PETER VAN DOREN, CATO INSTITUTE
When gasoline prices rise, politicians search for a policy response to calm the motoring and voting public. A temporary suspension of federal and state gasoline taxes is one such policy. Would such a suspension reduce prices at the pump? The answer requires knowledge about how much of the gas tax is paid by consumers and how much is paid by producers.
Regardless of whether the legal responsibility to pay the tax falls on producers or consumers, economic theory suggests that the burden of taxes falls on the market participant whose behavior is less responsive to price. If consumer demand is more responsive to price than supply, then more of the tax burden falls on sellers and more of the benefits from a tax holiday accrue to sellers. If consumer demand is less responsive to price than supply, then more of the tax burden falls on consumers and more of the benefits from a tax holiday accrue to consumers. And because the policy proposal is for a temporary rather than permanent suspension of the gasoline tax, we have to answer these questions for a timeframe of months rather than years. Thus, longer term investment decisions affecting supply and consumer decisions about vehicle choice are not part of the analysis.
The classic economic reference on the issue found that the federal tax was split evenly between producers and consumers while state taxes fell almost entirely on consumers. That is for the U.S. as a whole, consumers and producers were both equally insensitive to price and thus shared the tax burden equally and would share the benefits of a tax reduction equally. At the state level, supply can be diverted much more easily to other states in response to state taxes thus state gasoline taxes fell almost exclusively on consumers who would largely benefit from state gasoline tax holidays. A more recent paper on state taxes also found that “gasoline taxes are fully passed through to consumers regardless of season or capacity utilization.”
But during 2000 and 2008, when oil prices were high during election years and talk of gasoline tax holidays was in abundance, prominent economists asserted consumers would not benefit from tax holidays. In 2000 Paul Krugman said “The quantity of oil available for U.S. consumption over the near future is pretty much a fixed number” In 2008 Gregory Mankiw said “What you learn in Economics 101 is that if producers can’t produce much more, when you cut the tax on that good the tax is kept … by the suppliers and is not passed on to consumers.”
How can these various claims be reconciled? The short‐run world supply of gasoline may be very insensitive to price as Krugman and Mankiw asserted. But the supply to the United States may be more price flexible. We can induce gasoline imports by lowering our taxes on gasoline relative to taxes in other countries. Taxes in Europe are already very high, especially on diesel. The average tax on gasoline is €0.56 per liter ($2.33 per gallon) in Europe, and €0.44 per liter ($1.83 per gallon) on diesel. By comparison the U.S. federal tax on gasoline is 18.4 cents per gallon. The higher tax on gasoline in Europe has resulted in greater use of diesel. This fact combined with the inflexible ratio of diesel to gasoline production from crude (in the absence of catalytic cracking in the refining process), results in Europe having excess gasoline that traditionally has been a source of elastic supply for the U.S. market. Lowering our tax makes sending supply to the United States even more attractive to producers.
The same logic applies to state gasoline taxes. The short‐run United States supply of gasoline may be somewhat inflexible to price. But the relative supplies among states are more price flexible. State taxes range from just under 9 cents per gallon in Alaska to about 59 cents in Pennsylvania. Using the variation in state gasoline taxes from 1983 through 2003 Marion and Muehlegger conclude that “gasoline taxes are fully passed through to consumers regardless of season or capacity utilization.” Thus, state gasoline tax holidays would result in lower prices for consumers.
Just because consumers would benefit does not imply that gasoline tax holidays are appropriate public policy. Unless expenditures are reduced, a federal gasoline tax holiday implies more borrowing at the federal level. So do current economic circumstances justify federal borrowing to smooth consumption? My colleague Ryan Bourne has discussed this issue. Borrowing is appropriate when negative supply shocks reduce actual output below normal trend as long as savings occurs when actual output is above trend. Actual output now has almost returned to pre pandemic trend and thus borrowing now would not seem appropriate. Another colleague, Chris Edwards, has documented that states are currently enjoying large surpluses so state tax cuts are certainly viable without borrowing. But gasoline taxes, like all consumption taxes, are more efficient than income taxes and probably less regressive than general consumption taxes. So other tax cuts would have better efficiency and distributional consequences than temporary gasoline tax reductions
Peter Van Doren is Senior Fellow and Editor of the Cato quarterly journal, Regulation, and an expert on the regulation of housing, land, energy, the environment, transportation, and labor. He has taught at the Woodrow Wilson School of Public and International Affairs (Princeton University), the School of Organization and Management (Yale University), and the University of North Carolina at Chapel Hill. From 1987 to 1988 he was the postdoctoral fellow in political economy at Carnegie Mellon University. He received his bachelor’s degree from the MIT and his master’s degree and doctorate from Yale University.