In defense of the gas tax holiday

You can always trust an economist to hate a popular idea.

In this case, its the gas tax holiday first proposed by John McCain – and then embraced by Senator Clinton.  Perhaps it was the latter’s shameless opportunism that has scared so many right-wingers off, but just about everybody “in the know” has a reaction similar to Doug over at Below the Beltway:

Apparently, the Republican National Committee has decided to sign on to John McCain and Hillary Clinton’s stupid, and in the end pointless, idea to suspend the Federal Gas Tax during the summer.

. . .

There isn’t a lot that I agree with Barack Obama on in terms of policy, but in this one he is absolutely 100% correct. Suspending the Federal gas tax will do nothing to address the “problem” of higher gasoline prices in the long term, and it is unlikely to have any real impact at the pump for the majority of consumers.

The fact that he supported such a suspension as an Illinois Legislator and now opposes it as a Presidential candidate is, in my book, a point in his favor. Unlike the other two Presidential candidates, he isn’t pandering to the public by putting forward an idea that sounds good when you first hear it but, in reality, accomplishes nothing.

Now, I will acknowledge I do not have a doctorate in Economics – just a Master’s; also, I do not teach Economics at a University – just a Community College.  Still, I’d like to think I have some expertise I can bring to this discussion, and while the arguments of Doug et al sound very sensible - especially as it rejects the populist impulse – they are also very, very wrong.

Gasoline, like everything else, is a good that follows the laws of supply and demand, but those laws mean different things to different goods.  In some cases, consumers demand for a good will fall steeply as the price rises; we call those goods elastic goods.  Other goods, however, will see hardly any change in demand despite price fluctuation; these goods are called – wait for it – inelastic.

Taxes on elastic goods an have a dramatic effect on demand if the sellers (who have to collect the tax and send it to the governments who levy them) try to pass the tax cost onto consumers in higher prices.  Thus, the sellers usually raise the price of elastic goods more gingerly (if at all) and end up eating the tax cost.  Inelastic goods are another matter; since demand is unlikely to change much, sellers can more easily pass the tax cost on in higher prices.

So which one is gasoline?  Well, according to a recent analysis by Jonathan Hughes, Christopher Knittel, and Dan Sperling (all professors in the University of California system), gas is a very inelastic good, meaning it is consumers, not sellers, who are actually paying the gas tax.  Thus, a suspension of the gas tax would indeed lead to lower prices at the pump.

The question next becomes: what will consumers do with the money?  Will they spend it - thus adding to short-run GDP?  Or will they save it, adding to the pool of investment money (or reducing the debt pressure on same) and leading to a long-term increase in economic capacity?  As one would expect, the answer is some of both, meaning a marginal gain in GDP now and potential GDP later.  Given the knife’s edge on which the economy currently sits, every little bit will help.

But what of the lost revenue to the federal government?  Well, that question depends on how well one thinks Congress is doing with the taxpayer’s money, especially on transportation (which is where gas-tax money goes).  Putting aside that this is, well, Congress, there is also the more pertinent question of how effective a gas tax really is as a user fee.  Keep in mind, Washington gets the money whether you drive on the Interstate System or not, thus you end up paying for roads you don’t use.

Unfortunately, most right-wingers have been led astray by (of all people) Adam Smith, who considered roads one of the few things deserving of government funds.  Transportation has been considered “good spending” by conservatives ever since, despite the massive differentiation of street uses (interstates, primary roads, secondary roads, and subdivision streets) that clearly put into question the idea that governments should maintain every square inch of asphalt.

In the final analysis, the question devolves to this: is it better for the government to spend this money or for the people to spend it?  To ask this question is to answer it.

Are there better ways to reduce the tax burden?  Of course there are, but McCain is already supporting many of them, including cutting the corporate tax rate and ending the Alternative Minimum Tax.

With luck, the gas tax suspension will force people to think about better ways to pay for roads (perhaps shifting in part from use-based to value-based, from federal funding to more localized funding, and/or from taxes to tolls).  Even without such desperately needed soul searching, it will provide a quick boost to the economy when it is needed the most – at a cost of less than half the earmark total from last year (Toronto Star and the Heritage Foundation).

Just remember: Hillary Clinton supporting something doesn’t make it wrong.