Thursday, April 17, 2008

Gas Tax Wiffleball versus Fuel Price Hardball

By Raymond Richman and Jesse Richman

Not long ago, Sen. McCain humbly admitted that economics was not his forte. This week in Pittsburgh, he proved it. Indeed he proved that none of his economic advisors knew any economics either. Worse, he also proved that he and his advisors knew very little about taxes either. He proposed eliminating the federal gasoline tax of 18.4 cents per gallon during the coming summer months of June, July, and August. (Presumably he would like the states to follow suit.) This is bad economics and bad policy. Ineffective and lacking heft, it is gas tax wiffleball. We need to play hardball.

Why is this bad economics? The resulting reduction in price would encourage more trips and therefore greater consumption of gasoline. Such an increase in consumption would tend to raise the price of oil and worsen our trade deficit. We want consumers to consume less not more gasoline. Such a reduction in gasoline consumption would tend to bring the price of oil down. Indeed, because of the inelasticity of the supply of oil, the increased demand for gasoline and the resulting increase in the price of oil would likely cause oil prices to rise, offsetting in part the intended effect of the tax holiday.

At best, the reduction will have a barely noticeable effect on price. The Federal gas tax is now only five or six percent of the cost of a gallon of gasoline. In the face of recent and anticipated price increases, the share accounted for by the tax is minor.

But of greater concern is the fact that the gasoline tax is a user tax, the proceeds dedicated to the construction and maintenance of roads, highways, and public transportation systems. Do we really want to cut back on such expenditures during a recession? The transportation authorities should be accelerating their expenditures not postponing them.

To reduce the price of gasoline, we need to reduce the price of oil, now exceeding $110 per barrel with the price of gasoline at $3.45 per gallon. The problem of the high price of imported crude oil and the high domestic price of oil products including gasoline is the damage it is doing to our economy. We do not need to submit passively to the high price of imported oil, but McCain’s plan will not help. Playing hardball on fuel prices requires the U.S. to make real choices on both the demand size and supply side, choices that decrease demand and increase supply.

Supply side: remove unnecessary restrictions on drilling for oil. For instance, Sen. McCain should announce that he will permit drilling in the Arctic National Wildlife Refuge (ANWR) and other public lands. Just announcing that we will do so could cause the price of oil to fall. The benefits would be considerably greater than costs. According to the 2003 National Academies of Science report to Congress, the environmental costs associated with drilling on the North Slope have so far been quite minor. The oil that is foregone by the current restrictions on drilling likely has a market value of billions of dollars and the exploration, drilling, and pipelines would provide many thousands of good jobs directly and indirectly. Longer-term, we should continue to seek alternative sources of motor fuel as we are now doing.

Demand side: He should also give notice to the Organization of Petroleum Exporting Countries that we consider their cartel to be illegal and that we intend to take countermeasures. OPEC restricts the output of oil in order to raise prices and we have done nothing to prevent the practice. If our exports to them were equal to our imports from them, the high price of oil would have little impact on us economically. The problem is that they do not import as much from us as we import from them. Rising oil prices exacerbate our trade deficit which helps drive down the dollar, and leads oil prices to rise still higher. OPEC countries could break this cycle by increasing imports from us. The alternative is for the U.S. to decrease imports from OPEC. One approach would be a large gas tax, but this would hurt the poor in particular. Another approach would be gasoline rationing as proposed by Martin Feldstein in 2006. This would share the pain more equally. Both approaches would impose pain, and neither should be taken lightly. However, reducing consumption might well have benefits.

A reduction of our imports of oil by ten percent would require the reduction of imports from current levels of 9.3 million barrels per day to 8.4 millions. Although it has been shrinking, the U.S. share of the world oil market remains very large. Reducing our imports ten per cent would probably cause a dramatic fall in world oil prices.

If Sen. McCain is serious about reducing the price of gasoline and oil, he should put forward an effective proposal, one that increases supply or decreases demand. Cutting prices and thereby increasing demand is unlikely to help much.

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