Should States Temporarily Repeal Gas Taxes?

May 12, 2006

With the high price of gasoline in an election year for most lawmakers, many state legislators are pondering whether or not to temporarily repeal their states excise and/or sales taxes on gasoline. From CBS News:

With a gallon of gas breaking $3 and voters unhappy, elected officials in a number of states are taking a sudden, sharp dislike to gasoline taxes, proposing to eliminate the levies that are a mainstay for road programs – or at least suspend them for the summer.

Governors have floated ideas to trim or suspend state gas taxes in Maryland, South Carolina and Connecticut. State legislators are pushing similar measures in Georgia, New York and Nevada. The proposals are winning vocal support from Republicans and Democrats alike, though none have yet become law.

“We think it would have real bottom-line benefit to a lot of working families who are struggling with the price of gas,” South Carolina Gov. Mark Sanford said on Wednesday, when he proposed suspending the state’s 16.8 cent-per-gallon tax for three months.

Critics say the proposal is a mistake, questioning whether drivers would actually see the tax cut, the potential to undermine necessary road and transportation programs and the larger environmental impact. (Full Story)

Given that the goal for lawmakers is to try to lower prices at the pump by alleviating these taxes, the obvious economic question becomes – who currently bears the burden of the tax? What some politicians seem to not understand is that lowering the tax by a given amount does not automatically lower the final retail price by that same amount. It all depends on who bears what economists refer to as the “economic incidence.”

And economic incidence all depends on elasticity, or the measure of sensitivity that buyers and sellers have to price changes. If buyers are not very sensitive to the price of gasoline, while suppliers are highly sensitive to the price, then eliminating the tax should significantly lower the price at the pump because the consumers are currently bearing the load of the tax burden. Under this scenario, revenue that would have flown to government mostly goes into the pockets of consumers.

However, if buyers are more sensitive to the price of gasoline than suppliers, then consumers are not going to be helped much by an elimination of the tax, and most of what would have been government revenue will flow to the producers.

Economic theory suggests that suppliers are more sensitive to price (i.e. the after-tax price they receive) in the long-run than the short-run. That is, in the short-run, they cannot move supply as quickly as they can in the long-run. For tax policy, this would suggest that permanent reductions in the tax on gasoline would be more effective at lowering the price at the pump than would temporary repeals.

Having a solid understanding of the economics of gas prices is essential for policymakers because poor policy like mandating that the reduction in the final price at the pump exactly equal the amount of the tax cut (thereby ignoring tax incidence) could result in shortages and therefore gas lines.

For more on gas taxes, visit our newly created section on the topic.


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