Tuesday, April 29, 2008

What to Do About Gas Prices?

As an economist, as a person who worries about climate change, and as someone who believes the Democratic Party's electoral success is very important, if only to spare us more of the damage that the GOP has done over the last quarter-century of its hammer lock on federal policy, I find political discussion of gas taxes to be extremely frustrating to watch.

Democratic politicians regularly use high gas prices as a club with which to beat Republicans. I understand that politicians use the issues they think will work. And the nexus between oil company profits and GOP officials whose policies have been awful for most people in the bottom four quintiles of the income distribution (and probably plenty in the top one) has got to be pretty tough for Democratic candidates and officials to resist.

But the fact of the matter is that gas prices should be high. They should be high for the very simple and now very obvious reason that the pressure on the world's climate needs to be reduced. Our country's foolish policy of keeping gas prices low while providing implicit (and sometimes explicit) subsidies to the vehicles that get the worst mileage should have ended many years ago. Demand-side pressure on gas prices is finally pushing gas prices into the range they should have been for many years.

But that last paragraph tells only part of the story. One effect of the low-gas price policies we've pursued for so long is that it's induced many people to buy very fuel-inefficient cars and trucks. These are the people who are getting nailed hardest in the wallets by today's high gas prices, and I don't blame them for being upset. If you drive a vehicle that gets 18 miles per gallon for 12,000 miles a year, then you use about 670 gallons of gas a year. Even a $1.00 per gallon increase in the price of gas over a period of one year alone therefore translates into more than the stimulus tax rebate that a single person with sufficient income will receive over the next month. A married couple each of whom drives such a car 12,000 miles a year will receive a smaller rebate than the one-year cost of a $1 per gallon gas price hike.

By any reasonable standard, the increase in gas prices translates into real money for a huge number of people in this country, especially under current economic conditions.

But since the reason this is true is that American consumers have been induced to buy inefficient gas guzzlers, with serious environmental consequences, policies that would reduce the price of gas should be the last thing we consider. (On this score, the gas tax holiday that Sens. McCain and Clinton have proposed at least has the virtue that it would likely do very little, leading to at most a very small change in the price of gas; McCain's proposal would add to the deficit by increasing windfall profits of oil companies, while Clinton at least has proposed a new windfall profits tax to undo her proposal's provision of windfall profits.)

So what to do? I propose the following two-pronged policy:

  • Prong 1. No change in the gas tax until the economy improves. At that point, we would begin to increase the gas tax annually by some fixed amount that would be stated in advance, allowing people to make informed car-purchase decisions. Consumers would shift consumption toward more fuel-efficient vehicles, and automakers would see this coming, so they would shift R&D toward such vehicles. Over time, the efficiency of the U.S. auto fleet would improve, cutting emissions and making us less dependent on all that foreign oil over which everyone always frets.
  • Prong 2. Every person who owns a car and files a tax return would receive a Gas Price Rebate (GPR). The amount of the GPR could vary with income if means-testing is desired to keep the overall cost of this program lower than it would otherwise be. However, the GPR would not vary according to the type of car people own. It could be set at something like
(12,000/avg MPG of U.S. fleet) x (the 2002-2008 change in the per-gallon price of gas)

We could adjust any particular component of the GPR. The point isn't the exact formula, but rather the fact that the GPR does not vary with the type of car that a person drives but does provide relief to the millions of Americans who responded to the bad incentives created by the misguided/chicken*$@# representatives the people themselves elected. People who want to keep driving those H2 and Mustang monstrosities (Ok, I admit it -- I used to drive a Mustang) can do so if they want, but they'll have to pay for it.

Thus, the two prongs together move incentives in the right direction (prong 1) while helping alleviate the real suffering going on out there due to gas price increases (prong 2). What I hope makes such a policy politically viable is the combination of the two elements. Yes, opponents will slam prong 1, but prong 2 is there as a retort.

As for paying for prong 2, some headway can be made with the increase in gas taxes in prong 1. It's a truism of microeconomic theory, though, that a tax-induced price increase will reduce equilibrium quantity, so it's likely that any GPR big enough to make prong 1 politically feasible will require additional funding. To deal with this, I propose ... you guessed it, an increase in taxes on upper-income Americans. And while I think the best way to do this would be those who make even more than I do, if need be, I'd be happy to pay more in taxes to help make this plan a reality.

Update: Here's Obama talking about the McCain-Clinton proposal today.


The Man in the Hat said...

Nice analysis Gelbach, but how about another prong? Fund the rebate by taxing the profits of automakers, with a tax whose base rate is multiplied by the average gas mileage of their vehicles sold in the tax year. As they shift away from marketing gas guzzlers to avoid taxes, the average cost of the gas consumers' rebate will also fall AND we will actually be consuming less gas per vehicle mile.

Then what we really need is some further incentives to get the auto industry to move away from cars altogether and reinvest in the light rail systems they systematically acquired and shut down almost a century ago in many US cities.

Jonah B. Gelbach said...

man in the hat:

you can achieve all the same results of your proposal with the gas tax itself. your proposal has the advantage that it might be politically more palatable than a further increase in the gas tax. on the other hand, it would likely go over poorly in michigan, a state the dems need to win. so on political grounds there are pros and cons.

as for incentives for the auto industry, shifting consumer demand is certainly one such incentive!

i definitely do agree on light rail.

say hi to your lovely wife for me


Brooks said...


You recommend "No change in the gas tax until the economy improves."

Why do you oppose raising the gas tax now in conjunction with the rest of your recommendations? Why wait on your recommended policy "until the economy improves"?

Jonah B. Gelbach said...


i recommend waiting because i recognize that legislative decisions have to be made by legislators, most of whom (all but 66 or 67 senators) have to run for re-election between now and November. Basic realism suggests that what you suggest would make that re-election harder and therefore garner no support. After the election is over, things will be easier. Yes, this is a purely political calculation. But you know that old line about not letting the perfect be the enemy of the good....Better to do something good in a few months than never to do it at all.

Jonah B. Gelbach said...

just to be clear, i did originally say "until the economy improves", and i also just wrote that i'm ok with waiting until after the election. obviously those timelines needn't coincide exactly. that said, i'm guessing that they'll be pretty close. also, another point, one i originally had in mind but didn't address in my reply to you just now, is that a broad-based tax increase during a recession is generally bad demand-side policy. (by contrast, raising taxes on upper income folks generally has relatively little short run ag demand impact, but the gas tax is broad-based.)

so there's a short run-long run tradeoff, which i resolved in favor of the SR in my original post. but it's arguable that a revenue-neutral policy of increasing gas taxes and giving correspondingly higher lump-sum rebates would cure the SR demand-side problem. so in principle, the political feasibility issue is the bigger reason.

Andrew said...

Nice post. I don't think that "the man in the hat's" proposal of taxing the profits of the automakers specifically is a viable strategy, since those profits will likely be small or negative for quite a while.

I think you could simply stipulate that the rebate itself is taxable as income, so that some of its cost is recouped. You could also design it to be revenue-neutral by increasing income tax rates as needed.

That's the sort of green tax swap that has broad intellectual support across the political spectrum. You would be in league with AEI and Greg Mankiw, for example, disagreeing perhaps only on how progressive the income tax increases would have to be.

David Jeffery said...

I kind of like we're you're going with this - but the idea that you get a tax rebate if you own a car but not if you don't jars with me (yes I realise the theory is that you're just getting back some of what you already paid in gas tax). So a family with two cars gets two lots of rebates but the family who has made do with one car gets only one? Wouldn't this just encourage families to go out and buy that second car they were dithering about? Wouldn't it encourage someone who gets by without a car to buy one?

Brooks said...


Thanks for your replies.

The political calculation is sensible.

Re: your secondary argument/rationale for delay -- "that a broad-based tax increase during a recession is generally bad demand-side policy" -- that touches on the reason I asked the question. I was wondering if your rationale for delay was that we wouldn't want to raise the gas tax during a recession (for Keynesian, aggregate demand reasons, and perhaps also for humanitarian reasons). If that's part of your rationale (and it seems to be, but please correct me if I'm misinterpreting), then the question is "What is ideal about 18.4 cents/gallon?" from that perspective? In other words, if it's bad to RAISE the gas tax during a recession, then why isn't it good to LOWER the gas tax in a recession, unless the current tax rate is, for some odd reason, ideal?

I realize that your rationale is broader than the "recession" consideration, and that the political considration is your primary rationale for delay, but I'd be interested in your answer to my question regarding your secondary argument.

Jonah B. Gelbach said...

andy--thanks for your comment. my sense is that you're right about the broad-spectrum point in terms of policy advisers. i hope that policy*makers* on the right (and the left, given all their recent gas-price demagoguery) will join in soon.

david--i'm not married to the idea that only people with cars get the rebate, tho it gets harder to sell it as specifically a *gas* price rebate if you don't limit it that way. but i don't see this as a critical issue (one could always also condition the rebate on having owned a car by January 1, 2008, or something).

brooks--thanks for your second comment. i have no particular sense that 18.4 cents is optimal, except that it's been historically way too low for the reasons i gave in my post. as long as the rebate is big enough to offset ag demand slowdown, you can increase the gas tax now if you want (but good look getting that one done in this climate).

Brooks said...

Thanks Jonah [n/t]

Mak Thorpe said...

Note that the cost of "gas" in an Electric vehicle is 89 cents per gallon. Note also that these electric vehicles include Cadillac Escalade Hybrid, and Ford Escape SUVs. They are not golf cart wannabes- these are the vehicles that Americans love and prefer not to be told they can't have.

The main barrier to adoption of these vehicles is that for them to have batteries large enough to run for more than a mile or two on electricity, the cost of the vehicle would be $6000 to 10K more.

Sure, if folks did the calculation they would see that due to the savings in fuel, the battery would pay for itself over several years. Problem is, most consumers don't make decisions that way.

Economic solutions must focus on this reality. It's a simple financing proposition, and it's revenue neutral.

Prong 3: Like Federal student loans, a car buyer is offered a federal battery loan that covers the entire cost of the battery. The loan is recovered through surcharges on the electricity used to recharge the battery. All surcharges are pooled between consumers so that everyone's batteries are paid off whether they are a heavy driver or not. Surcharges are added at a discount to the current price of gas, so that consumers always get a better deal than if they were using gas.

For full switchover to electric vehicles, national power generation must increase by 25%. This increases the income for utilities substantially. The catch is that for all power going to electric vehicles, utilities must build alternative energy sources to cover the new demand. They are guaranteed 35 cents per KWH so they will be assured of a handsome margin on this investment. The higher KWH price comes out of the surcharge.

Metering is done using EVDO communication from a cellphone processor on a chip embedded in the battery. The battery refuses to recharge if it has not been able to contact the utilities' website and get authorization within the past N days. So if the user doesn't pay their bills, tough break. Chip cannot be bypassed for direct charging since it is fused into the battery itself. Surcharges go away when the battery payoff period expires, and everyone gets 89 cent "gas"*.

How does that sound? I am a member of an economic development committee for my state's democratic party and am proposing this as a policy position for legislation in my state.

*89 cent "gas" price assumes the national average of 10 cents per KWH.

Unknown said...

How about, we just confiscate all cars, and have the bureaucracy dictate which car you can drive on which day, and how many miles you may drive it? Karl Marx would be proud!!

Jim Luckett said...

I think we need revenue-neutral taxes on fossil fuels and they should be very, very simple. No fancy formulas that can lead to mistrust by the public, or plundering by special interests.

Place a big tax on all fossil fuels of $x per BTU and rebate 100%of the revenue to the public equally per capita. Every man, woman and child gets 1/300 millionth of the revenue collected.

Same for any cap and trade system for carbon: Auction every permit, give none away free, and rebate 100% of the revenue on an absolutely flat, reverse-head-tax basis.

Do your redistribution of wealth and your investment in R&D through some other means. Don't mix issues. The American public needs to be led to a sharp focus on the fact that relative prices need to be fixed to internalize the externalities (obviously, translated from jargon to plain English when presented to the public).

Unknown said...

That's right the democrats are going to be the saviors of the world, and will fix all of our problems. You want to base our economic policies on your unfounded fear of global warming. There is no concrete evidence that our planet is on a warming trend. Much of the data we have shows that the earth has actually cooled one degree over the past one hundred years. Not to mention we had one of the coldest winters in decades last year. Any data we do have that does say the earth is on a warming trend can’t pinpoint whether it is manmade or just a natural occurrence. I would like to point out that the environment has warmed and cooled all throughout earth’s history.
You think it is good for the world to have high gas prices, but you aren’t taking into consideration all of the consequences that comes along with it. As the cost of gas rises it cost more for every single industry in the U.S. to operate causing massive inflation, job losses, and ultimately a recession. It will affect world food production increasing world poverty. Americans, who donate more money than any country in the world, will have less or be more apprehensive to donate money to charities around the world causing more starvation. Not to mention the millions of dollars that Americans donate to the many different disease research organizations. Then again liberals think bigger even more inefficient government , and higher taxes are the answers to all our problems.

Anonymous said...

I completely disagree with the opinions/proposals on "What do About Gas Prices". Up front, I want to say that I'm not an economist. I am an engineer and farmer developing renewable energy biomass projects in the Southern U.S.

The reason for the current spikes in high gas prices is not a supply and demand problem with oil. The problem is a supply and demand problem with the U.S. Dollar currency.

The WSJ has an excellent article which shows a graph of a perfect correlation between the decreases in the Fed Funds rate versus the price of oil.

As the Fed tries to address one problem with the U.S. economy on capital liquidity, its creating another problem in the free fall of the U.S. Dollar in International Money Markets.

As the U.S. Dollar falls, International Money Funds are moving into commodity markets.

The true problem that no politician wants to address (except maybe Ron Paul) is basic kitchen table economics of "you can not spend more than you make".

While Democrats are labeled "Tax and Spend", "Spend and Borrow" Republicans with their Supply Side Economics are certainly no better.

What we need is (Gulp!) to amend the Constitution and let Bill Clinton run again. Clinton understood this economics stuff, balancing the federal budget on his watch. This is why Alan Greenspan describes Clinton as the best Republican President in recent history.

My economic proposal of "what to do about Gas Prices" are:

(1) Balance the Federal Budget.

(2) Apply Federal Payroll taxes on all income (no cap) until the Federal Budget is balanced. Use the additional tax revenue to retire U.S. Debt -- which will increase the value of the U.S. Dollar.

Personally, I don't believe Obama or McCain understand economics very well.

Steve from Florida

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Anonymous said...

It is relieving to see others believe gas prices should be high. It is the only way to encourage alternative energy development. However, I do not see how a tax rebate on gas is helpful. While the transition may be painful, and the lowest income earners will be least prepared to buy new efficient cars, I hardly believe we should subsidize use of gasoline.

Surely the administrative cost to distribute the rebate is a sufficient deterrent from this policy. At worst, we could spend the money better elsewhere to promote innovation rather than encourage stagnation.

As with any tax rebate, we pay for the collection and redistribution of the money. We can work much more efficiently and simply. Either tax and use the money, or dont. I dont want to pay just to have money returned to me.