers and producers.


Do we know what these price elasticities are? Well, we know from this 2003 CBO report by David Austin and Terry Dinan that in the long run a plausible supply elasticity is 2, and plausible demand elasticities are in the -0.3 to -0.9 range. So the incidence of the tax on consumers is bigger than that on producers, for that time horizon.


But these elasticities are relevant for the long run (in this case, used to evaluate the relative merits of CAFE standards versus a gasoline tax). The proposed gas tax holiday was for a short duration of months. In this case, the short run price elasticity of supply is near zero, and the demand elasticity is plausibly near zero as well.


Assume both supply and demand are equally price inelastic, and this means the incidence of the Federal tax is about 50-50. Eliminating the gasoline tax for a short duration gives a windfall to both consumers and producers, of about equal proportion. (By the way, this conclusion is not true of state gasoline taxes; see Chouinard and Perloff (2004)). Now, giving a windfall to refiners and providers of feedstock for gasoline production might be a worthy goal, but I don’t believe that was the stated goal. If those corporations get a windfall then either it gets stored away to be spent on investment in a new refinery or addition to an old refinery sometime in the future, or it leaks out to overseas oil producers.


Oh, and by the way, to the extent the lower price spurs gasoline consumption, this should increase the petroleum and petroleum products component of U.S. imports, and thence putting further upward pressure on the price of oil…

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35 thoughts on “Puzzled

  1. esb

    This is an election year (as most of us are aware)
    and before November we will be treated to all manner of suggestions from politicians and their familiars.
    Most will be downright dreadful or simply stupid but all will be carefully crafted to sound like someone is not just standing there but doing something, when in most cases the opposite is the correct action.

  2. Brooks

    If supply and demand were both perfectly inelastic over some range of prices, we’d have overlapping vertical supply and demand curves over that range, and therefore multiple equilibria. Either suppliers would price at the top price of that overlapping vertical segment if they wanted to maximize short-term profit, or they’d price somewhere below that price due to objectives other than maximizing short-term profit (e.g., wanting to slow the development of substitutes or of conservation, or reducing the risk of governmental intervention such as a windfall profits tax or price controls). If it’s the former, then removal of the tax will simply lead to suppliers raising the price by the equivalent amount, resulting in no retail price change and increased profits for suppliers. If it’s the latter, suppliers would allow the retail price to decline by some or all of the amount of the (removed) tax.

  3. Bulldog Bond

    I believe that the federal tax bite is 100x larger than shown in figure 2. By my calc its 5.6% in March 08.

  4. AJ

    It’s 18.4 cents per gallon. At $3.28 per gallon, you get the 5.6%. I think we have a decimal problem…

  5. Buzzcut

    First, the Federal tax is quite low, either in real or in relative terms.
    Yes and no.
    Barackstar Obama keeps mentioning Exxon-Mobil’s profits, which were roughly $40B on $440B revenue, or a profit rate of 10%, or 35 cents on a $3.50 gallon of gas.
    Now, I’m not entirely sure how much the federal gas tax is, but there’s a sticker on the gas pump where I fill up “informing” me that the gas tax I’m paying is 44.5 cents per gallon.
    So the combined state, federal, and local gas tax I’m paying is roughly 50% more than Exxon-Mobil’s profit from extracting, refining, and dispensing the product.
    Keep in mind that Exxon-Mobile is more or less the best run company on earth, not just the best run oil company. None of the other companies are anywhere near as profitable, as any BP stockholder will tell you.
    With that said, I agree with Menzie that the “tax holiday” is bad policy, and gas taxes are very low by historical standards.

  6. Nemo

    Gas prices rise in the summer due to leisure driving, correct? Doesn’t that imply that the short-run summertime demand should be relatively elastic?
    I have no reference to back this claim, just intuition…

  7. JRip

    dear buzzcut and others

    Here is the data on Exxon Mobil from the most recent 12-month reported results:

    Revenue – $361.71 billion

    EBITDA – Earnings before Interest, Tax, Depreciation and Amortization – was $73.1 billion.

    Net Income – $40.61 billion

    Federal excise tax per gallon – 18.4 cents

    State taxes (as of July 1007) range from adding:

    8 cents in Alaska

    to 44.4 cents in California.

    Oregon, Kansas and Idaho are 43.4 cents total
    and
    Georgia is 44.9 cents total. If buzzcut does not live in one of those 4 states the sticker he reports MIGHT be out of date or the gas tax has been changed since the report I read.

  8. Buzzcut

    JRip, you are neglecting local taxes. Various Illinois counties collect a local gas tax.
    They also charge sales tax on gas!
    This is why gas in Chicago is in the $3.75 range. I believe the Cook County gas tax is 10 cents, and the sales tax in Chicago is 9.5%.
    But what’s your point? That E-M is making an 11% profit, not “rougly 10%” as I said?
    That the gas tax is at least 26 cents, not 45 as I said?
    Does that change the substance of my observation? Taxes are as significant, if not more significant (i.e. California) to the cost of gas as Barackstar’s “obscene profits”.
    I don’t think that an 11% profit margin is anything to write home about.

  9. MarkS

    Menzi
    Of course it makes most sense to INCREASE taxes on petroleum products, in an attempt to balance America’s trade deficit, conserve a limited resource, and provide enough funding to maintain the crumbling transportation infrastructure. McCain has received almost unanimous criticism of his “Gas Tax Holiday” in the conservative, liberal, and independent press… His populist pandering indicates desperation for contributions, economic ignorance, and creeping senility.

    The most significant thing shown in your gas tax chart (Figure 1), is that inflation rapidly erodes real gas tax revenue, (which inevitably results in parallel deterioration of transportation infrastructure). Also interesting, is that the frequency of gas tax rate hikes has increased, as congress responds to increasing complaints about roads.

    While it will no doubt be contentious, I would suggest that you or James devote at least one discussion to BLS price indexes. CPI values have increasingly lost credibility over time. The government and financial system have many incentives to perpetuate inflation and under-report it.

  10. lilnev

    Silly economist, this is a political proposal, not an economic one at all. As such, it’s pretty good politics — the Democrats will either have to accept bad policy (and McCain looks like a leader, “solving” the problems of everyday Americans) or resist it, and probably lose some votes.
    Also, the short term elasticity of supply in the US is (negative) short term elasticity of demand in the rest-of-world, via the ability to reroute tankers.
    peace,
    lilnev

  11. dilbert dogbert

    Cutting federal gas taxes just leaves headroom for the states to increase theirs.
    We have prices over $4 per gal here in California where I live. We drove from Palo Alto to Donner Lake last week and I did not notice any impact of these prices on average driving speeds or the amount of traffic on the highways.
    How high does the price have to go before people really change their driving habits? For me I think near $10 per gallon would change my habits and most likely bring crowds into the streets with torches, pitchforks and ropes.

  12. psummers

    Nemo,
    You’re right that summertime price increases are largely due to increased leisure driving. But us economists think of that as an outward (ie, rightward) shift of the demand curve (demand for gas is higher at any given price).
    Elasticity refers to the slope of the demand curve. So what you’re suggesting is that the summer demand curve is flatter (more elastic) than the non-summer curve. That could be the case, but then again it might not be. (Demand could be less elastic in the summer — “we’re going to Yellowstone no matter what!”)
    The point is that it’s the shift in the curve that’s causing the higher summer prices, not its slope.
    PS

  13. MarkS

    Buzzcut-
    Its silly of you to argue that Exxon’s 10% net income on revenue of $440.7 billion in 2007 is modest.
    On 12/31/07 Exxon had:
    ………$114.7 Billion in tangible assets
    ………$ 40.6 Billion in Net Income
    ………= 35.4% ROI (Return on investment net after tax)!

    Large industries, typically post 8-15% ROI. For instance, CSX posted 15.6% and Weyerhaeuser 13.6% ROI in 2007. Exxon’s profitability is more than double other industries. Exxon for the most part is selling an extractable commodity. Inventory costs are low relative to sales and cash flow is huge. Under normal circumstances you would expect ROI to be on the low rather than high end of the range.

    Gas taxes, whether they come out to $0.18 or $0.44 per gallon locally, pay for the road and transportation infrastructure that Exxon/Mobile needs to make a market for its product. I have always been amazed that modest gas taxes have been able to finance the incredibly extensive road and highway system in the United States. If you want to eliminate gas taxes, we could privatize the entire system and install toll gates everywhere, just imagine what that would do for commerce!

  14. Lee

    Of course it’s strictly a political proposal, but that’s exactly why economists should criticize it. Why should McCain and bad policy win by default?
    The Dems should point out that this is just another Republican gift to the oil industry, not a benefit for consumers: “Will gas stations actually lower prices if this passes?”

  15. Hitchhiker

    MarkS. Net income divided by total assets represents return on assets, not ROI. If ancient memory serves ROI or return on investment would be 40B divided by a market cap of 500B or roughly 7%.

  16. Hitchhiker

    MarkS. I found these numbers handy. I think ROE was perhaps the term you were looking for.
    Profit Margin (ttm): 11.23%
    Operating Margin (ttm): 16.80%
    Management Effectiveness
    Return on Assets (ttm): 16.47%
    Return on Equity (ttm): 34.47%
    Income Statement
    Revenue (ttm): 361.71B
    Revenue Per Share (ttm): 65.562
    Qtrly Revenue Growth (yoy): 28.60%
    Gross Profit (ttm): 171.70B
    EBITDA (ttm): 73.01B
    Net Income Avl to Common (ttm): 40.61B
    Diluted EPS (ttm): 7.28
    Qtrly Earnings Growth (yoy): 13.80%
    It is a nice number but, meaningless without relevant comparison. I don’t know how they stack up to industry averages. If ROA and ROE are the same, are they debt free. I need to look into this some more.

  17. Nick G

    “return on investment would be 40B divided by a market cap ”
    Really? I would think that would be Return on Market Cap, not ROI. I suppose a new investor might think of it that way, but I would think that “investment” would be book value of actual investment, not whatever price the market puts on your stock today.

  18. Hitchhiker

    Funny numbers all over the place. Why can’t conventions be used? The aforementioned ROE and ROA numbers in the summary imply a leverage multiplier and it shows debt of 9B.
    The actual balance sheet for Exxon Mobil 2007 shows total assets of 242B with intangible assets of 7B. What then is a net tangible asset listed of 114B? They do actually have some long term debt as the leverage multiplier indicates. About 25B plus other long term liabilities. They have fixed property,plant, and equipment of 120B. So again what the *& is net tangible assets of 114B and how is this number derived? EM’s ROA is 16% and ROE is 34%. Shareholders have been doing pretty well by them. Certainly not the next big one but steady reliable performance.

  19. E. Poole

    Now, I’m not a microeconomist by training. Nor do I play one on TV.

    Menzie Chen: Who is playing a microeconomist on TV?

  20. Bruce Hall

    While the federal government could suspend gasoline taxes for awhile, in the long run we would be better served if the federal government lifted restrictions on drilling in areas with known reserves which would increase supply relative to demand.
    Secondly, the federal government could provide gasoline tax relief for any STATE that convinced a company to build a refinery of significant size… as an additional refinery to those in place, not a replacement. A large part of the run-up in cost has been attributed to the lack of refining capacity rather than the lack of oil… especially regarding diesel stock.

  21. MarkS

    Dear Hitchhiker-
    I agree that “ROI” is commonly associated with Return (dividends paid plus market capital gains) divided by initial Market Cap, to yield an investment’s capital efficiency.
    “Market Cap” describes speculation in the equity market, not the capital investment in the industrial enterprise.

    I used “ROI” in its economic sense: The return on assets employed. Exxon management is primarily concerned with the return on the capital they have invested, not with the current market price of their stock.

    Investopedia defines ROI as follows:
    Return On Investment (ROI)
    “A performance measure used to evaluate the efficiency of an investment or to compare the efficiency of a number of different investments. To calculate ROI, the benefit (return) of an investment is divided by the cost of the investment; the result is expressed as a percentage or a ratio.
    Return on investment is a very popular metric because of its versatility and simplicity. That is, if an investment does not have a positive ROI, or if there are other opportunities with a higher ROI, then the investment should be not be undertaken.
    Keep in mind that the calculation for return on investment can be modified to suit the situation -it all depends on what you include as returns and costs. The term in the broadest sense just attempts to measure the profitability of an investment and, as such, there is no one “right” calculation. For example, a marketer may compare two different products by dividing the revenue that each product has generated by its respective expenses. A financial analyst, however, may compare the same two products using an entirely different ROI calculation, perhaps by dividing the net income of an investment by the total value of all resources that have been employed to make and sell the product.
    This flexibility has a downside, as ROI calculations can be easily manipulated to suit the user’s purposes, and the result can be expressed in many different ways. When using this metric, make sure you understand what inputs are being used.”

  22. haiki

    Remember back when we had to get in line to get gasoline, because of a shortage? The administration can’t bring that up, because their is no shortage. Otherwise we would be standing in lines again.
    Bring down the price of gas to reasonable levels, get the people back in their cars, and workers back in their trucks, the economy bounces back! Unless the oil companies like it just the way it is?
    Here’s an idea for those that do not much driving. Fill up your tank for $7. For seniors and others who may only drive their car a few times per week, every other day perhaps, on short trips, around town. You can fill your gas tank for $7. How you ask? This is easy on the pocket book, and one that I prefer. The next time you fill your tank and you make a short trip, your tank is about perhaps 2 gallons short. On your next outing pull into the gas station and put in about $7 worth, no more. So your tank is not completely full perhaps. Well on your next trip get $7 more, no more. Try it, youll like it. Isnt it a little bit better than spending $50 or more on one filling?
    haiki

  23. Joseph Somsel

    Yes, this is a political gesture, and a darn good one!
    Many here and elsewhere argue for INCREASING taxes on energy, especially gasoline. The arguments are almost completely theory and seldom look at it from the point of view of the taxpayer.
    From a taxpayer’s viewpoint, lower cost energy is good and lower taxes are even better good. How does one argue with a straight face that the solution to $4 a gallon gasoline is really, truly $5 a gallon gasoline?
    The payoffs from higher taxes are in the future and suppositional. Yea, and there’s pie in the sky when you die…..
    As the upcoming election involves energy policy and the average voter starts to pay attention, I predict that the “higher taxes for your own good” point of view will fail at the ballot box.
    Good riddance.

  24. don

    Menzie -
    As you note, if supply to U.S. consumers is elastic relative to U.S. demand, more of the benefits of the tax cut will go to U.S. consumers. Since the supply to the U.S. will respond to changes in foreign consumption as well as in global production, it is probably more elastic than U.S. demand.

  25. Menzie Chinn

    Don: But the time horizon is three months. I don’t think over this time frame, supply is elastic discernably more elastic than demand.

    Joseph Somsel: I think one needs a theory before one can judge the desirability of a policy. Sorry, even somebody as empirics-driven as myself recognizes that.

    E.Poole: Watch CNBC long enough, and you will see somebody play a microeconomist on TV, and indeed, occasionally one of them will be microeconomists by training.

  26. Buzzcut

    Guys, we are going on a huge tangent that we don’t need to go on.
    When Hillary! or Barackstar talk about profits, what are THEY talking about?
    I think dividing income by revenue to get a profit margin is exactly what they are talking about.
    Here is BP’s operating statement. Looks like they made a 10% profit too.
    Is a 10% profit margin all that good? The only reason Exxon made $40B is because their revenue was simply monsterous. This gives you a feel for what the scale of oil refining is. The throughput is staggering.

  27. Joseph Somsel

    Menzie Chinn – I would suggest one needs wisdom more than theory. Even then, it helps to have the RIGHT theory, one that can predict the future.

  28. Menzie Chinn

    Joseph Somsel: Well, I have a theory; I think it’s right. It involves utility maximization subject to budget constraints. I has producers that profit maximize, possibly in a non-competitive market. The resulting model leads to supply and demand curves. I augment that with information about elasticities from the extent econometric literature. And, indeed, I am looking at the issue from the perspective of (gas) tax payer, and producer. That might not be wisdom, in your book, but I think it’s a good start.

  29. david

    You know, there’s a test case for this. In Japan the (I think) 25 yen/liter gas tax expired March 31 and hasn’t been reinstated. From Reuters:
    TOKYO, April 4 (Reuters) – Japan’s retail regular gasoline prices have dropped further, after a provisional gasoline tax expired on March 31, a research body said on Friday.
    The average pump price of regular gasoline in Japan was 134.3 yen ($1.31) per litre ($4.96 a U.S. gallon) on Thursday, down 7.9 yen from April 1, the day after the gasoline tax expired, data from the Oil Information Center showed.
    The agency, which normally releases data once a week, released the ad hoc survey to take into account the expiry of a three-decade-old “temporary” gasoline tax earmarked for road construction.

  30. Rich

    Of course you are aware that low US gas taxes mean that the marginal impact on gas prices of crude price changes is close to 1:1.
    In Europe, where tax is more like 75% of the pump price, they’re consequently 4:1.

  31. Don P

    No matter how we argue the details of fairness of this tax to oil companies – there are simple facts that tell the story
    1. oil companies are doing well (I do own oil stocks)
    2. US gasoline prices are lowest in the World for OIL IMPORTING country
    3. Oil lobbyist continues to be a well-paying job
    4. Percent of tax on oil has decreased
    5. US dollar will suffer more as greater percent of dollar spent on oil goes overseas
    6. Raising gasoline tax will not hurt business as much as raising crude oil price – as diesel jet fuel and heating are not affected.
    7. To adjust US gasoline prices to that of other oil importing nations tax should be about $2.18.4 per gallon.
    8. US taxpayer (with big oil screaming) would NOT stand for $2.18.4/gal federal tax on gasoline
    UNLESS…
    PAY ME UP FRONT PROPOSAL:
    Based on the fact that average family drives about 20000 miles a year in a 20 mpg(actual mileage) car = 1000 gallons -
    $2000 April 15 Federal income Tax rebate for each family
    Start April 16 with $2.18.4 per gallon Federal Gasoline tax.
    This is a zero sum game for the average family – but they get the money up front and may use the money to buy a higher mpg vehicle.
    Walk to work – make $2000
    Drive a Prius 20000 miles a year – make $1000
    Drive a Hummer 5000 miles a year – make $1000
    Drive a Hummer 20000 miles a year – lose $2000.
    The Federal gas tax has been stuck at 18.4 cents per gallon since mid 1990s when gas was under a dollar – so this is really a return to previous rates and doesnt bring us to World parity in price at the pump.
    The tax is really progressive in that:
    The rich have more cars boats planes and other gasoline toys
    The rebate will selectively benefit the less wealthy who tend to have older smaller cars and often cant get a new car unless they had $2000 for a down payment.
    Everyone thinks they get better gas mileage and drive less than they do – so will pre-calculate this proposition favorably.
    Again – conservatives will like the idea of use tax as opposed to income tax.
    Law and order types will like the fact that those who dont file will not get any benefit.
    Anti -illegal immigrant conservatives may be smart enough to notice that it will put significant pressure on undocumented denizens – though I suspect the effect will be very small based on their limited driving.
    Business can have the rebate (but not more than $2000) only against actual gas receipts – otherwise sham claims.
    Business will also benefit as Diesel would not be taxed and more should be available as gasoline use decreases and more crude in made into diesel and likewise into jet fuel.
    Phase in may be necessary to sell this but it will diminish the possibility of using the rebate to buy new technology.
    The car companies need to and could benefit and big oil can afford a slump in sales. The State and the Nation could use less wear and less congestion on the highway system.
    This brave step would increase respect for the ability to sacrifice the Americans have shown in the past with rationing and sacrifice in the wars and ability to come together for the common good as during the depression

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