Co-blogger Scott Sumner has written an excellent post on how a temporary cut in the federal gasoline tax (from its current 18.4 cents to gallon to zero) will cause the 4 effects he mentions.
I think Scott leaves out a 5th effect that swamps his 4: it will increase Americans’ demand for price controls on gasoline.
The one thing I want to take issue with in Scott’s post is his statement that “Most of the tax cut goes to suppliers in the short run, helping refiners.” Scott may well be right, but it’s important to uncover an implicit assumption that he doesn’t mention: his assumption that the demand for gasoline is substantially more elastic than the supply of gasoline.
I agree with Scott that the supply of gasoline is highly inelastic. But we energy economists are also used to thinking of the demand for gasoline as being highly inelastic. It’s true that we don’t know much about the elasticity of demand for gas at current prices because we haven’t had much experience with prices at this level, even inflation-adjusted. Helping Scott’s case is the basic idea that the higher the price you start at, the more elastic is demand. Hurting Scott’s case is that there is some degree of discretion on the part of refiners in the extent to which they produce gasoline or produce other refined products. So even with a completely fixed refining capacity, an increase in the price of gasoline as seen by refiners can increase the amount of gasoline produced.
Let’s set a base case. If the demand for gasoline is just as elastic as the supply, then an 18.4 cent tax cut will be shared equally between producers and consumers. Producers will get a price net of tax that is 9.2 cents higher; consumers will get a price gross of tax that is 9.2 cents lower.
But if, as Scott expects, the demand is substantially more elastic than the supply, producers will get a much larger share of the 18.4 cents and consumers will get a much smaller share.
Say consumers get 5 cents of the tax cut per gallon.
What happens next?
A lot of them are going to be angry. “Those so-and-so oil companies were greedy and they kept the lion’s share of the tax cut. Let’s have the feds impose price controls so that we can get a bigger share.”
We all know what happens with price controls. When the price control keeps the price below the free-market price in a relatively competitive industry, there’s a shortage. People line up for gasoline. And the deadweight loss from their time in line can be a bigger factor than any of the 4 factors that Scott mentions.
A case in point is Proposition 13 in California, which, when passed in June 1978, immediately cut property taxes by a massive amount. I had some economist friends who were finishing their PhDs at UCLA and were in rental apartments. Their landlords, and many other landlords in California, sent fliers to their tenants before the vote telling the tenants that if Proposition 13 passed, their rents would fall. We economists knew that was unlikely because governments in coastal California were heavily restricting supply, making it highly inelastic, whereas demand was somewhat elastic.
Proposition 13 passed, rents didn’t noticeably fall, and tenants were pissed. What did they do? Call for rent controls, which were imposed in many cities in California. In some cities, such as Santa Monica, over 40 years later, rent control is still in force, with all the distortions it causes.
READER COMMENTS
Scott Sumner
Jun 23 2022 at 11:57am
Good points. I should say that I’m not an expert on the refinery issue. It is usually the case that most of the tax cut would go to gasoline consumers. But some experts seem to believe that with the problems in the refinery industry, the supply right now is unusually inelastic.
Michael Giberson
Jun 24 2022 at 12:13am
US EIA data on refinery capacity usage is here: https://www.eia.gov/dnav/pet/hist/LeafHandler.ashx?n=PET&s=WPULEUS3&f=W
The average for the year so far is just over 90 percent, not much different than the average over the last thirty years of 89.5 percent.
In the last two and a half months capacity usage has been higher–92 to 94 percent–compared to between 87 to 91 percent in the first three months of the year, and maybe this is evidence that we are in a particularly inelastic portion of the supply curve.
But it is pretty normal for U.S. refinery capacity usage rates to be higher in the 2Q and 3Q and lower in the 1Q and 4Q. Summer driving season and all that. The usage rate may not tell the whole story, but it isn’t suggesting anything unusual is happening at that corner of the market.
Petroleum products exports shot up in March, which suggests US capacity may be filling in for Russian exports while the world market adjusts to trade sanctions and other Russian invasion effects.
Philo
Jun 23 2022 at 12:52pm
This post is a good illustration of how hard it is to do macroeconomic policy analysis: here, and generally, you are forced to rely on (largely armchair) social psychology in predicting the effects of different policies. Not much confidence can be placed on results attained by such means.
Matthias
Jun 26 2022 at 6:55am
That’s why federalism is so important.
Now, if only we could get the different states to enact policies depending only on unbiased coin flips..
Thomas Strenge
Jun 24 2022 at 12:02pm
There is a government policy that may actually cause small refineries to shut down. Refineries are required to blend ethanol into their fuel. Apparently smaller, older refineries don’t do this due to corrosion issues and have to buy renewable credits to offset. Those credits are in short supply and very expensive. So, yes, refinery capacity is very inelastic right now, and there is no incentive to build new ones in the US because it’s probably a ten plus year project. And gas cars are supposed to be outlawed by 2030. We’re killing ourselves.
James Merritt
Jun 24 2022 at 4:59pm
Here in California, I think that a moratorium on both the State gas tax and the requirement of California re-formulated gas (CRFG) would help ensure that California motorists would feel actual relief at the pump. For one thing, the total per-gallon amount at issue is a lot bigger than the Federal 18 cent-ish tax. So if even only a portion of the producer-price drop were passed along to consumers, that would still be a noticeable and welcome cut. But by pausing the CRFG requirement, California gas stations could compete for and stock up with the gas that the rest of the country uses; they would then be motivated to compete on price for the consumer dollar at retail. I remember a time when the majority of daily-use tableware at my Mom’s house came from filling up the car during California’s gasoline price wars! If we’re going to revisit 1970s inflation, then let’s repeat the gas wars of the 1960s and 70s, too, with or without tableware! 😀
Thomas Strenge
Jun 27 2022 at 4:16pm
I believe that the CFRG standard is the main reason for high gas price in California. Basically, Texas gas is no good in California.
Matthias
Jun 26 2022 at 6:57am
Yet another instance of welfare for the well-off.
Instead of giving everyone some money, they give people a subsidy / tax cut in proportion to how much gas they buy.
Obviously richer people can afford more gasoline.
David Henderson
Jun 26 2022 at 2:58pm
It’s hard for me to see why a tax cut is welfare. I’m guessing you keep about 60 to 70% of your income after taxes. In other words, the government refrains from taxing you that added 60 to 70%. Can we reasonably say, Matthias, that you are on welfare?
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