This week President Biden announced a call for a federal gasoline tax holiday. This means that the $0.18 federal tax on gasoline and $0.24 tax on diesel would be suspended until the end of September. Ideally, this tax holiday would decrease prices from the current $5.00/gal national average to $4.82/gal. With support from state governments also suspending their taxes, it could bring the average even lower.
In order for this to happen demand for gasoline would need to be perfectly inelastic. To have perfectly inelastic demand, consumers need to be willing to pay any price for the good. Meaning, the price of the good itself has no effect on the demand for it. Which, if gas was say $10/gal or $100/gal, surely I’d expect us all to be driving less! Even if you have to drive to get to your place of work, if you’re being paid less than the cost of fuel to get there, it doesn’t make sense to continue to work.
But, say demand was relatively inelastic. In order to see the price decrease oil and gas companies choose to keep their markups consistent. A markup is the difference in price between what the good sells for, and the cost of all the inputs for the good. So things like crude oil, labor, marketing, etc. all go into the price of a gallon. A graph of this below:
A note here that refining costs seemed to reverse trend coincidently when I left the industry… so I’m not saying I was really good at my job in downstream refining but I’ll let you draw your own conclusions :)
This data assumes 0 markup, meaning 100% of the price per gal is attributed to the 4 categories above. This seems unlikely. Just like the refining cost was highly unlikely to be near 0 for a few months in 2020, employees were still being paid and machines operated. So, I’d assume the markup (or loss in the case of 2020) is included in the Refining category. If the markup were to be consistent, I’d expect a lot less variability in Refining costs.
So, with the federal gas tax holiday, if demand stayed the same and markups were consistent (highly likely that neither would happen), we would see this temporary, $0.18 price decrease from $5/gal to $4.82/gal. In reality, the price might not even decrease at all, as oil and gas companies choose not to pass on those savings to the consumer. They might simply charge the same price and pocket $0.18 per gallon.
I’d imagine it would be unwise of them to do so, since it may provide ammunition for the “Greedflation” narrative some politicians are trying to push, suggesting that corporations are taking advantage of strong aggregate demand and relative inelasticity of consumers due to restricted spending during the pandemic. This idea may have merit, but my response would be not to punish companies for making money (which they are designed to do), but let them charge higher prices. Higher prices lead to increased profits which leads to expansion which leads to better pay to attract new talent and grow the business. If consumers are being proportionally hurt by it, then demand will decrease.
This poses the problem for consumers at the lowest end of the income distribution, which, are disproportionately hurt by energy and food inflation than high earners. But if we are willing to subsidize fossil fuel companies via a federal gas tax holiday, why not simply give that money to those at the lowest end of the distribution who’s demand is likely to be the most inelastic for energy anyway?
Tangent aside, if it is likely that oil and gas companies would temporarily decrease prices due to the federal gas tax holiday, then what? Well, with gas being cheaper for everyone, demand would likely increase. If this were to happen, it would only exacerbate the problem since we are already facing a supply crunch due to the war in Ukraine. This would drive prices straight back up, and only make the problem worse as there is more demand that the supply is trying to meet.
If I haven’t convinced you to this point that the federal gas tax holiday would be a bad idea- in 2008 when gas prices were high a petition of 321 economists wrote an open letter condemning the idea:
SUNDAY, MAY 4, 2008
OPEN LETTER FROM ECONOMISTS OPPOSING THE GAS TAX HOLIDAY
321 SIGNERS AND COUNTING
ANY ECONOMIST INTERESTED IN ADDING THEIR NAME TO THIS STATEMENT PLEASE EMAIL gastax08@gmail.com WITH NAME AND AFFILIATION
An Open Statement Opposing Proposals for a Gas Tax Holiday
In recent weeks, there have been proposals in Congress and by some presidential candidates to suspend the gas tax for the summer. As economists who study issues of energy policy, taxation, public finance, and budgeting, we write to indicate our opposition to this policy.
Put simply, suspending the federal tax on gasoline this summer is a bad idea and we oppose it.
There are several reasons for this opposition:
First, research shows that waiving the gas tax would generate major profits for oil companies rather than significantly lowering prices for consumers.
Second, it would encourage people to keep buying costly imported oil and do nothing to encourage conservation.
Third, a tax holiday would provide very little relief to families feeling squeezed.
Fourth, the gas tax suspension would threaten to increase the already record deficit in the coming year and reduce the amount of money going into the highway trust fund that maintains our infrastructure.
Signers of this letter are Democrats, Republicans and Independents. This is not a partisan issue. It is a matter of good public policy.
So what does one do? The root of the problem is that demand is a lot higher than supply. So we can increase supply. Either domestically through proven oil reserves or removing the economic sanctions put on Russia. This isn’t great from a humanitarian standpoint or environment standpoint by promoting drilling, and recently it hasn’t been great for the environment in general. Germany is restarting coal fired power plants (super-polluters) due to decreased natural gas capacity coming from Russia, and the SCOTUS is likely to throttle EPA’s ability to regulate emissions from the power sector.
So if we don’t want more supply, we can decrease demand. This may look like promoting work from home as many companies now have the infrastructure for it, taking fewer vacations, or transitioning more quickly to more efficient cars or public transit. The IEA was on the money with its recommendations to decrease demand in order to avoid relying on Russia energy.
In this post I wanted to consider more broadly what this tax holiday is an example of. I see it as a red herring. A distraction from the actual problem, and a play to gain voters for mid-terms in November. How the President even got associated with raising gas prices in the first place I don’t know, but this argument also doesn’t make much sense. Clearly from the graph above the biggest contributor to gas prices is the price of crude oil, which the President has no power over. Again, this is a form of red herring just on the opposite end of the aisle.
Another example of a red herring in the energy industry is radiation from nuclear power plants causing cancer.
The radiation figure above is based on a UN study for trough CSP, a specific type of solar plant rather than just panels. I suspect this rumor may have propagated similar to the the oil industry convinced us all that any plastic can be recycled.
In general, these red herrings are showing there is a need for more transparency in tracking political movements, in order to parse out the truth from the political agenda. So, I have another free startup idea for those of you out there at home keeping track: an app which tracks political rhetoric and compares to actual legislative items that politicians pass.
It would ideally look something like this: I open the app and answer a short survey about issues that are important to me, and include my zip code. I’d then be sent a report of current legislators at the local, state, and federal level, and how they match to my preferences. Then, it shows the politicians history and statements for or against the issue, and develops a score based on how moderate or extreme the person is on each. This would allow me the user, to save time researching before going to the polls, as well as keep politicians accountable via a built in system to send petitions for or against new legislation that relate to my views. It would also track donorships: if Ted Cruz receives $800,000 from the oil and gas industry it would also show that, making me question his motives. We need politicians to represent and listen to us more than industry. We simply need more truth and less theatre if we ever want to have justice and equality as we progress as a nation.
Tbh the more I think about this one the more I disagree here that the tax holiday is a bad idea.
I definitely have not been happy with some of the Democrats rhetoric around 'greedflation'. I disagree with this because I do believe that there is enough competition among gas stations that prevent price gouging. I don't believe collusion is happening or even possible. Consumers also have technology now such as the GasBuddy app that helps keep the market competitive.
If you agree that the market is competitive and demand is relatively inelastic then doesn't removing a gas tax result in a partial benefit to consumers? Sure, you do also expect some demand increase and benefit to producers but as you point any remaining benefit that goes to consumers especially helps low-income families. It's a regressive tax to begin with, so why not take the opportunity to get rid of it and replace it with something more progressive down the line?
I do agree that the Federal gas tax holiday is a red herring with regards to lowering wholesale prices globally (because it removes an artificial constraint on demand), but I do believe that it helps low-income families domestically in the short-term. A far more egregious red herring I heard this week is calls to ban US crude oil exports! We need a piece from you on differences in crude qualities and the interconnectedness of the global oil market! I'd be interested to know why other solutions such as repealing the Jones Act (which I believe would help prices domestically) have not been floated as much.
Wouldn’t allowing drilling for more oil in the USA and allowing the pipeline allow for the cost of Crude oil to be lower?