Gas Taxes, Meet Econ 101

McCain and Clinton want a summer cessation of the gas tax. Obama says that it is political pandering and won't help people who are hurting at the pump.

Obama is right.

When the short-term demand for a good is inelastic (meaning: short-term demand is relatively unresponsive to variations in price), as the demand for gasoline is, then a reduction in taxes will lead immediately to increased consumption until the price of gas once again reaches the market-clear price. In other words, if the gas tax is suspended the price will fall. When the price falls, people will buy more gas. Because of the increase in the quantity of gas demanded, the price will go right back up to its pre-tax-suspension level.

However, the quantity of gasoline demanded will increase if the tax is suspended. So such a policy would essentially be a hand-out from taxpayers to oil companies, with the added cost of environmental degradation and an increase in carbon emissions. 

In short, it's a remarkably stupid policy proposal. Obama should be commended for refusing to pander when given such an easy opportunity. He is losing ground in the polls for the sake of intellectual honesty, while Clinton and McCain are gaining cheap points by preying on peoples' ignorance. So good for him, and bad on them.

(P.S. This economic intuition is a fundamental assumption for members of the Pigou Club. If you share their goals and ethical assumptions, then it's easy to share their conclusion that gas taxes should be significantly higher; not lower.)

UPDATE:

Bryan Caplan likes the idea. But not for the same reasons as Clinton. His support is of a more cynical nature: he thinks that lowered taxes will preclude price controls, which he views as a greater evil, and in any case he thinks that eliminating the taxes won't have any strong negative effect. The second part is almost certainly true, and the first part is likely but not assured (and it is likely true because of American political tradition and our aversion to price controls; not because of the "irrationality" of the citizenry). If the profits of oil companies increase while gasoline prices continue upwards (as seems likely), then it seems likely that populist policies -- including price controls or other ill-minded ideas -- would become more likely, not less. I could draft the speech now: "Oil companies are getting rich on the backs of hard-working Americans. We tried to lower the burden by cutting out the taxes, but the greedy oil executives just grabbed more of the surplus. And so we should act punitively to re-direct money from these robber-barons back to the American people." And so price controls begin.

I know that Caplan knows more about game theory than I do, so maybe I'm missing something. But it seems to me as if he's acting as if this were a one-shot game, when it clearly isn't. 

An Assault on the Pigou Club

I'm in favor of carbon taxes. I also realize that they are politically infeasible. So does Robert Reich, who proposes an alternate solution to the energy Hydra Head (climate change, exporting money to despots, exposure to potential supply shocks, etc.), and it isn't cap-and-trade:

The best idea I've heard is described as a carbon auction. Companies would have to bid for the right to pollute. And, most ingeniously, the money raised in the auction would be shared equally by all citizens in the form of yearly dividend checks -- just like the residents of Alaska now get yearly dividends for their share of the state's oil revenues.

I mean, it's our atmosphere, right? Think of a national park or a national forest. No company is simply allowed to take what they want from it, free of charge. Why should the atmosphere be any different? In a carbon auction, companies would have to bid against other companies for a portion of the atmosphere they intend to use -- within overall limits that reduce pollution levels.

Get it? It's a win-win. The auction market itself determines who can pollute and by how much. And since companies will inevitably want to reduce their bidding costs, they'll search for new technologies that cut their emissions. And even if companies pass on increased costs to their customers, we'll still be better off because we'll get dividend checks and cleaner air.

Message to presidential candidates: American voters will buy this one. And it's good policy.

Reich is certainly right: a carbon auction is more politically feasible than a Pigouvian carbon tax. But it's also less effective. The overall aim -- to reduce emissions -- is the same, but the Pigouvian tax attacks demand, while the carbon auction takes aim at supply. In order to have the same effect, carbon auctions would have to have a prohibitively high "reserve" (minimum price), and/or the number of available carbon permits would have to be limited in some way, thus mirroring the cap-and-trade system which Reich opposes.

Reich maintains that this system would foster technological improvements in order to reduce their costs. This would be true if the energy industry was competitive, with little or no barriers to entry. In fact, however, the energy industry most closely resembles an oligopoly, with incredibly high fixed costs and many other barriers to entry. As American deregulation has shown, treating the energy industry as if it were a competitive industry can have disastrous results.

The carbon tax may be less politically feasible, but it would certainly have a greater effect. It is regressive, but making it revenue-neutral by combining it with a big expansion of the EITC could off-set most of those negative effects. A carbon auction might be more feasible; it might even be second-best, but it can't be better than that. And, as Matthew Yglesias is wont to say, all progressive policies seem impossible at first; changing the political dynamic is a process. But that doesn't mean that we should stop trying, or automatically settle for the easiest option.

(ht: Greg Mankiw, who doesn't seem impressed with Reich's logic)

Tax Gas

TNR joins the Pigou Club.

i'm attracted by the idea, but even simpler solution seems possible: cut subsidies. if Americans had to pay market prices for gasoline - as Europeans do - then they would consume less of it - as Europeans do. increasing taxes on a subsidized industry makes less sense to me than simply cutting out the subsidies. the effect is the same, but with an added plus: it reduces economic distortions instead of increasing them.