Savings from a gas tax cut – winners and losers

Kojo A.Quartey

As gas prices have skyrocketed over the past few weeks, we are all feeling the pain at the pump and would appreciate some relief. The price of gasoline has a direct impact on the other goods we buy and, consequently, on the inflation rate, which is the highest in 40 years. How will some gas tax relief translate? Well, it’s complicated. This is due to the concepts of supply and demand, the “incidence” of a tax and the concept of “elasticity”. Therefore, there can be no assurance that a reduction in the federal/state gasoline tax will directly benefit consumers as intended. My comments here are purely economic.

It is the supplier who obtains the immediate relief from the tax reduction, and it is up to this supplier to then pass on part or all of this reduction to the consumer. The amount passed on depends on price elasticity, i.e. how people react to the change in price – the larger the reaction, the more elastic it is. Inelastic means a small reaction to price change. The more inelastic the demand, the more the supplier holds back and the less savings are passed on to the consumer. The supplier controls the price at the pump, the consumer only controls the quantity he chooses to buy. It is almost impossible for a consumer to control the price of a product that he has to buy anyway.

Let’s apply this concept of elasticity to gasoline prices. Gasoline demand is inelastic in the short run. It’s one of those goods that people tend to consume anyway as its price changes because there are few substitutes and it tends to be a necessity. Gasoline prices tend to be inelastic because as the price of gasoline increases, the demand for gasoline does not decrease significantly. Even if gas prices go up, people don’t necessarily drive less, although with big increases people start carpooling or using public or alternative transportation, if they can.

Recently, as gasoline prices have risen, policymakers have considered lowering the federal and/or state gasoline tax. Certainly viable alternatives. There is only one small problem with this: a reduction in these taxes does not mean that gasoline prices will be reduced by the amount of the tax. There is nothing to prevent the supplier from capturing most of this drop and not passing it on to the buyer because demand will always remain high for this product, which has few substitutes and tends to be a necessity for many, because it is price inelastic.

Tax incidence is an economic concept that describes who ultimately pays the cost of a tax increase or who benefits from a tax decrease. This payment or benefit is not always direct. The fundamental question is to know who bears the burden or benefits from the advantage or the reduction of the tax? The supplier (company) or the consumer? It’s complicated, and not all economists agree on the tax incidence, because it depends on a variety of factors, including but not limited to consumer reaction to the tax. Suppose we eliminate the federal gas tax. For example, if the price of gasoline decreases by a tax rate of, say, 20 cents, will gasoline prices decrease by 20 cents? Unlikely, as the supplier will capture some of this decrease and consumers will always pay more than the 20 cent decrease. The supplier keeps some, say 10 cents, and passes the rest on to the consumer. In effect, the consumer ends up saving only 10 cents, the supplier earns 10 cents, and the government loses all 20 cents, which then does not go to the government services for which they were originally used. In short, tax revenue would be diminished, the supplier would gain some of it, the consumer would gain a smaller one than expected.

Ultimately, there are so many factors when it comes to passing a gas tax on to consumers through suppliers; it is not that simple. It is complicated.

Kojo A. Quartey is president of Monroe County Community College and a former professor of economics.

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