I am as unhappy as anybody about high oil prices making everything on Earth expensive, but I am getting a little annoyed by the Presidential candidates glib statements about how the intend to make it better.
Both Clinton and McCain have come out for a gas tax holiday over the summer. This is a horrible idea for at least two reasons. (1) It will just be a wind fall for oil producers. (2) We need to lower our oil consumption, and high prices are the most effective means for doing so.
Reason #1: As Greg Mankiw points out, removing the gas tax will be a windfall for refineries, not for consumers. This is because the short-term supply of gas is relatively inelastic, so the tax incidence is largely on producers rather than consumers already. (This is pretty clear to anyone who has taken econ 101 as is amply evidence by the fact that I actually understand it.)
Let me unpack that statement. Particularly during the summer, refineries are operating close to maximum capacity. This means that even when prices increase substantially, there is a relatively small increase in output — they have no more output to give. When a tax is imposed, it places a wedge between what consumers pay and what producers get for their product. Now the producers would very much like to pass the entirety of that tax onto consumers in the form of higher prices. However in this case they can’t because the consumer’s have a greater ability to leave or stay in the market than the refineries do. The refineries are going to make gas at maximum capacity regardless; the consumers can decide not to drive and take public transportation. Therefore, the refineries can’t raise prices too much as a result of the tax because people would just not buy gas.
In econ speak, this means that because the supply of gas is inelastic relative to the demand for gas, the tax incidence falls mostly on the producers rather than the consumers. The producers pay more of the tax than the consumers do. Further, it is not going to lower the price much because the refineries were already bearing most of the price increase.
Viewing this in reverse, if we remove the tax that money isn’t going to go to consumers. It will go back to the producers who were paying most of the tax in the first place. So unless McCain and Clinton have a vested interest in corporate welfare for oil refineries, this is a bad idea. It isn’t going to put money back in people’s pockets.
Reason #2: From a long-term point of view, we need high gas prices.
TAANSAFL, dammit. If it is indeed our intention to reduce oil consumption and fight climate change, then we are certainly not going to do it by lowering oil prices. You can argue whether it is wiser to have carbon credits or a carbon tax or carbon quotas. (I fall on the side of a carbon tax. The issue is discussed here.) But you can’t argue that whatever we do is going to be utterly without pain.
Virginia Postrel reiterates this point:
It’s infuriating how all three presidential candidates prattle on about the need to fight global warming while also complaining about the high price of gasoline. The candidates treat CO2 emissions as a social issue like gay marriage, with no economic ramifications. In the real world, barring a massive buildup of nuclear plants, reducing carbon dioxide emissions means consuming less energy and that means raising prices a lot, either directly with a tax or indirectly with a cap-and-trade permitting system. (Alternatively, the government could just ration energy, but fortunately we aren’t going in that direction.) The last thing you’d want to do is reduce gas taxes during the summer, as John McCain has proposed. That would just encourage people to burn more gas on extra vacation trips–as any straight talker would admit. (Emphasis in original.)
A long period of high oil prices will do more for lowering demand for gasoline in this country than anything the government could possibly do. If you want to fight global warming, you have to admit that belt tightening is involved.