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174 IRET Congressional Advisory 1 (2004)

handle is hein.taxfoundation/iretcgadv0171 and id is 1 raw text is: INSTITUTE FOR RESEARCH ON THE ECONOMICS OF TAXATION IRET is a non-profit 501 (c)(3) economic policy research and educational organization devoted to informing the public about policies thait will promote growth and efficient operation of the market economy. May 26, 2004 Advisory No. 174 GASOLINE PRICE HIKES SPAWN POOR POLICY PRESCRIPTIONS Recent increases in the price of gasoline and other energy products have led to calls for federal action. The best policy is to be patient and let markets work to increase supply and restrain demand. Patience, however, is in short supply in an election year, and policy makers delight in having an excuse to increase their power and their press coverage. The resulting proposals are almost universally bad. For example, Charles Krauthammer's May 21st column in the Washington Post and Investor's Business Daily on the spike in gasoline prices gets an A for angst and an E for economics. He laments that we did not impose a high tax on gasoline when oil prices were $7 a barrel to push conservation, drive down oil prices for producers, and drive gasoline prices to $3 a gallon with the extra money pumped into the U.S. economy (via the U.S. Treasury) rather than having it shipped to Saudi Arabia... His statement assumes that suppliers would pay much of the tax in the form of lower world oil prices. As for the tax revenue, he assumes that Congress would lower other taxes with the revenues, with consumers no worse off. He would use tax policy to reorder the U.S. economy to be less dependent on foreign oil. Krauthammer's willingness to intervene massively in the U.S. economy for geopolitical advantage is unnerving. His belief that it would be relatively costless rests on two wrong assumptions: that producers would continue to sell willingly at the depressed price (inelastic supply) and that consumers would readily reduce their consumption with little inconvenience (elastic demand). Only then would suppliers bear most of the tax, and consumers suffer little pain of adjustment. (Chart 1.) Real world measurements show a highly elastic energy supply - short term, if the U.S. doesn't pay the world price, it doesn't get the goods; long term, price increases induce new supplies and new technologies that have kept energy prices falling in real terms for decades - and fairly inelastic demand - consumers cut back very little in the short run and only modestly in the long run when the real price changes. (Chart 2.) Krauthammer's prescription would have cost consumers a bundle for years, and would have left pre-tax world oil and gasoline prices about where they are now, with tax-inclusive gasoline prices about $0.50 to $1.00 above current prices at the pump. Economic distortions would be large and permanent. Krauthammer makes a third wrong assumption: that Congress would cut other taxes in a beneficial manner that would leave the economy and the consumer better off in spite of the distortions. History suggests Congress would spend every cent. It makes no sense to create an artificial scarcity today because a resource might become scarce in the future. That just moves the potential pain forward and turns it into a certainty. Even ignoring the benefits in present value of deferring the (hypothetical) cost of adjustment, note that future technology will be more advanced and future generations will be richer; new reserves will be tapped more easily in the future and the need, if any, to switch to alternative fuels will be handled more easily then than now. In fact, the 21st century may well see declining real energy prices, just like the 20th. As for geopolitical concerns that we shouldn't be dependent for our energy on people who hate us, that e~em kfl A * * gg~ 8 ~eg

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