Wednesday, April 30, 2008

A Gas Tax Holiday. Seriously?

Although neither are in office, Senators Clinton and McCain have both endorsed a gas tax holiday this summer, temporarily eliminating the 18¢ per gallon federal excise tax. To his credit, Senator Obama has denounced the holiday as not "an idea designed to get you through the summer" but one "designed to get through an election." It is also bad economics.

The price of fuel during the "holiday" will depend on gas's elasticities of supply and demand. As the short-run supply of gas is fairly constant—in the short-term, supply is fixed as factories (at least over the summer) already run at full capacity—the holiday price of gas will rise to meet the pre-holiday price.

Put another way, given the fixed supply, the price of gas will rise until the quantity demanded drops to meet the quantity supplied. Since the supply is invariant with respect to the tax, the price will not change.

Gas taxes, in the short-term anyhow, do not modify behavior—they just transfer payments from the supplier to the state. Thus, Clinton's version of the holiday, which replaces the gas tax with an offsetting tax on gas producers, asininely accomplishes nothing, but at least her plan is funded.

Let's assume fuel prices do drop. Over the course of the summer, this will save the average driver the cost of about a tank of gas (Obama says half a tank, but my calculation comes out a little higher). Now, if the price drops, the quantity demanded will increase and thus consumption increases (this will bid the price up, as we are now assuming supply is not inelastic, by some amount less than the full 18¢). What happened to yesterday's policy of the day, global warming? And what happened to last year's headliner, crumbling infrastructure, which the gas tax funds?

The proposal is just pandering, but if we really care about stimulating the economy by putting money in consumer's hands, there are better methods than targeted tax credits—for example, cutting marginal income tax rates.