Pure Pedantry

(Keeping with our trend towards a week of economics — see here and here — I have another post where I attempt to talk above my pay grade.)

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.

Comments

  1. #1 Steve
    April 30, 2008

    Absolutely so. I think the candidates know all this and don’t care. High oil prices make things suck – believe me, when it costs $50 or more to put 13 gallons of gas in my vehicle, it sucks – only higher prices will generically reduce our gas consumption. When gas is this high, my employer actually listens when I say things like “We can reduce the cost of our commute by 20% by telecommuting 1 day a week.” It makes me think twice before I jump in the car and run to Microcenter.

    High gasoline and oil prices also increase the market viability of alternatives, making them economically more sensible. Higher energy prices have a lot of beneficial impacts ‘over the long haul’.

  2. #2 Joseph
    April 30, 2008

    personally, I’d recommend *higher* taxes on gas, and imposing a 55-mph national speed limit again. The latter would start the relief *now* and the former would do it in the long run.

    Unfortunately, this also would make me totally unpopular with the nation.

    Gas should’ve been $4/gallon back in the 90’s, if not before.

  3. #3 mrgeek
    April 30, 2008

    You’re missing the incredible genius behind this plan — it’s a brilliant way to reduce the jobless rate and cut our CO2 emissions. Cutting the gas tax will promote more driving this summer. Since cutting the gas tax will also dramatically cut into the highway trust fund, the bridges and highways that all these cars and trucks will be driving on will fall into even worse states of repair, causing horrendous accidents. New jobs will be created hauling all the vehicle bits off what’s left of the highways, and with all the bridges out, nobody will be driving anywhere — dramatically lowering our CO2 emissions.

    It’s just another example of our brilliant leaders in Washington looking out for the little guy.

  4. #4 Barn Owl
    April 30, 2008

    I’m not optimistic about the “higher gas prices will reduce consumption and driving” scenario. I think most people will just whip out their credit cards to pay for gas, whatever the price per gallon, and pretend that debt doesn’t exist, or will be magically erased somehow at some unspecified time in the future. My grandparents’ generation was very good at economizing, belt-tightening, “making do”, or whatever you want to call it, but after WWII, we Americans have pretty much sucked at any sort of financial self-discipline.

  5. #5 shonny
    April 30, 2008

    Are the US motorists subsidised by the rest of the world?
    Just curious, because EVERYWHERE else petrol (‘gas’) prices are way above US prices.
    Australia $1.50 per litre = USD 5.80/US gallon
    Norway (oil producing country) NOK 12/litre = USD 9.20/US gallon.
    Maybe Norwegian prices at the pump would get some sense into US motorists??

  6. #6 Joseph
    May 1, 2008

    shonny; china, for example, has price controls on gas that keep it artificially low. Also translating to USD is misleading due to the weak dollar; a better comparison might be as percent of monthly earnings.

    But yes. In general, gas in the US has been too cheap too long.

  7. #7 Dunc
    May 1, 2008

    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.

    Haven’t you heard? They’re also going to introduce a bill to repeal the laws of supply and demand, so everything will be fine. Next week they’re going to promise to look into repealing the first law of thermodynamics.

  8. #8 Levi
    May 1, 2008

    Next week they’re going to promise to look into repealing the first law of thermodynamics.

    <sarcasm>Maybe they can repeal the 2nd law so evolution will work.</sarcasm>

  9. #9 Andrew Dodds
    May 1, 2008

    My last fillup was around $160 equivilent..

    Here in the UK, high prices over a couple of decades (Currently circa $9/gallon) have lead to modest improvements – I average around 40mpg from a diesel which is by no means small, and I believe that the lastest small diesels are getting ~70mpg.

    OTOH, it’s a quandry for those that regard Carbon taxes as a good idea than an effective tax of something like 200% has lead to an improvement in efficiency of only 50%.

  10. #10 Ian
    May 1, 2008

    Clinton evidently plans to recoup the gas revenue loss by taxing oil company windfall profits (like Exxon’s record $40 billion or whatever it was last year), so this would seem to negate point 1 in your third paragraph, but it doesn’t rob you of the other points.

    The fact is that we in the US have been spoiled rotten for too long and been blinded to the realities of both using and wasting oil. While no one likes the high prices, we’d better get used to them!

  11. #11 ponderingfool
    May 1, 2008

    Clinton evidently plans to recoup the gas revenue loss by taxing oil company windfall profits (like Exxon’s record $40 billion or whatever it was last year), so this would seem to negate point 1 in your third paragraph, but it doesn’t rob you of the other points.
    **************************

    Which means Clinton’s proposal is great politics but accomplishes nothing one way or another. She gets to look like she is helping consumers while appearing to get “tough” on oil companies. This blunts McCain on the former and allows her to go on the offensive on him in that regard. Obama she can go after by not caring about the average American (i.e. playing on he is an elitist listening to those eggheads in academia who don’t “understand” the world outside of the ivory tower).

  12. #12 sailor
    May 1, 2008

    You could say that Bush has two great achievments. One is getting fuel up (it should be much higher, the gas tax should really pay for the oil wars). The other is ensuring that either a woman or a black man have an excellent chance of being the next president.

  13. #13 Opisthokont
    May 2, 2008

    I agree with just about everything that has been said here, with one exception: the 55-mph speed limit. In a country as large as the USA, such a speed limit is impractical, and with a great many cars (cars, note — not SUVs and pickup trucks) there is little if any decrease in fuel economy between 55 and 70 mph. Vehicles in Europe manage higher average fuel economy in spite of higher speed limits. Since the subject of windfalls has been brought up, the 55-mph speed limit is just that for the insurance companies, who are eager for any excuse to raise their subscribers’ rates.

  14. #14 Kayla
    May 2, 2008

    I too think this “holiday” is ridiculous. The US is so oblivious to the fact that they are contributing hugely to this problem (global warming) and, from what I see, think they are invincible to the consequences (not everyone, but MANY). As shonny mentioned, other countries pay way more for gas up-front. I don’t completely understand the situation, but I think it has to do with not hiding certain fees in other taxes, such as state and federal, for things like protecting our oil reserves. It is a fact – our nation is a selfish one. I really think we need to concentrate on more options for public transportation and reduce the amount we drive, eliminate the number of unnecessary trips we make. I admit, I am selfish too. I love being able to drive my car to work. But, if we are going to fix this problem, I would be willing to sacrifice driving my car every day and opt for public transportion or riding my bike. However, we are a long way from here. Especially for rural areas. But a “gas tax holiday” is definitely not the answer.

  15. #15 Darth
    May 2, 2008

    I agree, in fact let me go one step further. Sales taxes should be tripled on all consumer products. As a society we need to drive down demand and reduce economic activity in order to save the environment. Sustainability IS prosperity.

  16. #16 kenga
    May 2, 2008

    In a country as large as the USA, such a speed limit is impractical, and with a great many cars (cars, note — not SUVs and pickup trucks) there is little if any decrease in fuel economy between 55 and 70 mph.

    That statement is directly contradicted by my experience. I see approximately a 10% loss at 70mph vs 55mph in my late model 4-cyl car.
    It’s a little bit worse in the case of my motorcycle – which is carbureted instead of fuel-injected. And has a much lower weight/power ratio. And still gets much better fuel economy.

  17. #17 John M
    May 2, 2008

    Here’s an idea. The math is not very hard. Check my facts at: http://www.census.gov/prod/1/pop/p25-1129.pdf and http://www.reuk.co.uk/Nevada-Solar-One.htm
    The government should have subsidized the building of solar power plants instead of spending $528Billion on the Iraq war.
    The Nevada Solar One power plant went online with 64MegaWatts of power in 2007. Enough for about 40,000 households at a total project cost of about $240Million (between 9 and 13 cents per kWh). Had they loaned/subsidized that war money to the energy companies at 80%, they could have built plants to generate at least 176GigaWatts, probably more at a cost of about 7 cents per kWh which is very competitive with current greenhouse producing prices. This is enough energy to supply 110 Million homes (slightly more households than are currently in the US).
    This would have been a good start at moving to a solar electric/hydrogen economy. Nevada currently has enough usable land for about 600GigaWatts of solar power. While it would be impractical to try to supply the whole country with electricity directly from one state, the electricity could be used to convert water to hydrogen fuel. BTW, 7 to 8 cents per kWh is roughly equivalent to around $4 per gallon of gasoline. That would have been high 5 years ago, but it looks like we are about to sail right past that.

  18. #18 Pablo
    May 3, 2008

    Why don’t people just listen to the gas companies? They keep saying that the price of gas is driven by supply and demand and market forces. That doesn’t mean “taxes”.

    The short answer is, the oil companies have discovered that they can charge $4/gallon for gas and Americans will pay it (actually, I suspect they have always known it, but needed the marketing ability to pull it off without bringing in the wrath of government controls). Therefore, whether the gas tax is $0.20 or $0.50 or $0.00, they will still be charging $4. The only question left is who gets the money?

    As I said, the dumb thing is that the oil companies won’t deny it. They’ve said it for years that it is a market thing. And in the end, they’ve got the American public by the short and curlies.

  19. #19 Michael
    May 3, 2008

    The short answer is, the oil companies have discovered that they can charge $4/gallon for gas and Americans will pay it

    Oil companies cannot set those types of precise prices for gas at the pump. Most of the money is made “upstream” which means profit off a barrel of oil…”Downstream” there is a less margin of profit which is referred to as gas…

    Here is the problem with rising gas prices. Production for US crude is the lowest it’s been since 1949. One of the biggest areas of decline is the Alaska pipeline which hasn’t been pumping out as much oil as it use to. Oil companies are at an all time low in replacing the oil they pumped out of the grown which is currently at 82 percent a year. It could go lower as production declines. The harsh reality is that oil production from the 70’s is running dry.

    Even if we could drill for more oil production, the US refineries are up to capacity. We haven’t built a refinery since 1976. Foreign oil isn’t exactly on the upward trend either.

    Rising demand from Africa, China, India, have played a major role in the higher prices at the pump. In Africa all debt was forgiven and their industry boomed resulting in an increase for oil. Companies are just in love with making goods in China, but it’s high population have been buying cars which increases the demand for oil. More people in India are driving more than ever before in their history.

    Do you really think Oil companies want to make less oil with the price barrel being so high? No, this is why they are doubling back in Alaska where they are allowed to search for oil to see if they missed any.

    I agree, a gas tax will not solve the ever declining production of oil with a higher demand for oil related products resulting in a painful price at the pump.

  20. #20 Eric
    May 3, 2008

    “TAANSAFL, dammit.”

    That was my exact quote to my wife on the subject. However, when it comes to politicians, they know we love lower taxes and to also have any program that might benefit in someway. Instead of addressing the complexities of a situation, it is much easier to pander to the unthinking voter (most of us, unfortunately).

    And that is why politics sucks.

  21. #21 Eric
    May 3, 2008

    “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.”

    I missed this first time through, although it is exactly the point (in a tangential manner). The current energy infrastructure (oil, cars, etc.) just isn’t up to the task of providing the energy required (wanted) by the amount of the world’s population that now has the economic resources to get it (think of India and China). This means that there needs to be energy resources that are independent of CO2 output, such as nuclear, wind (NOT ethanol), solar and anything else some crazy physicist/engineer can come up with.

    Energy rationing isn’t going to work, unfortunately, some times the only solution is new technology to solve scalability problems (in this case the energy needs of 6 billion+ people).

  22. #22 Coin
    May 4, 2008

    Hm, bit of a late response, but something I’m curious about:

    We need to lower our oil consumption, and high prices are the most effective means for doing so.

    Is this really true?

    I’ve not got much background in economics. I’ve actually taken, like, one microeconomics class, and that was almost entirely about pricing and demand. “Supply elasticity” is a concept that makes sense but isn’t something I’m much familiar with. Ditto “tax incidence”. So I’m not very well equipped to understand the economics of this issue.

    Anyway, something we did cover is demand elasticity. And really, if I’m not remembering horribly wrong, I seem to remember that our textbook’s example (literally) of a commodity to which demand is inelastic was gasoline. Now, given, I took this class back when the idea of a “price fluctuation” in gas meant “between seventy cents and a dollar”, not “between one dollar and four”, but still, this makes sense. It doesn’t seem like demand for gas would be particularly responsive to raises in price. Is it?

    Me, I need gas because I need to go places, and I need to go to those places no matter what the gas costs; if gas suddenly is exorbitantly expensive, then this means that I will have to be going without other things, because I’m not going to be able to get the choice of not driving to work. The only thing I could possibly do as a result of sustained high gas prices is, for example, moving so that I don’t have to drive so much. But this is itself an expensive and difficult act, and only works assuming I don’t at any point in the future change jobs (thus potentially negating a move to be near work). I’m not sure why things would be different for anyone else. I guess maybe high or low gas prices could influence people to pick cars with more or better mileage, but gas these days is too expensive even if you have really good mileage.

    Basically, it seems somewhat unlikely to me that sustained high gas prices would significantly lead to decreased gas consumption, unless electric cars suddenly become widely available or something. And although the gas holiday sounds like a bad idea for other reasons, it seems REALLY unlikely to me that a price fluctuation from $3.90 to $3.70 would significantly alter the amount of demand (although your point is surely a good one that consumers are more able to change the amount of gas they consume than refineries are able to change the amount they produce).

    Is there reason to believe that fluctuations in gas price alter gas usage? Like, actual data or studies or anything? Do we know what gas demand relative to the size of the population has done over the last eight years as the price of gas has increased? Is there something important I am missing?

    Thanks!

  23. #23 jefrir
    May 4, 2008

    @Coin

    Higher prices may influence people to use other forms of transport, to carpool, or to walk. For example, when traveling between home and uni, I have a choice between the car and the train. Currently, if I’m on my own the price is about the same. An increase in gas prices would make it easier for the train to outweigh the car.
    Of course, for this to work properly, the taxes ideally need to go into subsidizing and improving public transport. In this city, public transport already beats cars for local travel because it is quick, frequent, convenient and reasonably cheap.
    Many people will still drive needlessly, whatever the cost, but hopefully we can reduce that number.

  24. #24 Michael Kremer
    May 4, 2008

    @Coin
    Adding to jefrir:

    In the long run, artificially low gas prices have contributed to the construction of a society in which you need a car to go places — a society in which everyone lives in houses with big yards, miles away from their places of employment, and in which grocery store, job, place of worship, home etc, are all too far away from one another for walking and too far from sources of reliable public transport to allow for any alternative to a car. I happen to live (fortunately) in an urban neighborhood where I am within a five to fifteen minute walk from most of the things that I need to go to on a daily basis (including work), and a quick bus or train ride from downtown. I live in an apartment in a small building, with a small yard, but with several parks nearby. I have a car and use it about twice a week, mostly for transporting teenagers to things outside of our neighborhood. I am lucky, in the US, in being able to live this way. But higher gas prices might, in the long run, lead to the revival of more neighborhoods like mine

  25. #25 Richard Simons
    May 4, 2008

    Part of the problem in North America is that current planning policy makes it virtually impossible to provide employment for people within walking distance of their home. Large blocks of land are zoned to be exclusively for residential, business or industrial use, yet many businesses and some industries are compatible with housing.

    In addition, suburbs are generally designed with the assumption that people will have cars and not use public transit. It seems shopping malls are planned to be inaccessible to public transit (to keep out the riffraff). Where provision is made, it is often unsatisfactory. A major shopping mall in Winnipeg, for example, has stands for buses to a wide variety of places but to reach them you have to cross a road to a parking area. There are small unheated glass shelters with no doors, suitable for California but woefully inadequate for a prairie winter.

    There is unlikely to be much change in the use of cars until there are changes to public policy, with legislation if necessary, to improve access for people who use other means of getting around.

  26. #26 Paul Ojanen
    May 4, 2008

    As others have already stated, this problem is long term. The 50 year hydrocarbon auto orgy caused our society to be ridiculously designed. There are entire communities, such as the Northwest suburbs of the twin cities, where there no sidewalks. No alternative means of transport is efficient, because the designs themselves were hodgepdoges of new road followed by real estate speculators; noone was allowed to say ” what will we have in 20 years?”…or ” should we really asphalt over our best agricultural soil for a kmart parking lot and 4000 houses?”. Anyone who did was ostracized like a 1950’s labor activist. They cannot, and do not want to see the truth. We are trapped in a re-engineering nightmare with massive non-road infrastructure needs, the same auto based development process occurring, and at all costs, both for structural and two generations of cultural reasons, must, must keep the cars moving. The problem is it cannot happen, for no fuel or technical fix will be like cheap and easy Arab light crude. The final question must be…and never gets asked…Do we really want the world to look like Coon Rapids or Andover?..Is that it? The pinnacle of society is an aging strip mall?

  27. #27 martin cardinal
    April 27, 2011

    I have heard of all of the problems with the gas on the news but what really bugs me is the fact that the prices increase to six dollars by the end of this year. the whole point is to go green. I know you hear it all the time but it is the truth. We are using ten times the amount of oil that we discover. Try riding a bike. And maybe even walk. Buy a hybrid or invent something. Save the world and save your money in the long run.

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