Thursday, April 17, 2008

Econ 101: Will a Gas Tax Holiday Help Consumers?

I haven't been paying too close attention to the specific policy proposals, but this one from John McCain really caught my attention.

PITTSBURGH (AP) — Republican Sen. John McCain on Tuesday called for a summer-long suspension of the federal gasoline tax and several tax cuts as the likely presidential nominee sought to stem the public's pain from a troubled economy.


John McCain in the past has said that he doesn't understand economics. Well, it shows.

Let's start with the fact that refineries are essentially operating at capacity. In summer, when travel is at its peak, this is especially true. This translates to a completely inelastic supply curve. What does economics 101 teach us about taxes and completely inelastic supply curves? It teaches us that there will be virtually NO price effect at the pump. You will just be transferring the tax revenues to the oil companies. So the claim that this would stem the public's pain is absurd.




Here is a graph of the situation. If the tax is removed, P* will still be the price that consumers pay, but it will also become the price producers receive. [In the long-term the tax removal might stimulate a move in the supply curve, but this is a short-term tax].

And, by the way, I am not just picking on Republicans, the Democratic candidates in their rush to find populist appeals have unleashed some questionable proposals. But this is such a simple example of bad economics, I could not resist the teaching opportunity.

9 comments:

Jeff Alworth said...

You have educated a simple blogger and reduced global ignorance by one person. Not a bad day.

Jeff said...

It would be a full time job to point out the problems with the candidates' policy proposals.

This could provide plenty of fodder for you blog.

I hope you don't feel the need to be 'balanced' however -- call the shots as you see them.

Richard Martens said...

I say keep the tax and fix the potholes.

Bob said...

It's not worthy that neither is supply perfectly elastic (and in fact there is surplus right now, read: http://tonto.eia.doe.gov/oog/info/twip/twip.asp ), but demand is about as close to being perfectly inelastic as anything we have.

As a result, when economists actually bothered to study this (instead of speaking ideologically and off-cuff), they concluded that the federal gas tax is shared equally amongst producers and consumers (see here: http://www.ses.wsu.edu/PDFFiles/JournalArticle/Chouinard/gastax.pdf)

Note that under that study's scenario, there was no excess profits tax in place on oil producers, which would change the equation.

Can anyone please explain to me why so many economists are pretending that supply is perfect inelastic, and that demand is elastic, when the opposite is true in both cases? Thank you.

Leah said...

What do you mean perfectly inelastic? The OPEC cartel means they are going to supply a quantity that meets demand at an arbitrary price of their choosing. So wouldn't that be a horizontal curve like the price-setting curve in the wage-setting graphs, where firms have ultimate decision-authority on the y-variable, price?

Given quantity, at any price. Given price, at any quantity. I'm confused now.

Patrick Emerson said...

The difference is that OPEC has control over a lot of the crude oil production but the supply bottleneck is at the refining stage where oil is made into gas. Most of the refineries in the US are at full capacity.

Patrick Emerson said...

Bob, temporary inventory variation from demand fluctuations are not the same thing as excess capacity at the refineries.

Demand is definitely not perfectly inelastic as we are seeing a drop off in overall demand with high prices, but it is highly inelastic.

Bob said...

Refineries operated at 97% capacity during 2006 (the most recent complete data set I could find from DoE). Consumption of gasoline has decreased 3-5% since then.

Therefore - refineries are operating below capacity. Most likely they are somewhere around 92-95% capacity.

Moreover, even after adjusting for seasonality, refineries have an above average surplus inventory for this time of year, based on rolling 5-year average.

It would be a mistake to conclude that supply is perfectly inelastic, as Krugman and others did.

Patrick Emerson said...

You may well be right Bob, I am no expert, but from what I understand much of the difference between actual and full capacity is due to maintenence issues.