Arnold Kling

Oil Econ Follow-up

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Health Care Follow-Up... Oil Econ, Once More...

Earlier, I posted on the Strategic Petroleum Reserve. Nick Schulz has some more on the gas price issue.


Ketchup at a retail grocery store is $0.16 an ounce meaning it rings in at an impressive $20.48 a gallon, almost ten times what gas costs.

Gas is also cheaper than orange juice ($6.64 a gallon), Snapple ($10.32 a gallon); olive oil ($51.04 a gallon), eye drops ($995.84 a gallon) and nasal spray ($2,615.28 a gallon) according to figures from the Department of Labor, Consumer Price Index.


He links to Lynne Kiesling, among others, for economic analysis.

If the electorate thought the way I do, then President Bush would not get very far with his attacks on Senator Kerry for allegedly supporting a higher gasoline tax. I think that higher gas taxes would capture more revenue domestically and put less into the pockets of OPEC. It is a policy that deserves careful consideration.

For Discussion. Will the rise in the "OPEC tax" reduce U.S. economic growth significantly?


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COMMENTS (23 to date)
Eric Krieg writes:

Like it or not, this is a country that relies on the automobile for transportation. A gas tax is a limit on our freedom of movement.

That's not exactly an economic argument, but it is still true.

Back in 2000 when we had a price spike to over $2.00 per gallon here in Chicago, I noticed a decrease in traffic volume during rush hour. So I don't think that the Americans are totally insensitive to the price of gasoline. And if the poor aren't driving, they probably aren't working either. I don't think we want to force the poor to work less.

Shank writes:

I see higher gas prices as an opportunity to encourage the use of public transportation and for the development of alternative energy sources to be relatively cheaper than it has been. I live in Tulsa, Oklahoma - consistently the cheapest city in the United States to buy gasoline. And, as luck would have it, hardly anyone uses our public transportation system. Gas prices measure our willingness to pay for the independence of having our own vehicles. If you don't want to pay higher gas prices, don't purchase gasoline - take the bus, walk, car pool, bicycle, etc. Businesses can also use this opportunity to invest in alternate, perhaps more efficient, energy sources - which will help our economy in the long-run.

Boonton writes:

I think you missed Arnold's point. When you tax a good being supplied by a monopolist, the person who pays that tax turns out to be the monopolist. IF OPEC has the market power to control the price of gas and gas is, let's say, $1.75 /gal then a $0.25 gas tax will not result in prices of $2.00 per gal. The prices will remain the same and OPEC will cut their profits to pay the tax.

Eric Krieg writes:

>>If you don't want to pay higher gas prices, don't purchase gasoline - take the bus, walk, car pool, bicycle, etc. Businesses can also use this opportunity to invest in alternate, perhaps more efficient, energy sources - which will help our economy in the long-run.

You have to separate market driven price increases (say, from increased demand in China, or the fact that the easily recovered oil has been all used up) from ones caused by taxes or regulations.

If gas prices increase for market driven reasons, then money spent increasing efficiency is well spent.

If gas prices increase because of taxes, then money spent to increase energy efficiency is subject to opportunity cost. What else could that money be spent on? Would spending the money on something else make us better off than if we spend it on energy efficiency?

I don't think that the government should be making gasoline artificially cheap or artificially expensive. Gas taxes that go to fund transportation infrastructure are probably a good idea as well.

But when you start jacking up the gas tax just because you don't like OPEC, you are going to damage the economy because of opportunity cost. Investing in energy efficiency is not going to give you the financial returns that investing in communications and IT are going to give you.

People forget that the IT boom of the 1990's coincided with historically low energy prices (really, the lowest energy prices on record). Gas sold for 89 cents a gallon in 1998. All that money that we didn't spend on energy was plowed into the IT bubble.

Do the math. The Honda Civic hybrid costs $2000 more than a similar non-hybrid Civic. The hybrid gets 47 mpg in the city cycle, vs. 32 for the non-hybrid. What kind of ROI is that? Not very good. At 12,000 miles per year, at $1.78 a gallon (what I paid yesterday morning at Marathon here in the Chicago 'burbs) your ROI is 8.4% and your payback period is over 9 years. I can guarantee you that the Civic Hybrid is not going to last 9 years and 110,000 miles. You would have to replace the battery before that time, which is a multi-thousand dollar expense.

Investing in energy efficiency is for suckers.

Shank writes:

Unless demand for gasoline is completely elastic, wouldn't at least some of the increase in gas tax fall on the consumer? If we slapped an additional $.50/gallon tax on gasoline, I doubt prices would stay the same. I see them rising by something closer to $.50/gallon - It would hurt OPEC, but only slightly.

Am I grossly overestimating the inelasticity of demand for gasoline?

I don't disagree with a gas tax in principle, but I don't see it as an effective way to deal with OPEC. Investing in public transportation infrastructure at this point seems vital, so that we can reduce our physical and psychological dependence on our vehicles. That way, when gas prices rise, due both to increased worldwide demand and to artificial reductions in supply, people - especially in the lowest income range - will have more options.

Eric Krieg writes:

Shank, you underestimate how crappy it is to rely on public transportation.

The reason that no one utilizes PT in cities like Tulsa is that it simply takes too long to get where you need to go. There isn't enough density to make PT work.

The difference in commute times might be as much as 4 or 5 times! You want to make the poor waste their time on 2 hour commutes when with a car they could do it in 20 minutes or 1/2 an hour? That hardly seems fair.

Boonton writes:

Demand would have nothing to do with it. In the case of a monopoly, they adjust output so as to maximize revenue. This is where elasticity of demand is taken into account. At $1.75 per gal, OPEC may get the most revenue while at $2.00 per gal OPEC may loose revenue since people will not consume as much gas.

Say $1.75 is the ideal price from OPEC's point of view. In that case a $0.25 gas tax cannot be passed onto the consumer. OPEC, remember, would take a revenue hit at $2 per gal. The price of gas remains the same only OPEC pays $0.25 per gal of its profits to the US gov't. This is what Arnold means when he says a gas tax takes money out of OPEC's pockets.

Randal Verbrugge writes:

Suppose the government must collect $X in taxes. The question then becomes, what should be taxed, and how much? Leaving aside a perceived requirement that the tax system be progressive (there is no reason why all desired progressivity can't be acheived on the spending side, e.g. transportation vouchers), the key is to minimize the deadweight burden. If there is a tax which brings private costs closer to social costs, that's a great tax.
I would argue (agreeing with MankiwI [I don't know if his current "affiliation" necessitates a change in his opinion ...]) that the gas tax is, from this perspective, a good tax. Gasoline consumption causes pollution and congestion, external costs. And gas taxes would stimulate the development of cleaner energy sources, including "nuculer" energy.
Another good tax is a property tax, by the way; you can't affect the total amount of land in the economy (it's in fixed supply), and it would discourage empty lots.
Then we could get rid of less efficient taxes; supply your favorite one here.

mcwop writes:

Rely on public transport? Via Public transport it takes me over an hour to get to work. It is a 12 mile drive.

Shank writes:

Thanks for the explanation, Boonton. It makes sense now. I guess if a monopoly *could* get away with raising prices, it would have done it already.

Lawrance George Lux writes:

A rise in the Gas tax will not affect the U.S. economy very much, unless it is impactive; small increases do not affect economic and social operations very well, simply applying pressure for increased Wages and Profits. Would it cancel OPEC revenues? No, as they have multiplex sources of Sales venue, and the U.S. economy has to purchase as currently set up.

I would like to see an effective Fuel tax, one which is pegged to a Base Year, differs by type of fuel--Heating Oil, Disel, Gas, Propane, and increases at proscribed rate per price increase over Base Year. The level of Taxation would propel proper refining capacities by the greater profitability to the Refiners for each needed product at sustainable levels of Output. Setting the perferred rates, though, would require extreme specialist analysis. lgl

Eric Krieg writes:

Boonton, your explanation makes no sense. First, the cost of a gallon of gas is not all due to the price of crude. There are all kinds of different costs reflected in the price (taxes, cost of refining, cost of marketing, even the cost to get the stuff out of the ground and transported to your local gas station). I don't see how OPEC can be shown to absorb all those costs.

OPEC is hardly a perfect cartel. There is plenty of cheating going on by memebers, not to mention that not every oil producer is even in the cartel. More or less, the Saudis are the only ones who have excess capacity, everyone else is pretty much pumping as much black gunk out of the ground as they can.

Eric Krieg writes:

>>If there is a tax which brings private costs closer to social costs, that's a great tax.

And if the gas taxers like John Kerry actually made such an argument with real numbers, the world would be a very nice place.

In actuality, no one justifies the gas tax in terms of the social cost of automobile use. At best, it might reflect a portion of the nation's road building needs.

Calculating the social cost isn't exactly an easy thing to do. It would be interesting if a Democrat argued that the gas tax should reflect Iraqi reconstruction costs, and a portion of our military budget. At least then there would be real numbers to go along with the rhetoric.

Daniel Lam writes:

"When you tax a good being supplied by a monopolist, the person who pays that tax turns out to be the monopolist."

I don't think this is quite right. A profit-maximizing monopolist sets the price so that the elasticity of demand with respect to per-unit-profit is equal to one. If P is the price per unit, C is the production cost per unit, and f(P) is the demand function, this elasticity is

(P-C)/f * f'(P) = 1

A tax levied on the producer leads to a higher C, causing this elasticity to fall below 1, giving the monopolist an incentive to raise the price.

Jim Morse writes:

If we're going to tax gasoline to capture more revenue domestically and put less in the hands of OPEC, why stop there? Why not tax everything we import? Think of the revenue we'd capture! Think of how much less we'd put in the pockets of those darned foreigners! Heck, if we set the tax on imports high enough, we could keep imports out of our country completely! We'd be putting absolutely no money in the pockets of foreigners! Just think of how rich we'd be then!

Shank writes:

It seems that the tax would be fully absorbed by OPEC only if the U.S. were the only buyer. If OPEC produces at a level to set the world price at $1.75/gallon as a profit maximizing point, and the U.S. passes a $.25 gas tax, it means that OPEC would have to change production to a point that the world price of gas is $1.50 (so that consumers are paying $1.75 - the $1.50 cost of gas plus the $.25 tax). That would mean that their revenues from other countries would fall from $1.75/gallon to $1.50/gallon. It seems that OPEC would change production so that the world price would fall slightly, but that the price would not be low enough to offset tax to U.S. consumers. Am I missing part of the puzzle?

luke writes:

What is the gas tax used for? My understanding is it is meant to be an indirect user fee and the revenues from it are supposed to go to the repair and development of roads...is this correct?

What other reasons would there be for the tax? If we want to decrease our dependency on OPEC, let consumers stop buying OPEC oil, or let companies get our own oil reserves, or let people start choosing solar or whatever.

I don't think the purpose of a tax is to discourage or limit people's choices, but rather to pay the costs that those choices impose onto public property.

Shank, I'm also in Tulsa, OK. I'm an Economics and MIS major at OSU-Tulsa...drop me an email sometime?

-L

Eric Krieg writes:

Well, the federal portion of the gas tax supposedly goes into a "trust fund" for the building and maintenance of the interstate highway system.

The most effective way to promote fuel efficiency would be to raise the gas tax, I don't think that there is any question about that.

All I question is a) what effect will an increase in the gas tax have on the poor and b) couldn't we be making more effective "investments" than energy efficiency?

Also, there is an implicit assumption being made when complaining about OPEC. The assumption is that the member states of OPEC are "bad guys", and that they would be better behaved if they didn't have all that oil revenue.

And we're really talking about Saudi Arabia when we talk about OPEC.

From what I have seen, Saudi would be even more of a basket case if it didn't have that oil. They would be a bigger, more populous Yemen. We could have MORE problems emminating from a poor Saudi than the rich one we have now.

Bernard Yomtov writes:

Shank,

What you are missing (Boonton too, as Daniel explains) is that the imposition of a tax shifts the demand curve, from OPEC's point of view. (Alternatively, you could say it shifts the marginal cost curve). So the profit-maximizing price in the US does notjust drop by the amount of the tax.

You are correct that OPEC must consider the world market, not just the US market, in setting production levels.

Boonton writes:
The most effective way to promote fuel efficiency would be to raise the gas tax, I don't think that there is any question about that.

Actually there are other methods. One idea I had was a $500 tax on cars whose fuel economy was in the bottom 25%-tile and a $500 rebate on cars in the top 25%-tile. In effect you are subsidizing above average cars and taxing below average ones. This would be a good incentive, IMO, to drive the average fuel economy up. Since fuel efficient cars also tend to be smaller and less expensive (the hybred cars are an exception since they seem to be more expensive)...this may induce lower income people to trade in used cars for new cars further improving economy.

Robert Smith writes:

Investing in public transportation infrastructure at this point seems vital, so that we can reduce our physical and psychological dependence on our vehicles.
Shank on April 1, 2004 11:05 AM

I?ve never understood this fascination with PUBLIC TRANSPORTATION. It?s expensive, unpopular with most of the public, inconvenient, easily disrupted and almost never pays for itself based on ridership. It strikes me as an elitist answer to what they see as a problem, that they probably won?t be using themselves. I know that there are exceptions, NYC and D.C. come to mind. But those are in fact exceptions. The fundamental question is how does an individual get from Point A to Point B at the lowest cost and the least inconvenience? Realizing that trade-offs may be required. The only possible answer is: It Depends. Why do we have this continued Stalinist Central Planning, top-down driven, cookie cutter approach to problems of this magnitude. We don?t do it with food or housing and we have no shortages in those areas. Who thinks that the government is more capable than the Market at making those decisions?
But, to bring this back to topic. The question was about the price of gasoline. My question is this: Given that gold has gone from $260 per oz to over $400 per oz ? an increase of more than 50% over the last 2 years, would we be having this great debate about OPEC/gasoline taxes/Public Transportation if the price at the pump were in the $1.10 ? 1.30/gallon range? Probably not. And measured in terms of cost of oil, at the wellhead per ounce of gold, has the price of gold actually increased that much? Again, Probably not.
Now, to those who want to increase the taxes paid per gallon of gas, to achieve some ?social good,? I have a question. Do we want the federal government to get into the business of manipulating the behavior of citizens to achieve some ?approved? behavior? Insert your political opposition into control of the White House and both Houses of Congress, give them that kind of power, and see how comfortable you are with that situation.
Personally, I want the value of a dollar relative to gold to be kept within a fairly narrow range, I want the government to be prohibited from social engineering and I want taxes to pay for the cost of government ? which should be kept as small as is possible under current circumstances. Is that to much to ask for?
Robert Smith

Bernard Yomtov writes:

"Personally, I want the value of a dollar relative to gold to be kept within a fairly narrow range, .... Is that to much to ask for?"

Yes. This alone is very clearly too much to ask for.

Scott Wood writes:

The market for oil has to exhibit a few other characteristics for the monopolist to absorb the full amount of the tax. A US oil tax would shift the demand curve for OPEC oil in. Econ 101 teaches that the monopoly profit maximizing response to a decrease in demand is to reduce quantity supplied, but not ordinarily enough to completely maintain the price. Thus, the tax ends up falling on both consumers and producers, with the exact distribution determined by the elasticities of demand and supply.

Since OPEC is the marginal supplier of oil in the world, the demand for their oil might be more elastic than you think, but it's surely not perfectly elastic.

Personally, I now favor an oil tax more than ever, provided other taxes are reduced by a comparable amount, so on net consumers aren't hurt by the tax increase.

I'm at a loss to construct the corresponding tax reductions to compensate for the oil tax increase. I'd vote for a flat reduction in the income tax, but replacing income tax revenue with oil tax revenue would be very regressive (especially in the obvious prices), and I'd rather find something else. (Increasing the income at which the income tax starts would help, but still leave out a lot of people who pay no income taxes.) A sales tax reduction would probably accomplish my goal, but they're all state taxes (and not all states have them), and this oil tax would have to be federal. I'm curious if anyone has any other thoughts.

Also, FWIW, since 80% of my reason for favoring the oil tax is to reduce the wealth of crazed Arab lunatics (read: Saudi Wahabi fundamentalists), I'd want to make this an import tax, something that is so against my nature (tariffs: bad, oil: fungible) that I'd like someone to explain why I'm mistaken.

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