The Case Against McCain’s Tax Free Gasoline Holiday
April 17, 2008
John McCain’s proposal for creating a “tax free gasoline holiday” is laughably atrocious. I realize that my opening sentence just offended 99 out of 100 average Americans, but allow me to present my argument and take a few moments to think about it before automatically concluding that I’m totally off my rocker.
The economics of gasoline production are painfully complicated and I admit, I possess far from a complete understanding of it. That said, I feel that my knowledge of the subject is strong enough to draw a few basic conclusions. Many Americans don’t know that gasoline and crude oil are distinct commodities. Crude oil is pulled up out of the ground and by itself, is relatively useless. Crude needs to be converted into usable products before we consume it for energy. Oil giants like Valero, Chevron, and BP operate refineries that take crude oil and refine it into gasoline, diesel, kerosene, asphalt, and other useful products.
As demand for products like gasoline grows, refineries take more crude oil and crank out more refined products. The problem is that there is a finite capacity at which these refineries can produce, and we’ve just about reached it. That means that as demand for gasoline increases supply is unable to keep up the pace – creating a supply shortage and driving up prices. Think about it, the reason why gasoline prices are historically higher in the summer than in the winter is because Americans consume more gasoline in the summer; refiners, unable to keep up with the demand, simply raise their prices to compensate for the shortage. In the winter, refiners start operating below capacity again and traditionally supply/demand equilibrium can be reached.
So what happens when you eliminate the federal gasoline tax between Memorial Day and Labor Day as McCain proposes? Well… since demand is high and drivers are willing to pay the (arguably) absurdly high gasoline prices, and since refiners are maxing out capacity, when the gasoline tax is eliminated, refiners will simply raise their prices to fill in the gap. Effectively, revenue that was previously going to the federal government will simply shift to the bottom lines of these corporations. If McCain’s goal is to pad the profits of oil refiners, then his policy is great; if his goal is to help ailing consumers, then his policy is terrible. Ironically enough, politicians in this country love to bash oil companies for windfall profits and make empty promises to supply Americans with gasoline at below market prices, and their policies tend to do exactly the opposite.
Of course, there are other negative consequences. America’s bridge and road infrastructure is decaying at an alarming rate. Where does a substantial portion of the money for bridge and road repair come from? You guessed it, the federal gasoline tax. And don’t forget the fact that burning carbon is incredibly bad for the environment; but that is a topic worthy of its own discussion, and not necessary to prove my point that McCain’s policy is a disaster.
Why not just build more refineries in the United States, you might ask? The answer is the classic “not in my backyard” problem. Oil refineries are big, dirty, polluting machines. Nobody wants to live near an oil refinery, and as far as politics and economics goes, the well being of a few frequently outweighs the well being of many. Why? Because 5000 residents in small-town Texas, who will have to live near the refinery and whose lives might ultimately be destroyed because of it, care significantly more about keeping the refinery out than the millions of Americans who will save pennies on their next fill-up. These small town Texans will do everything in their power to lobby congress and local government to keep the refinery away from their homes; the consumers who would benefit from the refinery will lobby very little (if at all).
For a long time I’ve harped on this blog that gasoline prices are too low and we should raise gasoline taxes, not slash them. I stand by that contention. It certainly isn’t a popular position, but it is necessarily for the long term stability of our country, which due to half-baked policies like McCain’s, is growing increasingly unstable. The reason that gasoline taxes work is that it increases the cost of driving at the margin. Each time you get on the road you have to ask yourself whether or not that extra mile is worth it, increasingly the answer is “no” – and that is exactly the point. It doesn’t matter how much you love your big bad truck, the world is changing in a way that makes driving that guzzler unsustainable.
If you believe in markets, you should be in favor gasoline taxes. Some might say such a statement contradicts itself; after all, free market capitalists hate taxes. However, this is only true in a world free of externalities. Realistically, given the external costs of consuming gasoline, the real cost of a gallon of gasoline is significantly higher than what we pay at the pump. To many, this concept goes in one ear and out the other, but for Harvard economist Greg Mankiw and dozens of academic economists who support gasoline consumption taxes, it makes perfect sense. Gasoline taxes bring the price we pay closer to the fair market price (factoring in external costs). If you believe in markets then you already know that over time we will come up with solutions to rising energy costs; the question is whether the transition will gradual or painfully abrupt. Slashing gasoline taxes and encouraging dangerous behaviors like McCain proposes will make the ultimate transition much harder and more painful than anything we’ve experience thus far.
The economics of gasoline production are painfully complicated and I admit, I possess far from a complete understanding of it. That said, I feel that my knowledge of the subject is strong enough to draw a few basic conclusions. Many Americans don’t know that gasoline and crude oil are distinct commodities. Crude oil is pulled up out of the ground and by itself, is relatively useless. Crude needs to be converted into usable products before we consume it for energy. Oil giants like Valero, Chevron, and BP operate refineries that take crude oil and refine it into gasoline, diesel, kerosene, asphalt, and other useful products.
As demand for products like gasoline grows, refineries take more crude oil and crank out more refined products. The problem is that there is a finite capacity at which these refineries can produce, and we’ve just about reached it. That means that as demand for gasoline increases supply is unable to keep up the pace – creating a supply shortage and driving up prices. Think about it, the reason why gasoline prices are historically higher in the summer than in the winter is because Americans consume more gasoline in the summer; refiners, unable to keep up with the demand, simply raise their prices to compensate for the shortage. In the winter, refiners start operating below capacity again and traditionally supply/demand equilibrium can be reached.
So what happens when you eliminate the federal gasoline tax between Memorial Day and Labor Day as McCain proposes? Well… since demand is high and drivers are willing to pay the (arguably) absurdly high gasoline prices, and since refiners are maxing out capacity, when the gasoline tax is eliminated, refiners will simply raise their prices to fill in the gap. Effectively, revenue that was previously going to the federal government will simply shift to the bottom lines of these corporations. If McCain’s goal is to pad the profits of oil refiners, then his policy is great; if his goal is to help ailing consumers, then his policy is terrible. Ironically enough, politicians in this country love to bash oil companies for windfall profits and make empty promises to supply Americans with gasoline at below market prices, and their policies tend to do exactly the opposite.
Of course, there are other negative consequences. America’s bridge and road infrastructure is decaying at an alarming rate. Where does a substantial portion of the money for bridge and road repair come from? You guessed it, the federal gasoline tax. And don’t forget the fact that burning carbon is incredibly bad for the environment; but that is a topic worthy of its own discussion, and not necessary to prove my point that McCain’s policy is a disaster.
Why not just build more refineries in the United States, you might ask? The answer is the classic “not in my backyard” problem. Oil refineries are big, dirty, polluting machines. Nobody wants to live near an oil refinery, and as far as politics and economics goes, the well being of a few frequently outweighs the well being of many. Why? Because 5000 residents in small-town Texas, who will have to live near the refinery and whose lives might ultimately be destroyed because of it, care significantly more about keeping the refinery out than the millions of Americans who will save pennies on their next fill-up. These small town Texans will do everything in their power to lobby congress and local government to keep the refinery away from their homes; the consumers who would benefit from the refinery will lobby very little (if at all).
For a long time I’ve harped on this blog that gasoline prices are too low and we should raise gasoline taxes, not slash them. I stand by that contention. It certainly isn’t a popular position, but it is necessarily for the long term stability of our country, which due to half-baked policies like McCain’s, is growing increasingly unstable. The reason that gasoline taxes work is that it increases the cost of driving at the margin. Each time you get on the road you have to ask yourself whether or not that extra mile is worth it, increasingly the answer is “no” – and that is exactly the point. It doesn’t matter how much you love your big bad truck, the world is changing in a way that makes driving that guzzler unsustainable.
If you believe in markets, you should be in favor gasoline taxes. Some might say such a statement contradicts itself; after all, free market capitalists hate taxes. However, this is only true in a world free of externalities. Realistically, given the external costs of consuming gasoline, the real cost of a gallon of gasoline is significantly higher than what we pay at the pump. To many, this concept goes in one ear and out the other, but for Harvard economist Greg Mankiw and dozens of academic economists who support gasoline consumption taxes, it makes perfect sense. Gasoline taxes bring the price we pay closer to the fair market price (factoring in external costs). If you believe in markets then you already know that over time we will come up with solutions to rising energy costs; the question is whether the transition will gradual or painfully abrupt. Slashing gasoline taxes and encouraging dangerous behaviors like McCain proposes will make the ultimate transition much harder and more painful than anything we’ve experience thus far.
