When the government decides to cut taxes, it cannot directly control who benefits. The so-called incidence of the tax cut is determined by supply and demand. When demand is relatively constant, the tax tends to benefit buyers. When supply is more inelastic, more benefits go to sellers. The best the government can do is observe how taxation works out in practice and then adjust policy accordingly.
Consider the case of Maryland, which suspended its gas tax for a month last spring. Analysis suggests consumers saved as much as 26 cents a gallon — with an additional 10 cents being kept by sellers. That extra 10 cents per gallon of profit emboldened gasoline refiners to push more supply into Maryland rather than other states.
It was this additional supply, not the tax exemption, that lowered costs for Maryland residents. After the tax exemption ended, gas prices in Maryland were higher than in neighboring states.
If all 50 states and the federal government introduced gas tax exemptions, refiners could not easily adjust supply from one state to another; they would just have to produce more gasoline. But a lack of refining capacity is precisely why US gasoline prices are so high to begin with.
Biden seemed to recognize this fact in a letter he sent to refiners last week, urging them to increase production. They would have to invest time and money to do this. A three-month tax holiday would boost demand now, encouraging consumers to take more holiday trips – before capacity can be increased – and push demand lower later in the year after capacity investments are complete. Rather than saving consumers money, a federal gas tax exemption is likely to lead to even higher profits for refiners in the short term and reduce their incentive to invest in the long term.
It is now clear that the government wants to reduce demand for oil and gas over the next decade, potentially stranding any new investment in the industry. It is precisely this mismatch between the White House’s short-term demands and its long-term policy that makes the entire oil and gas industry reluctant to expand.
If the White House were serious about tackling the gas shortage problem, it could take steps — but it needs to be more creative.
One such idea comes from Employ America, a left-leaning think tank that takes the market seriously: The Department of Energy could work with the Federal Reserve to sell oil producers insurance against falling prices. If demand for oil stays high or geopolitics pulls more supply out of the market, the insurance expires unused. If demand for oil falls, the Department of Energy can take advantage of lower prices to replenish and expand US strategic oil reserves to cushion the price shock.
Instead, the government is threatening refiners with antitrust action while Congressional Democrats consider a tax on windfall profits. A gas tax exemption — and the increase in windfall profits — would put Congress and industry on a collision course.
If the Biden administration wants the oil and gas industry to produce more gasoline to drive down prices, then it must do something it seems reluctant to do: work with the industry to put it in a more dominant position globally . In this way, the industry can increase its exports even if demand from the US falls. A three-month gas tax holiday would be the worst of both worlds – it would boost domestic consumption precisely when production is at capacity, while doing nothing to encourage the industry’s international expansion.
More from the Bloomberg Opinion:
• Sorry, but for you, oil is trading at $250 a barrel: Javier Blas
• Kingdom holds all the cards in US-Saudi Reset: Bobby Ghosh
• Big Oil’s windfall creates industry dilemma: Liam Denning
This column does not necessarily represent the opinion of the editors or of Bloomberg LP and its owners.
Karl W. Smith is a columnist for the Bloomberg Opinion. Previously, he was vice president for federal policy at the Tax Foundation and an assistant professor of economics at the University of North Carolina.
For more stories like this, visit bloomberg.com/opinion