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A Federal Gas Tax Holiday Is A Terrible Idea


President Biden is proposing a three-month federal gasoline tax holiday. He may want to appear to be doing something to address high inflation, which is both an economic concern and a growing political problem for his Administration. But suspending the gas tax is a terrible idea that, on the margin, will make inflation worse, not better.

The impact of a federal gas tax holiday would be extremely modest. On average, a driver in the US uses about 600 gallons of gasoline annually. Suspending the 18.4-cent-per-gallon federal levy would save a typical driver less than $10-a-month. To put it another way, the federal tax represents about 3% of the cost of $5-a-gallon gasoline.

Biden also urged states to suspend their gas taxes. Because state levies often are much higher than the federal tax, the impact would be more significant and drive prices even higher. But since Biden has no ability to suspend state gas taxes, let’s stick with the federal tax.

While the effects would be small, almost everything about a gas tax holiday runs in the wrong direction. It would:

· Increase consumption at a time of low supply, thus driving up pre-tax prices and worsening climate change.

· Discourage consumers from purchasing more energy efficient vehicles.

· Provide a windfall to oil producers, the very companies Biden has been blasting for price gouging.

· Temporarily eliminate a key funding source for infrastructure improvements.

Let’s unpack a few of these issues:

Demand for gasoline. Gas prices skyrocketed in recent months because of a growing imbalance between oil supply and demand. Supply was constrained in part due to Russia’s invasion of Ukraine. At the same time, demand increased sharply as the COVID-19 pandemic receded.

While a tax holiday will lower the after-tax price of gas, that lower price will boost demand, worsening those supply shortages, and, yes, raising the pre-tax price. Any net benefit for drivers would be very small.

It is hard to know exactly how much the tax cut would affect driver behavior. Economists have long estimated that consumers barely respond to short-term changes in gas prices. They don’t drive less, and they don’t buy more fuel-efficient vehicles.

But more recent studies found that drivers may be more responsive than previously thought. Several estimate that for every dollar prices increase, spending on gas falls by between 27% and 37%, largely because people drive less.

However, even the newer studies were done before the current situation. How will a combination of extremely volatile prices, the effects of COVID-19, and the increases in telecommuting opportunities affect consumption? Honestly, nobody knows.

The modelers at the University of Pennsylvania’s Penn Wharton Budget project, who assume a very low response to a temporary tax reduction, estimate drivers would buy only a gallon or two more over a nine-month holiday. Studies that assume a higher response would show a bigger increase in consumption. But, either way, drivers would buy more gas, which is exactly the wrong response when supplies are limited.

Effects on climate. Biden already must struggle between short-term demands for more energy and his longer-term goal of slowing climate change. But cutting taxes on gasoline conflicts with both. It only increases demand for energy and encourages the use of fossil fuels.

Who would benefit? The Penn Wharton analysis estimates consumers would receive about 80% of the benefit of a gas tax holiday. The rest would go to retailers and producers. But when supply is extremely limited, as it is today, even more of the benefit goes to producers. Biden is urging oil companies to pass the tax cut on to drivers but there is no way for him to enforce this.

This result conflicts with the Administration’s sharp criticism in recent weeks of oil companies that, it insists, are making windfall profits from rising gas prices.

Infrastructure spending. A gas tax holiday could reduce federal revenues by about $10 billion, depending on how long it lasts. Temporarily ending the tax, already insufficient to fund the Highway Trust Fund, would require the federal government to borrow more to pay for improvements to roads, bridges, and ports, which also would add to inflationary pressures.

The inevitable political dispute over how to make up the additional trust fund shortfall could even slow work on these projects or give governors pause before starting new ones. That, in turn, would be counterproductive since infrastructure bottlenecks are one cause of the supply chain issues that are limiting the availability of goods and driving up prices.

Biden’s gas tax holiday announcement, if it comes, might be little more than political theater. Congress must approve any gas tax cut and Senate Republican leaders already oppose it. Without their support, the plan is not likely to get the 60 votes needed to pass the Senate.

But Biden will be able to say he tried to do something about gas prices. And Democrats will claim Republicans will happily cut taxes for the rich and corporations but not for ordinary Americans.

Proposing a gas tax holiday may reap Biden small short-term political benefits. But suspending the tax would only worsen inflation.

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