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Friday, May 12, 2006

Paul Krugman: Gas Tax Follies

Staying with the topic of the previous post, oil policy, when George Bush was a candidate for president in 2000, he proposed a reduction in gasoline taxes as a solution to high gasoline prices, and similar calls have been heard at the federal level. Many states are currently entertaining serious proposals to reduce gasoline taxes as well, at least temporarily. Here's a rerun of Paul Krugman's March 15, 2000 column evaluating Bush's proposal to lower gasoline taxes, an analysis that is equally applicable today:

Gasoline Tax Follies, by Paul Krugman, Commentary, New York Times, March 15, 2000: Teachers of economics cherish bad policies. For example, if New York ever ends rent control, we will lose a prime example of what happens when you try to defy the law of supply and demand. And so we should always be thankful when an important politician makes a really bad policy proposal.

Last week George W. Bush graciously obliged, by advocating a reduction in gasoline taxes to offset the current spike in prices. This proposal is a perfect illustration of why we need economic analysis to figure out the true "incidence" of taxes: the people who really pay for a tax increase, or benefit from a tax cut, are often not those who literally fork over the cash. In this case, cutting gasoline taxes would do little if anything to reduce the price motorists pay at the pump. It would, however, provide a windfall both to U.S. oil refiners and to the Organization of Petroleum Exporting Countries.

Let's start with why the oil cartel should love this proposal. Put yourself in the position of an OPEC minister: What sets the limits to how high you want to push oil prices? The answer is that you are afraid that too high a price will lead people to use less gasoline, heating oil and so on, cutting into your exports. Suppose, however, that you can count on the U.S. government to reduce gasoline taxes whenever the price of crude oil rises. Then Americans are less likely to reduce their oil consumption if you conspire to drive prices up -- which makes such a conspiracy a considerably more attractive proposition.

Anyway, in the short run -- and what we have right now is a short-run gasoline shortage -- cutting gas taxes probably won't even temporarily reduce prices at the pump. The quantity of oil available for U.S. consumption over the near future is pretty much a fixed number: the inventories on hand plus the supplies already en route from the Middle East. Even if OPEC increases its output next month, supplies are likely to be limited for a couple more months. The rising price of gasoline to consumers is in effect the market's way of rationing that limited supply of oil.

Now suppose that we were to cut gasoline taxes. If the price of gas at the pump were to fall, motorists would buy more gas. But there isn't any more gas, so the price at the pump, inclusive of the lowered tax, would quickly be bid right back up to the pre-tax-cut level. And that means that any cut in taxes would show up not in a lower price at the pump, but in a higher price paid to distributors. In other words, the benefits of the tax cut would flow not to consumers but to other parties, mainly the domestic oil refining industry. (As the textbooks will tell you, reducing the tax rate on an inelastically supplied good benefits the sellers, not the buyers.)

A cynic might suggest that that is the point. But I'd rather think that Mr. Bush isn't deliberately trying to throw his friends in the oil industry a few extra billions; I prefer to believe that the candidate, or whichever adviser decided to make gasoline taxes an issue, was playing a political rather than a financial game.

There still remains the argument that the only good tax is a dead tax. This leads us into the whole question of whether those huge federal surplus projections are realistic (they aren't), whether the budget is loaded with fat (it isn't), and so on. But anyway, the gasoline tax is dedicated revenue, used for maintaining and improving the nation's highways. This is one case in which a tax cut would lead directly to cutbacks in a necessary and popular government service.

You could say that I am making too much of a mere political gambit. Gasoline prices have increased more than 50 cents per gallon over the past year; Mr. Bush only proposes rolling back 1993's 4.3-cent tax increase.

But the gas tax proposal is nonetheless revealing. Mr. Bush numbers some of the world's leading experts on tax incidence among his advisers. I cannot believe that they think cutting gasoline taxes is a good economic policy in the face of an OPEC power play. So this suggests a certain degree of cynical political opportunism. (I'm shocked, shocked!) And it also illustrates the candidate's attachment to a sort of knee-jerk conservatism, according to which tax cuts are the answer to every problem.

As a citizen, then, I deplore this proposal. As a college lecturer, however, I am delighted.

    Posted by on Friday, May 12, 2006 at 12:15 AM in Economics, Oil, Taxes | Permalink  TrackBack (0)  Comments (12)


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