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3 Sep 2005 11:18:01 Daniel Hellerstein.

Subject: Economics    
Post Katrina: the need for a gasoline tax

2 Sept 2005:The Need for a Gas Tax

Before Katrina, the U.S. faced a crunch in gas supplies primarily due to a shortage of refinery capacity. After Katrina, this bottleneck got even tighter.

What this means, is that the supply of gasoline (to the entire nation) will be diminished, and there is very little that can be done about it. In particular, increases in the retail price of gas will not induce a significant increase in gasoline supplies (though imports of gasoline may be somewhat responsive to this price increase).

Therefore, the most fundamental principles of economics tell us that something has to give -- demand exceeded supply before, and its even worse now. Roughly speaking this imbalance can be resolved using two mechanisms.

1. Rationing, either mandatory or voluntary. Drivers just use less gas.
2. Price increases. When faced with higher prices, many people will choose to drive less.

Since rationing is something Americans rarely use, the simplest response is a price increase. The key point is that as prices increase, demand will diminish. At a sufficiently high price, demand will equal supply. Recollect that due to refinery capacity being maxed out, supply is not likely to increase (at least in any significant fashion) in response to increases in retail price. Thus, this equilibrium price is only responsive to consumer demand.

What this means is that in order for demand to equal supply, consumers must pay this price. Anything less, and demand exceeds supply, and we have gas lines etc. (a form of rationing). If you do not want gas shortages, then consumers must pay this price. Must.

However, it does not matter what makes up this equilibrium price. In particular, it does not matter what fraction of this price is composed of gas taxes. Gas taxes could 0, 10, 50, 80 percent-- the key point is that the conusmer ends up paying the equilibrium price.

That is: in terms of final demand:

Who gets the money spent for gas -- the oil companies or the government -- does not matter. All that matters is that the retail price be at the equilibrium price, be at a price where total consumer demand equals supply.

So, America has a decision: who should get this increase in gasoline prices?

Reiterating, basic economics tells us that we will be paying a high price for gas, a price that is inescapable. This bump in prices can either go to the refineries/oil-companies-etc, or it can go to the government.

There is no escaping this.

• If the government imposes a tax, the final price paid by consumers will be this equilibrium price.
• If the government does NOT impose a tax, the final price paid by consumers will be this equilibrium price.

Hence, the choice is simple: would the American public prefer to see these billions of dollars in extra gasoline expenditures go to the oil companies or to the public sector. This is the choice. In particular, cutting taxes (so as to ease the burden on the public) will have zero final impact -- a cut in taxes will NOT decrease the required equilibrium price. All a cut in taxes will do is increase the profits of the oil industry.

Sadly, in the kneejerk anti-tax public mindset, this message would probably be lost in cries of anguish. What may be more presentable would be a windfall profits tax, levied against the oil companies. And while it won't be as efficient as a retail tax (since there are so many ways to hide profit), at least it will redirect some of this expenditure to the public sector (I am assuming that most people, me included, would rather see the government get this windfall). And it will do this in a way that does not effect the retail price -- the standard shibboleth about "if you tax us, we will just past the tax onto the consumer" does not hold in this situation.

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