Co-blogger Scott Sumner writes an excellent post about how a temporary reduction in the federal petrol tax (from its current 18.4 cents to zero gallons) will cause the 4 effects mentioned.
I think Scott has had a 5th effect that watered down his 4th: it would increase the demand for Americans to control the price of gasoline.
The point I want to address in Scott’s post is his statement that “most tax cuts go to suppliers in a short time, helping payers.” Scott may be correct, but it is important to uncover an underlying assumption he did not mention: his assumption that the demand for gasoline is sufficiently resilient compared to the supply of gasoline.
I agree with Scott that the supply of petrol is extremely resilient. But we energy economists are also accustomed to seeing the demand for petrol as highly resilient. It is true that we do not know much about the elasticity of gas demand at current prices because we do not have much experience with prices at this level, even inflation-adjusted. Helping Scott is the basic idea that the higher the price you start, the more resilient the demand will be. The scourge in Scott’s case is that there is some degree of prudence on the part of refiners to the extent that they produce gasoline or other refined products. So even with a completely stable refining capacity, an increase in the price of gasoline by refiners could increase the amount of gasoline produced.
Let’s set a base case. If the demand for petrol is as resilient as the supply, the 18.4 per cent tax cut will be shared equally between producers and consumers. Producers will get a net worth of 9.2 cents more; Consumers will get 9.2 cents less tax.
But, if Scott expects demand to be significantly more resilient than supply, producers will receive a much larger share of 18.4 cents and consumers a much smaller share.
Say consumers get 5 cents per tax cut per gallon.
What happens next?
Many of them are going to be angry. “These oil companies were greedy and kept the lion’s share of the tax cuts. Let’s impose price controls on the Fed so we can get a bigger share. “
We all know what happens with price control. When price control puts prices below the free-market price in a relatively competitive industry, there is a deficit. People are standing in line for petrol. And the fact that Scott mentioned deadweight loss from their time on the line could be a bigger reason than any one of the 4 factors.
One case is Proposition 13 in California, which, when passed in June 1978, immediately reduced property taxes by a huge amount. I had some economist friends who were finishing their PhD at UCLA and were in rented apartments. Their landlord, and many other California landlords, sent flyers to their tenants before the vote, telling them that if proposal 13 was passed, their rent would be reduced. We economists knew this was unlikely because coastal California governments severely restricted supply, making it highly resilient, where demand was somewhat resilient.
Proposal 13 passed, rents dropped significantly, and tenants were upset. What did they do? Call for rent control, which was imposed on many cities in California. In some cities, such as Santa Monica, more than 40 years later, rent controls are still in place, with all its distortions.