We can do better than a gas tax holiday

We can do better than a gas tax holiday

Some real ideas to address rising cost of living

The global run-up in oil prices that started even before Russia’s invasion of Ukraine has politicians scrambling to argue for cuts to the gasoline tax.

One bloc calling for cuts is Democratic senators up for re-election in 2022. I don’t begrudge anyone their right to posture for re-election. And honestly, I’m not even against a gas tax holiday if it would actually help them. But when I see Gavin Newsom and the California state legislature talking about a gas tax rebate, I do want to note that this is a very poor policy remedy for the problem.

The best way to think about what’s wrong with it is to start with the fact that one way we could reduce oil prices would be to halt all sanctions on Russia. It’s not just that the recently enacted ban on importing Russian oil raises prices; even the financial and economic sanctions that don’t directly target the energy sector impede Russia’s ability to produce and distribute oil. Of course, the reason not to lift all the sanctions is that we want to be sanctioning Russia!

By the same token, we shouldn’t respond to the downsides of sanction-induced increases in oil prices by subsidizing oil consumption. That winds up feeding back into Putin’s treasury. Even if the U.S. and its allies don’t directly import any Russian oil, the volume of non-Russian oil that the U.S. consumes still impacts the price that China and India pay Russia. The good news is that state governments are flush thanks to the American Rescue Plan, and interest rates on federal debt remain very low despite inflation, so the U.S. has the fiscal flexibility to spend money or forego revenue in order to cope with the economic impact of the war.

But California and other states looking to use tax policy to reduce the cost of living should do so without subsidizing oil consumption by taking advantage of the fact that gasoline is not the only thing they tax.

Cut the sales tax instead

While gasoline taxes are regressive, 45 states (which together account for more than 90 percent of the U.S. population) derive a large share of their revenue from an also-regressive retail sales tax.

To an extent, reasonable people can disagree about the merits of this kind of distributionally regressive taxes. My general view is that if your revenue is financing useful services, then it’s wise not to worry too much about the distributive impact of the revenue base because an effective public sector and a robust social safety net are inherently good for poor people.

But however you look at this, the gas tax is superior to the retail sales tax. They are both regressive, but the very poorest people tend not to drive (cars are expensive) and are stuck relying on America’s mostly terrible system of public transit buses. And of course, gasoline causes especially high levels of pollution.

My preference would be for virtually every state to raise gas taxes in order to reduce their sales tax. So if they want to respond to cost-of-living worries with a tax cut, I think states should move to cut the sales tax. Since the people who drive cars also buy things that aren’t gasoline, it helps them. But it also helps non-drivers and encourages people to respond to the shortages by driving less when possible.

The federal government does not collect sales tax. But it could, on a temporary basis, exempt the first $X of wages from payroll taxes (perhaps combined with a temporary Social Security bonus payout). That would put extra money in people’s pockets to help cover the cost of gasoline while also allowing them to react to pain at the pump by simply buying less gasoline and using the money for other purposes.

Gas taxes are pretty good

Due to the state-by-state and country-by-country variation in gasoline taxes, this is the kind of thing that gets studied a lot, and I think the evidence is pretty clear that gasoline taxes are a good idea even though the voters disagree:

Shanjun Li, Joshua Linn, and Eric Muehlegger find that higher gas taxes are effective at reducing consumption — that even in a country with weak mass transit options, there is a meaningful change in behavior.

James Poterba says the gas tax is less regressive than most people think (though still regressive), reinforcing my sense that moving on retail sales taxes would be a better idea even if you leave pollution concerns aside.

A fun Andrew Appleby paper from 2010 argues that the actual optimal level of gasoline taxation is $11/gallon.

We are not going to enact an $11/gallon gasoline tax, and I certainly don’t think that in-cycle senators should push for one.

But I do think Appleby’s broader point is worth taking seriously. All consumption taxes are unpopular, and any sensible elected official with fiscal capacity could see some upside from cutting them. But some specific consumption taxes, including taxes on cigarettes and alcohol and gasoline, provide benefits that generalized consumption taxes don’t. Our first choice as thoughtful people should always be to nudge elected officials in the direction of taxing gasoline more and taxing “all purchases of stuff” less. After all, if for all these years Americans had been buying somewhat lighter, smaller, more fuel-efficient cars and driving them somewhat less and in exchange had better furniture, appliances, and clothing, we’d be much better off today — including less subject to the whims of oil price fluctuations.

And beyond tax swaps, we really ought to be thinking more creatively about how to contain oil consumption broadly as part of the economic war on Russia.

Some more creative ideas

Economist Dean Baker tossed out an idea on Twitter that I think is also worth considering: “suppose we offered developing countries $10 for each barrel that they reduced net imports in 2022 from their pre-pandemic level.” Basically, pay poor countries to respond to higher prices by reducing consumption.

The main problem here is that if you look at the top 15 oil importers who collectively account for 83 percent of global oil imports, the only developing countries on the list are China, India, and Thailand. We’re not going to hand money over to China, and India has a long-term legacy alliance with Russia that they appear to be largely standing by during this crisis, so they may not be interested. That leaves Thailand and some very small players to work with. It seems to me that if you could talk Congress into appropriating the funds, that would absolutely be money well spent, but it probably wouldn’t move the needle all that much unless you could interest India.

That being said, maybe you could interest India. It is absolutely in the long-term interests of the United States to get India aligned with the U.S., Europe, and Japan on some kind of “team democracy”. One of the biggest benefits of finally being out of Afghanistan is that we no longer have American policy yoked to the goodwill of India’s main enemy. If getting them interested in a cash-for-reduced-oil-imports policy could be part of that long-term relationship building, that would be a huge win.

Domestically, we already have on the table a plan to invest money in subsidizing EV and e-bike purchases as part of the Build Back Better proposal. I would love to see Senate Democrats get their collective heads out of their butts and move on those critical energy provisions, but as far as I can tell progressives have no interest in compromising on their big ambitions and Manchin is now leery of stuff he said he supported a few months ago. It’s incredibly frustrating.

In most of the country, meanwhile, the basic mass transit infrastructure is so bad that I don’t think you can meaningfully increase ridership by reducing fares. But New York certainly could, and so could maybe a few other states.

The price corridor

Last but by no means least, I want to return to the idea I mentioned last week of trying to lower short-term prices by averting a future price crash.

In addition to buying and selling oil, participants in commodities markets can also trade oil futures, literally the price of buying a barrel of oil in the future. You can link together the futures prices to create a curve, showing the current price of oil at different points in time. And what you can see is that as the short-term price of oil has skyrocketed, the current market expectation (the orange curve) is that long-term prices will settle at around $65 per barrel — actually a bit lower than expected prices before the Russian invasion that sent short-term prices surging, I think because investors are now more pessimistic about economic growth.

This coming price crash is great news for consumers in the summer and fall of 2026, but it also weighs on the minds of investors considering how much money to plow into new fracking operations right now. After all, American oil and gas producers are already expanding production (this is what Republicans are in denial about) so to expand even more rapidly means moving onto projects with higher marginal costs. You don’t do that if you think the long-term payoff is going to be low-to-negative. And while sky-high short-term prices are bad for consumers (and bad for Joe Biden and thus bad for climate policy), low long-term prices are also bad for climate change.

So what Alex Williams, Arnab Datta, and Skanda Amarnath propose is that the federal government use the Strategic Petroleum Reserve to not only put some more oil directly onto the market today but to buy up future oil and put a floor under its price:

Since the SPR has inventory, and the ability to store crude oil for the future, it can and should help relieve pressure in the spot market. Critically, it can do so without disincentivizing future production by using its exchange authority. If done correctly, the simultaneous transaction should earn the taxpayer a net return.

The SPR would solicit proposals for exchanges, whereby it releases crude to a private intermediary in exchange for receiving the same quantity (plus a premium) of crude at a future date. The SPR would have to allow return dates of sufficient term to be of value to intermediaries (and the end oil producer), but most critically, it could require that returned barrels be sourced from producers’ newly drilled wells not currently permitted or associated with the current rig count–ideally increasing investment and production at the margin.

The idea is to create a kind of soft price control system for oil that prevents it from getting so expensive that everyone loses their mind, but also blocks super-cheap oil from putting producers out of business. Rep. Jared Golden and a few other moderate House members have embraced this idea, but the White House seems reluctant since climate groups are allergic to anything that smacks of drill, baby, drill.

But I think the current conversation around a gas tax holiday should be a reality check for environmental groups. The fact of the matter is that nobody in a contested election — not red-state senators, not even the governor of California — is willing to go to the voters with an “actually, expensive gasoline is good” message. What climate advocates do have is a compelling long-term solution to this problem: the promotion of mass transit and especially electric vehicles. They also have a Democratic Party that is very committed to pushing that long-term agenda. So the sensible thing is to help those allies maintain political power by working with them to do sensible things to address the short-term issue. But if they won’t, it would be fitting and appropriate for the Biden administration to break sharply with them and announce something like the price corridors plan and say explicitly, “my climate activist friends hate this idea, they are so committed to their long-term EV vision that they don’t want me to take any action to provide short-term relief, and I just think they’re wrong.”