John McCain has proposed, and now Hillary Clinton also supports, a “gas-tax holiday” for this summer. I am all for holidays but will this proposal really be effective in lowering gas prices?

The proposal from McCain calls for the elimination of the Federal Government’s 18.4 cent per gallon tax on gasoline and the 24.4 cent diesel tax from Memorial Day until Labor Day. According to the Associated Press, McCain has claimed the proposal, “would reduce gas prices, which would have a trickle-down effect, and help to spread relief across the American economy."

The bulk of the money from fuel taxes are used for infrastructure, including road improvements that use GARVEE bonds to borrow against these funds. McCain has intimated that the loss revenue would be made up to state and localities from general revenues while Clinton wants to use a “wind-fall” profits tax on oil companies to make up for the lost tax dollars. The problems with this program are that it will not reduce the price of gasoline by the amount of the tax and it is not a very efficient means of providing relief to the people who need it the most.

The price we pay for gasoline is only partially connected to the cost of production and the level of taxes. The price of gas has risen by almost $1 from its level last year, yet the cost of drilling, refining and taxes have not changed.

Why have prices gone up so much then? It is simple economics (though it is not as simple as I describe, but a basic discussion should suffice).

Demand for petroleum products have risen, principally due to the expanding economies of other nations (especially China and India). As the demand for gasoline increases, if supply stays the same, prices must increase in order for the market to clear (the oil and gas market is not purely competitive but approximations still can help to explain the real world). If prices did not rise, the supply of oil would be insufficient.

Let’s look at another example based upon a ridiculous policy proposed by the ignorant and easily confused Bill O’Reilly. O’Reilly wants the government to set the price of gas at some arbitrary amount (say $2) and not allow the gas stations to charge more than that. What would happen under such a plan? We would run out of gas. Why? Because the amount of gas we would demand would be higher than the amount of gas that would be supplied at that price. Even if the government forced the oil companies to keep the supply of gas constant, we would run out of gas.

Let’s be more dramatic. How would you change your behavior if gasoline was 20 cents a gallon? You would drive everywhere, buy big cars, and even brush your teeth with gasoline if you could. The amount of gas demanded could not be met by the supply. Just further proof that Bill O’Reilly is an idiot.

So what happens without the gas tax in place? Won’t prices go down? Not really. The prices are set for the amount of gas supplied to clear the market (all of the gas to be bought) not by the costs of production, including taxes. The prices will stay the same and the oil companies will just make higher profits. The only way to reduce gas prices, without resorting to rationing supply on a basis other than price (e.g. WWII style coupons or queuing), is to reduce the demand or increase the supply of the product (not the amount demanded or the amount supplied). This cannot be done in the short run and, according to John Maynard Keynes, in the long run we are all dead.

If the tax holiday plan would reduce gas prices, who would benefit the most? People who use the most gasoline would get the greatest benefits. Should we help out those with the giant pick-up trucks, RVs and Hummers? The best means to “help to spread relief across the American economy” is providing money to those who will spend it (basically the idea behind the tax rebate) or for the government to spend money on programs with large multiplier effects (as discussed before in relation to the Iraq War) and that provide for the common good (e.g. spending on infrastructure).

John McCain remarked that he did not know much about economics. By making proposals such as the gas-tax holiday, he is removing any doubt the voters may have about the validity of that statement. Hillary Clinton’s support shows there are now two candidates who don’t understand basic economic principles.

Go Yotes.

Dr. Jasper M. LiCalzi
Professor
Department of Political Economy
The College of Idaho