What about Gas
by bobbank, Sat May 03, 2008 at 02:30:39 PM EDT
I know what you're thinking: Oh, God, another blog about gas.
However, I have been disappointed by all the ideological arguments about this topic, with very little in the way of data, facts, or reason. I am not an economist, but I am a financial analyst who shares responsibility for managing a $750 million portfolio at a private, non-profit foundation. So crunching economic data is not unfamiliar to me. My purpose in this piece is not to advocate for or against the tax, although I may let an opinion out here and there.
Rather, I would like to present you with some data, so that you can put these rampant talking points into the context of real facts. Please be warned: this is a long, substantive document. It will be boring to anyone who insists only on spin and drama.
Part I: Refuting the Talking Points
The main talking points used against the gas tax holiday go something like this: lowering the price will increase demand, which is bad for the environment. Moreover, since supply is fixed, the price will be driven right back up again. Essentially you have just taken money from the government and given it to Big Oil.
Is it true?
In order to answer that question, we must test two assertions: (a) consumption of gasoline responds to short-term changes in price, and (b) supply of gasoline does not.
I conducted my inquiry at the Department of Energy's Information Administration. Because we are discussing small, short-term changes in price, I compiled monthly data for the past twelve months. Specifically, I measured actual supply and actual sales of motor-grade gasoline, expressed in thousands-of-gallons-per-day. I cross-tabulated this with average retail price of gasoline, to construct a classic supply-and-demand model.
Looking over the data, it quickly becomes apparently that neither of these talking points holds true. Supply fluctuates by as much as 34,000,000 million gallons per day, not exactly something one would consider "static". As well, neither supply nor demand seem to respond predictably to price. For example, from June to July, price decreased by 9 cents, or 3%. According to talking points, demand should have gone up, right? Wrong. Consumption actually decreased by 2%.
A picture is worth a thousand words, so here is a graphical representation of the short-term supply and demand of gasoline.
Do you see a pattern? It not, you're in good company. I attempted to perform several regression analyses on these data points. I tried using linear, logarithmic, polynomial and exponential models. The highest R2 I could get was 0.0911. All of this is a fancy way of stating what is obvious to your eye: there is no pattern. Neither supply nor demand for gasoline could be explained as a function of price, in the short-term.
Here's the key takeaway folks: there is no reason to believe that lowering the price of gasoline by 18 cents for three months would have any impact on consumption whatsoever. More likely, short-term fluctuations are explained by seasonal travel, changes in business needs, and things of this nature.
But what about over the long-run? Looking over the span of several years, a different story is told.
As you can see from this chart, demand continued to rise for four straight years, despite the fact that the price at the pump was beginning to skyrocket. But our appetite for petro-products was eventually curbed. You could think of it as a highly delayed reaction to changes in price. Let's look at the graph.
I was able to build an accurate model, but only by ignoring price, and simply expressing demand as a function of time. The R2 value indicates that my model explains 92% of the variation in demand. But how good of a predictor is it? I decided to put it to the test, and extend the trendline to 2008. According to the model, consumption should average around 370,000,000 gallons per day in 2008. During February 2008, when consumption is generally below average, the actual number was 363,500,000. Less than a 2% margin of error (better than any poll!) from a model that does not in any way incorporate price. Not bad, eh?
The takeaway this time: the market can adapt to changes in the price of gasoline, but it takes a long time. Think of it like a big ocean liner. These things cannot turn on a dime, folks, and neither can the market for gasoline. It takes a long period of time - laws passed to change fuel efficiency, consumers purchasing smaller and more efficient vehicles, new public transportation infrastructure - changes that cannot possibly occur in the span of three months - before consumption of a commodity like gasoline actually changes.
Part II: Framing the Debate Correctly
With the most common talking points refuted, we can now move on to another criticism of the tax holiday: it just won't add up. It has been estimated that the average American will save about 30 bucks, when all is said and done, and that just doesn't seem like a lot.
However, lowering the price at the pump doesn't just save you money when you fill 'er up. Gasoline is a significant driver of transportation cost - a hidden tax assessed on nearly every good and service you will ever buy. Therefore, it is more constructive to look at this as a second stimulus package, on the aggregate level. Assuming an average of 370,000,000 gallons per day, at 18.4 cents per gallon, the stimulus effect would be $6 billion over three months. By contrast, the rebate checks in the first stimulus package were estimated to total approximately $103 billion. So, relatively speaking, it is fair to describe it as a modest plan.
Consider this, though - the federal gas tax is perhaps one of the most regressive taxes in our country. Low-to-middle income families spend a much higher portion of their earnings on gasoline than their wealthy counterparts. In that sense, slashing the tax, even temporarily, is the progressive thing to do. More food for thought - if our longterm objective is to reduce gasoline consumption, we had better start thinking of alternate ways to fill the coffers of our Highway Trust Fund, because even at the peak of its revenue, there still isn't enough money in there.
Part III: Diarist's Thoughts
As we have seen, the talking points used against the tax holiday are largely false. As to the worry that Oil companies might just ramp up their price in response to the tax holiday, the very nature of a windfall profits tax creates a strong incentive against that behavior.
But does that mean the tax holiday is a good idea?
The truth is - despite all the hooplah - it is a small idea, economically speaking. It essentially amounts to adding a few more points onto the first stimulus package. Then again, no one ever complained about minor comforts. After all, the tax holiday has the virtue of being a progressive action, and it implicitly targets those most in need of a little relief right now. As to the question, why package it this way, instead of just writing another check? Simply put - this is a very attractive package to the consumers these politicians have in mind.
All three candidates have put forth comprehensive plans to address matters of energy and environment. It is ironic that this little cul-de-sac of an issue turned out to be the most contentious.
Update! Part IV: Economists begin to acknowledge debate
Recently, William J. Polley blogged about the flawed assumptions that demand is elastic (it is not) and supply is inelastic (it is not). In his piece, he notes that "Supply may be relatively fixed in the summer, but if short run demand is also inelastic, it is not a foregone conclusion that the suppliers will get all the benefit." He goes on:
We take as one of our stylized facts that gasoline demand is fairly inelastic in the very short run. A 10% change in gas prices this month will probably not cause me to change my driving habits much. A permanent 10% increase will cause me to change my habits more over time. The federal excise tax of 18.4 cents is roughly 5% of the going price. In fact, I think we can expect that the fluctuations in price over the summer due to refinery maintenance, hurricanes, pipeline problems, etc. could be as large or larger in magnitude. I wouldn't expect it to change driving habits much at all. In other words, the demand is inelastic. Not perfectly inelastic, but quite inelastic.
About supply, he observes:
Krugman suggests that the supply is practically fixed. If he's right in the extreme case (i.e. perfectly inelastic supply) then the game's over. The oil companies get all the benefit. But that's probably not the case either. A commenter at Angry Bear posts a link to the ever useful Energy Information Administration, or EIA. They point out in a recent newsletter that gasoline inventories are currently at the high end of the normal range. Given that production of the summer formulations has probably not fully ramped up yet, they probably have a little more wiggle room than Krugman is assuming.
The rub? According to this report from the Department of Energy, "gasoline inventories are currently still in the upper half of the 5-year average range for this time of year." In other words, there is some excess supply right now.
Here's the real kicker - the most recent academic study on federal gasoline tax found that "The federal specific gasoline tax falls equally on consumers and wholesalers." What this means is that, if price were to increase, it would likely not increase by more than 9.2% (note that this study had no reason to consider the effects of an excess profits tax into the equation - I believe it provides a strong disincentive toward continued price gouging). There would still be net savings to consumers. Keep in mind that this isn't just about what you save at the pump - but reduced transportation costs, which can affect many other commodities.
Here is another economist who points out that, because demand is inelastic in the short-run, tax incidence is likely to be 50/50.
Tags: gas tax Obama Clinton (all tags)
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