Gas Price Fixes That Won't

Summary

Hillary Clinton and John McCain are offering overburdened motorists a federal "gasoline tax holiday." But economists say that the proposal is unlikely to actually lower the price of gasoline. McCain’s plan would essentially give federal funds to oil refineries, while the net effect of Clinton’s plan probably wouldn’t be much at all, although it would create a lot of new administrative work.

President Bush took another tack, dusting off a couple of golden oldies that he said would help halt the escalation in motorists’ costs: allowing companies to drill for oil in Alaska’s Arctic National Wildlife Refuge and encouraging construction of more refineries.

But opening up ANWR would lead to a negligible bump in world oil supply, and would provide barely 5 percent of what the U.S. consumes today. The spigot wouldn’t even be fully opened until the mid 2020s — if Congress acts now, which isn’t at all likely. And Bush fails to acknowledge that investors aren’t interested in building refineries for strong business reasons that go beyond the tangled permitting process.

Analysis

In a week that saw furious truckers steer their rigs to the nation’s capital for a horn-blaring war dance over escalating fuel prices, President Bush and two candidates who want his job were offering proposals that are unlikely to provide any real comfort to motorists.

Happy Holidays?

Sens. John McCain, the presumptive Republican presidential nominee, and Hillary Clinton, who hopes to win the Democratic nomination, have both called for suspending the 18.4 cents per gallon federal tax on gas as well as the 24.4 cents per gallon tax on diesel. McCain proposed the idea on April 15, while Clinton introduced her twist on it on April 25. Both candidates claim that the “tax holiday,” which would extend from Memorial Day through Labor Day, would save Americans money by mitigating the rising price of fuel.

McCain (April 15): I propose that the federal government suspend all taxes on gasoline now paid by the American people — from Memorial Day to Labor Day of this year. The effect will be an immediate economic stimulus — taking a few dollars off the price of a tank of gas every time a family, a farmer, or trucker stops to fill up.

Clinton (from campaign Web site): Suspending the gas tax will provide real, immediate assistance to American families and for our economy. Recent testimony before the House of Representatives by the American Trucking Association indicates that even small changes in price can have big impacts. Just a one-penny decrease in the price of diesel annualized over an entire year would save the trucking industry $391 million a year.

Clinton campaign spokesperson Geoff Garin said in a conference call this week that the proposal would save each driver $70. The Clinton campaign did not respond to our request to clarify how it arrived at that figure. But the nonpartisan American Association of State Highway and Transportation Officials estimates that the total savings for the average American motorist works out to about $28; for a two-car household, that would be $54.

That’s IF prices actually dropped 18.4 cents per gallon. However, there’s every indication that they wouldn’t. Here’s why: According to the basic principles of supply and demand, cutting the price of an item causes people to buy more of it. That’s why stores put items on sale. But when something is priced too low, consumers will buy it faster than it can be manufactured, which leads to shortages.

For gasoline, this means that cutting the price by 18.4 cents per gallon — even though that’s only about 5 percent of the current going rate — will likely stimulate demand for more gas, economists say. Unfortunately, there’s not all that much more gas that can be provided to U.S. consumers. The refineries that turn crude oil into gasoline are already working at close to full capacity. According to the Department of Energy, U.S. refineries have the capacity to process 17.4 million barrels of oil each day. Since only about 46 percent of a barrel of crude oil is converted to gasoline, U.S. refineries, operating at their peak, can produce only 8.06 million barrels per day of the stuff most cars run on. But the DOE also says that the U.S. consumes 9.25 million barrels of gasoline per day. In other words, American motorists are already using about 1 million more barrels of gasoline per day than American refineries can produce.

With the supply of gasoline pretty much fixed (at least in the short term), the increased demand triggered by the price cut will lead consumers to bid up the price of gas. Len Burman of the nonpartisan Tax Policy Center says eliminating the federal tax won’t actually lower the price of gas because “supply constraints will push pump prices near their pre-holiday levels.” He goes on to warn that “if that didn’t happen, there would be shortages.” The libertarian Cato Institute’s Jerry Taylor agrees that a short-term gas tax holiday will have "little impact on pump prices."

For all the legislative prowess of McCain and Clinton, we’re doubtful that either candidate can rewrite the laws of supply and demand. That 18.4 cents per gallon won’t go to consumers. Instead, the proposal will simply shift that money from government coffers to the oil companies. We’re willing to grant that if the laws of economics themselves took a holiday and the price did drop that much, the amount saved might be meaningful to many motorists, particularly those who are low-income and those who drive a lot. And there would likely be all kinds of ancillary benefits involving price reductions for food and other products that have to be transported, as well as airline tickets and the like.

But we can’t find any economists who think we’ll actually see that drop in the price of gasoline. Others have tried and failed as well. And the Clinton campaign hasn’t produced one, either.

Plucking from the Profits

There’s another catch to the McCain and Clinton proposals. Currently, the gas tax is deposited directly into the Highway Trust Fund, which is used to pay for upgrades to roads and bridges. The American Society of Civil Engineers estimates that the three-month gas tax holiday could cost as much as $8.5 billion.

McCain has responded by pledging to fund the Highway Trust Fund out of general revenues. That, of course, means adding another $8.5 billion in federal debt, which in turn means adding as much as $383 million per year in interest payments.

Clinton’s plan is somewhat more complicated. She promises to impose “a windfall profits tax” on oil companies — the mechanics of which she hasn’t outlined — and use that to fund the gas tax holiday.

Clinton (May 2): We have a choice. We can choose to have you continue to pay the federal gas tax this summer or we can choose to try to make the oil companies pay it out of their record profits…We ought to say: Wait a minute, we’d rather have the oil companies pay the gas tax than the drivers of North Carolina, especially the truck drivers, or the farmers, or other people who have to commute long distances.”

Problem: If, as we outlined above, the price of a gallon of gas stays roughly the same despite the "holiday," then what used to be 18.4 cents that would go to the federal government for every gallon sold instead goes into the coffers of the oil companies as profit. That would be the profit that Clinton is proposing to tax to recover the cost of the gas tax holiday. (Clinton planned to introduce a bill today with New Jersey Democratic Sen. Robert Menendez to implement her proposals; Sens. Charles Schumer and Sherrod Brown introduced legislation in March to tax "excess profits" of oil companies.)

Paul Krugman, a Princeton economist, calls Clinton’s plan "pointless." We think it sounds a bit like a Rube Goldberg machine.

The ANWR Answer

Meanwhile, President Bush tried to reheat some energy proposals that he’s championed for years, to little effect. There are reasons for that.

Back during the 2004 presidential election and even before, Bush called for Congress to allow drilling in the Arctic National Wildlife Refuge, arguing that it would help the U.S. achieve energy independence, a goal we dismissed as unrealistic at the time. In 2003, 2005 and 2006, ANWR provisions were attached to several bills, but never made it to final passage. Not one to give up, Bush trotted the idea out again at a press conference this week:

Bush (4/19): The Department of Energy estimates that ANWR could allow America to produce about a million additional barrels of oil every day, which translates to about 27 millions of gallons of gasoline and diesel every day. That would be about a 20 percent increase of oil — crude oil production over U.S. levels, and it would likely mean lower gas prices.

ANWR could create nearly a million barrels of oil a day (though the mean estimated “peak” number is 876,000 and would not hold steady "every day" as Bush claims). Current U.S. crude oil production is 5.1 million barrels a day. With rather generous rounding, one could calculate that oil from ANWR would bring a 20 percent increase in current U.S. crude oil production.

But supply is only one part of the equation. Bush didn’t mention that with U.S. consumption at 20.6 million barrels of oil a day, the ANWR bounty, if all went well, could only satisfy 5 percent of the U.S. thirst. That wouldn’t have much impact on eventual gas prices.

More importantly, any effect from drilling in ANWR wouldn’t be realized for many years. Even if legislation to tap the oil reserves were passed today, it would take years to reap the crude. An Energy Information Administration analysis in 2004 concluded that "between 7 and 12 years were required from an approval to explore and develop the coastal region of ANWR until first production." The peak production of 876,000 barrels per day wouldn’t come about for another five years or so. So even assuming Congress gave the go-ahead today, the first oil wouldn’t begin flowing until sometime between 2015 and 2020, with peak output half a decade later.

Logic Alert

Bush was inconsistent in explaining ANWR’s potential impact on gas prices compared with other alternatives. A reporter asked Bush if he would consider temporarily ceasing the government’s purchase of oil to fill the Strategic Petroleum Reserve (SPR). He responded:

Bush: I don’t think it would affect price, for this reason: We’re buying, at the moment, about 67,000 to 68,000 barrels of oil per day, fulfilling statutory obligations to fill up the SPR. World demand is 85 million barrels a day. So the purchases for SPR account for one-tenth of one percent of global demand. And I don’t think that’s going to affect price.

The numbers are right. The SPR takes away about 68,000 barrels of oil per day, and according to EIA, world oil consumption is 83.6 million barrels a day. Furthermore, his conclusion that suspending the SPR purchases may not affect price is a fair one. Some experts have said it might; others dissent. As the Congressional Research Service summarized, gasoline prices "are sustained by a number of conditions" and they may remain unchanged "even if additional crude oil appeared on the market."

But the notion of tapping ANWR, the alternative Bush was pushing, can be dismissed using exactly the same logic. In fact, the EIA found in a 2004 study that:

EIA: ANWR coastal plain oil production in 2025 is projected to constitute between 0.5 to 1.3 percent of total world oil consumption.

So according to EIA estimates, the oil that could gush from ANWR would actually supply as little as four tenths of 1 percent more of world oil consumption than the oil that would result from halting purchases for the SPR. Not much of a distinction, particularly since ANWR oil wouldn’t begin peak flow for more than a dozen years.

Ramp Up the Refineries!

The influx of crude oil alone cannot lower prices. Bush alluded to this, noting that "another reason for high gas prices is the lack of refining capacity." It’s true that no matter how much crude oil you have, only so much can be processed into usable gasoline, depending on refinery capacity. And our current facilities are working at full tilt.

But Bush oversimplified the problem in saying, "we ought to expand our refining capacity by permitting new refineries and getting after it quickly." It’s true that there is a myriad of federal, state and local regulations and permits to navigate for anyone wanting to build a refinery. But he ignores the fact that they are tough to build, expensive, and for many companies, simply not worth the trouble.

As a 2005 New York Times story about a company’s attempt to build the first new refinery in the country since 1976 summarized:

NY Times: The business of turning crude oil into gasoline, jet fuel or heating oil has rarely been a lucrative proposition. It has dismal profit margins compared with its more glamorous cousin, exploration. It is highly cyclical and fairly unpredictable, because demand for gasoline swings sharply by season.

Ten years after the company first decided to try to build the refinery and seek permits, it still lacks enough investors and hasn’t begun construction.

Someone did get something right. Bush is correct in noting that the average price for a gallon of gas has climbed $1.40 in the last 18 months, from $2.25 to $3.65. So while politicians’ solutions may slip on faulty reasoning, the problem remains a stubborn fact.

— by Justin Bank and Joe Miller

Sources

American Association of State Highway and Transportation Officials. "McCain’s Gas Tax Holiday Would Devastate Highway and Transit Programs While Saving Motorists an Average of $28." 15 April 2008. Transportation.org. 30 April 2008.

American Society of Civil Engineers. "‘Gas Tax Holiday’ No Vacation for Economy, Consumers or the Environment." 15 April 2008. Denver Business Journal. 30 April 2008.

Americans for Transportation Mobility. "ATM Statement on Sen. John McCain’s ‘Gas Tax Holiday’." 15 April 2008. PRNewswire.com. 30 April 2008.

Bamberger, Robert and Pirog, Robert, "The Strategic Petroleum Reserve: Affects on Gasoline Prices of Selected Fill Policies," Congressional Research Service. 27 Sept 2004.

Bureau of Transportation Statistics. "Motor Vehicle Fuel Consumption and Travel." 2007. U.S. Department of Transportation: Bureau of Transportation Statistics. 1 May 2008.

Burman, Len. "McCain’s Gas-Tax Plan is On Empty." 18 April 2008. The Tax Policy Center. 30 April 2008.

Energy Information Administration. "Basic Petroleum Statistics." July 2007. U.S. Department of Energy. 30 April 2008.

Energy Information Administration. "U.S. Refineries Operable Capacity." July 2007. U.S. Department of Energy. 30 April 2008.

Hillary Clinton. "North Carolina: Hillary Clinton’s Plan to Address Soaring Prices at the Pump." 28 April 2008. HillaryClinton.com. 30 April 2008.

Murray, Mark. "The Downside to Suspending the Gas Tax." 15 April 2008. MSNBC. 30 April 2008.

Power, Stephen. "McCain’s Gas-Tax Plan May Be a Clunker." 15 April 2008. Washington Wire: The Wall Street Journal. 1 May 2008.

"Press Conference by the President," White House. 29 April 2008.

Taylor, Jerry. "Attention Sen. McCain: Moderation in the Pursuit of Tax and Spending Cuts is No Virtue." 18 April 2008. Cato @ Liberty. 30 April 2008.

Taylor, Jerry and Peter Van Doren. "Don’t Increase Federal Gasoline Taxes—Abolish Them." 7 August 2007. Policy Analysis. 30 April 2008.