Gas-Tax Holiday Wouldn't Lower Prices at the Pump

On the surface at least, giving drivers a summertime "holiday" on the 18.4 cent federal gasoline tax sounds like a good idea.

The proposal, first made by Republican presidential candidate John McCain, is now being supported by Democratic candidate Hillary Clinton.

Too bad the idea flunks basic Economics 101.

“Unless the goal is to temporarily boost profits for petroleum refineries and foreign producers, the proposal makes no sense,” says Len Burman, director of the Tax Policy Center.  

The reason is basic market dynamics. Supply is relatively tight, so any drop in pump prices would encourage even more demand when it is already rising with the traditional summer driving season.

That in turn could bump up prices, so any benefit to drivers from the a tax holiday could likely be temporary. Burman, in fact, says prices would rebound almost "immediately" because supply could not be ramped up quickly enough.

“If supply is fixed, it is very, very unlikely that the gasoline tax cut is going to produce lower prices at the pump,” says Jerry Taylor, senior fellow at the CATO Institute.

Not only that, but the Treasury would lose an estimated $10 billion in tax revenue over the three months, Taylor adds. Where would it go? To the oil and gas companies.

“There is nothing necessarily wrong with that--I’m a libertarian," says Taylor. "But it would be rather odd to see Hillary Clinton champion a policy whose net effect it to take money from the taxpayers and give it to ExxonMobil .”

Senator Barack Obama remains opposed to the oil tax holiday idea, despite having voted for a similar move on a state level, when he was an Illinois state senator.

Earlier this week, he derided the idea of the three-month suspension for offering every American $30 in savings. “Half a tank of gas – that’s his big solution,” he told a North Carolina audience about the McCain plan. Clinton’s plan is essentially the same.

Revenue raised from the oil tax is earmarked for the federal highway trust fund which distributes more than $28 billion a year to states to maintain road and bridges.

Clinton and Obama largely agree on a range of other key energy issues but analysts suggested the populist mileage supporting a tax holiday fit with Clinton’s desire to portray Obama as out of touch with the middle-class concerns. 

One uncertainty in the tax holiday scheme is that there is no guarantee that pump prices would reflect the full cut  - which would also apply to the 24.4 cent diesel tax   - between Memorial Day and Labor Day.

For consumers to actually see these cuts would require cooperation from oil firms and thousands of distributors, who are under no obligation, and who may have no incentive if they face limited competition. 

Past experience suggest prices rise quickly but tend to be stickier coming down again. 

Oil Inventory Market - Real Barrier to Consumer Relief?

One key question is just how fixed the country’s oil supply really is and how it would respond to increased demand.

There have been significant oil inventory build-ups but much of that is held by large institutional investors hedging against violatility in equities markets, and not short-term speculators more liable to respond to demand upticks, says Taylor.

“If …most of this oil inventory is locked up for these large institutional investors it is unlikely that that supply will be available in the market simply because demand kicked up a little bit in response to a price cut,” he says.

Aggravating this is that refiners are cutting back production runs to protect margins that are declining in the current gasoline glut, says Fadel Gheit, an oil analyst with Oppenhemier & Co.

Asked whether the cut-backs might invite government charges of collusion,
the CEO of a major refining company maintained his first obligation was to his shareholders, noted Gheit, declining to name the company.

Valero , one of the country’s largest refining firm has cut production, in response to earnings which have dropped precipitously.

Populist Politics or Tough Love

President George Bush was asked at his Tuesday press conference whether he supported an oil tax holiday but he dodged the question. If he had endorsed the idea, some might have wondered why he had not proposed it himself, said analysts.

But all the talk in recent says about an oil tax holiday might be just that – talk.

“This is a political proposal, not a policy proposal,” said Dan Weiss of the Center for American Progress, who was unaware that any bill had been introduced on the subject.

The effect is that it is a ‘nice gesture’ of populist concern with little or no downside, said Taylor. It is “an attractive political gesture is going to gain support just like the way that an attractive lump of sugar is going to gain the support of ants.” 

An oil tax holiday has been tried at the state level, including in Illinois, where state senator Obama voted with a majority in the state legislature for a six-month suspension of the state’s 6.25 percent sales tax on gas.

A subsequent study by the National Bureau of Economic Research found that gas prices fell just 3 percent and local public opinion polls showed that less than a third of drivers were even aware they were paying less.

Some economists maintain a national gas tax holiday would have even les impact for consumers than state tax cuts.

“The politician that would earn my respect – for a change – would be the one who says we should increase taxes not reduce them,” says Gheit. “We have an addiction problem – you don’t give people more of the substance that they are addicted to, you give them less.”

© 2009 CNBC.com