Comment: Gas tax holiday could actually force prices higher

Oil companies are reluctant to increase production. That’s the worst time to encourage more demand.

By Karl W. Smith / Bloomberg Opinion

In a disturbing sign of just how much the White House has lost its way, President Biden is asking both Congress and state governments to agree to a three-month suspension of the gasoline tax. Gas tax holidays are generally a poor tool for combating rising prices, but they would be especially damaging right now.

When the government passes a tax cut, it can’t control directly who benefits. The so-called incidence of the tax cut is determined by the forces of supply and demand. If demand is relatively fixed, then the tax will tend to benefit buyers. If supply is more inelastic, then more of the benefits will go toward sellers. The best the government can do is observe how the incidence of taxation lands in practice, then adjust policy accordingly.

Consider the case of Maryland, which suspended its gas tax for a month last spring. Analysis suggests that consumers may have saved up to 26 cents per gallon; with another 10 cents captured by sellers. That extra 10 cents per gallon profit encouraged gasoline refiners to push more supply into Maryland instead of other states.

It was that extra supply, not the tax suspension, that lowered costs to Maryland residents. After the tax holiday ended, gas prices were higher in Maryland than in neighboring states.

If all 50 states and the federal government enacted a gas tax holiday, refiners would not be able to simply adjust supply from one state to another; they would just have to produce more gasoline. Yet a lack of refining capacity is precisely why U.S. gasoline prices are so high to begin with.

Biden seemed to recognize this fact in a letter he sent to refiners last week urging them to increase their production. To do that, they would need to invest both time and money. A three-month tax holiday would increase demand now, encouraging consumers to do more vacation driving — before capacity can be increased — and then would push demand down later in the year, after capacity investments have been completed. Instead of saving consumers money, a nationwide gas tax holiday is likely to lead to even higher profits for refiners in the short term while reducing their incentive to invest for the long term.

Meanwhile, it’s clear that the administration would like to reduce demand for oil and gas over the next decade, potentially stranding any new investments that the industry makes. It’s precisely this mismatch between the White House’s short-term demands and its long-term policy that has made the entire oil and gas industry hesitant to expand.

If the White House were serious about addressing the issue of gasoline shortages, there are steps it could take; but it needs to be more creative.

One such idea comes from Employ America, a left-of-center think tank that takes the market seriously: The Department of Energy could work with the Federal Reserve to sell insurance to oil producers against falling prices. If demand for oil stays high, or if geopolitics takes more supply off the market, then the insurance will expire unused. If the demand for oil drops, the Department of Energy can take advantage of the lower prices to both refill and expand the U.S.’s strategic petroleum reserve, thus blunting the price shock.

Instead, the administration is threatening refiners with antitrust actions, while congressional Democrats are mulling a windfall profits tax. A gas tax holiday — and the increase in windfall profits — would put Congress and industry on a collision course.

If the Biden administration wants the oil and gas industry to produce more gasoline to bring down prices, then it will have to do something it seems loath to do: work with industry to put it in a more dominant position globally. That way, even as demand from the U.S. falls, the industry can increase its exports. A three-month gas tax holiday would be the worst of both worlds; encouraging more domestic consumption precisely when production is at capacity, while doing nothing to help industry expand internationally.

Karl W. Smith is a Bloomberg Opinion columnist. Previously, he was vice president for federal policy at the Tax Foundation and assistant professor of economics at the University of North Carolina.

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