Obama is wrong about the gas tax

Think Clinton's plan to suspend the gas tax temporarily is a bad idea? A similar measure in Illinois -- which Obama backed -- seems to have helped consumers.

By George Frost
May 6, 2008 2:54PM (UTC)
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Democratic presidential candidate Barack Obama has repeatedly accused rival Hillary Clinton of "pandering" for advocating a summer gas-tax moratorium, calling it a "classic Washington gimmick" that would do little to help consumers.

"That's typical of how Washington works," Obama says in a new TV ad airing in Indiana, where primary voters go to the polls Tuesday. "There's a problem. Everybody's upset about gas prices. Let's find some short-term quick fix that we can say we did something even though ... we're not really doing anything."


Obama dismisses Clinton's proposal to suspend the 18.4 cent per gallon federal gas tax as: 1) a political gimmick that will not deliver any significant relief to consumers, while diverting us from the serious energy reforms we need to undertake; 2) an opportunity for oil companies to raise prices to capture the missing tax increment; 3) an inducement to drivers to drive more, thus leading to more consumption and higher prices down the road; and 4) a drain on highway trust funding, which is sorely needed to repair our crumbling infrastructure.

This is powerful criticism because it resonates with a long-standing talking point against Clinton -- that she is a political phony willing to do anything to get elected.

But in this case, each of Obama's attack lines is either factually incorrect, or based on flawed logic. Could he be attacking Clinton just to deny her any political benefit? That would be as cynical and "old style" as anything Clinton has thrown at Obama lately.


American drivers are hurting, especially those who must drive a lot -- commuters, truckers, carpool moms. Millions of lower-income rural and exurban Americans must drive long distances to their jobs, meaning high gas prices take a disproportionately large chunk out of their incomes. Some are having to choose between gasoline and food. A savings of $30 or $50 is a significant amount of cash for at least some Americans.

Despite the "gimmick" slam on Clinton, could it be that Clinton is sincerely trying to help, albeit in a very modest, and politically self-serving way? The evidence suggests that Clinton's plan might work. It also raises the question of why Obama hasn't made a similar proposal. He was certainly proud to back a gas-tax moratorium eight years ago.

While an Illinois state senator, Obama supported a state tax holiday very much like Clinton's proposal, but without the saving mechanism of a windfall profits tax.


CBS News says Obama voted for the temporary lifting of the tax three times in the state Senate. The tax holiday was finally approved during a special session in June of 2000, when Illinois motorists were furious that gas prices had just topped $2 a gallon in Chicago. The moratorium lifted the state's 5 percent sales tax on gasoline through the end of 2000.

Obama told constituents that gasoline prices would drop: "Gas retailers must post on each pump a statement that indicates that the state tax has been suspended and that this temporary elimination of the tax should be reflected in the price per gallon of gas."


During one state Senate floor debate, Obama joked that he wanted signs on gas pumps in his district to say, "Senator Obama reduced your gasoline prices."

Now, running for president, Obama says the tax reduction was a complete failure, and that "the oil companies, the retailers" ended up benefiting most because they raised prices by the entire amount of the tax cut.

"I voted for it, and then six months later we took a look, and consumers had not benefited at all," Obama said. Having learned this hard economics lesson from his Illinois "mistake," Obama now argues that a federal tax holiday also will fail for the same reason -- the oil companies will take it all.


But Obama is wrong. He did not learn this lesson. In fact, the only scientific study done on the pass-through of the tax holiday savings to Illinois consumers (and those in Indiana, as well, whose citizens enjoyed a similar holiday) found that it actually worked to a large extent.

The study is titled "$2.00 Gas! Studying the Effects of a Gas Tax Moratorium," by Joseph J. Doyle Jr. and Krislert Samphantharak. Download the PDF here. The authors concluded that "the suspension of the 5% sales tax led to decreases in retail prices of 3% compared to neighboring states. And when the tax was reinstated, retail prices rose by roughly 4%."

This suggests that the tax holiday delivered at least 60 percent of the tax savings to motorists.


The economic basis for attacks on the Clinton tax holiday is a fundamental economic theory called "tax incidence." It says that the cost of a tax on any consumer product will be borne by those with lesser "elasticity" in the tug of war between suppliers and consumers. "Tax incidence" falls mostly upon the group that responds least to price -- the group that has the more inelastic price-quantity curve. In this instance, assuming that the supply of gas is pretty much fixed, it means consumers will end up paying those missing tax dollars directly to the gas companies in the form of higher prices. The increased demand triggered by the price cut will supposedly lead drivers to bid up the price of gas, swallowing the tax cut.

But this is not what happened in Illinois and Indiana back in 2000. And there are factors at work today that might provide equal or more "elasticity" to the producers, and prevent consumers from paying the price for the tax cut.

Gasoline inventories are currently very high, and these surpluses can absorb much of any increase in demand. (See here.). Should gasoline consumption surge still higher, in the short run, refiners can also divert enough of the crude oil meant for other products -- diesel or jet fuel, for example -- into gasoline to meet demand.

On the demand side, let's face it: This is a tiny price cut. It is not likely to spur demand much beyond the usual seasonal increase in driving. And if oil companies do what Obama says they will do -- jack up prices to cover the tax -- there would be no incentive at all to drive more.


The media has attacked the Clinton plan for not being supported by the think tanks and economists. But there are a few economists out there -- such as Bill Polley -- who point out that if short-run demand is also inelastic, it is "not a foregone conclusion that the suppliers will get all the benefit." In fact, Polley concludes that consumers would get a nickel a gallon or more benefit -- not much, but better than nothing.

What about the charge that Clinton's summer tax holiday will spur consumption, leading to sharply higher long-term demand, thus crippling our efforts to conserve? Well, the economic literature suggests otherwise.

Basically, it is absurd to say that a summer-long price drop of this tiny magnitude will have any long-term effect at all. A meta-study by Molly Espey of 101 different economic studies, published in Energy Journal, found that in the short run (defined as one year or less), the average price elasticity of demand for gasoline is only -0.26. That is, a 10 percent hike in the price of gasoline lowers quantity demanded by 2.6 percent. As long as the price stimulus is small and short-lived, there is little if any long-term effect. And most experts agree that in order to actually curtail demand through taxes, it would take a much higher tax than is politically feasible.

Not one of the three major presidential candidates is calling for a $2 or $3 a gallon tax increase. The better long-term approach -- given the lack of political spine by any U.S. politician on this subject -- is higher efficiency standards, and big-time investment into transportation alternatives. Both Obama and Clinton are pushing these.


Finally, Obama says the gas tax holiday would cost thousands of construction jobs and lead to crumbling roadways and bridges. But if Clinton replaces the lost revenue with a windfall profit tax on oil companies, as she insists is necessary, then there would be no harm to our infrastructure repair work.

Many -- including Clinton backer and economist Paul Krugman -- have questioned whether Clinton's proposed windfall profits tax would work: "In one pocket, out the other. So it's pointless, not evil, " says Krugman. "But it is pointless, and disappointing."

But under Clinton's plan, if properly implemented, any additional profit realized by an oil company by passing on the cost of the windfall profits tax to customers would also be subject to the tax. This means a dollar passed through to consumers to offset the tax would appear as profit ... and be taxed.

How to enforce this? Make it against the law for oil companies to pass the price of the windfall profits tax on to consumers, and then audit the oil companies' books. It is not a difficult accounting exercise to tax excess profits above a certain gross percentage per barrel of oil, or gallon of gas. Every major oil company has sophisticated profit segmentation reports that go to the very senior management of the company. These reports identify revenues, costs and profit at each level of the vertically integrated operation, broken down on a per barrel basis by product type, marketing region, you name it.


The oil companies also will have a powerful inducement to avoid being caught -- and in this kind of toxic political environment, they may actually swallow the tax.

But it takes a little bit of courage to take them on, and a belief that we do not always have to be victims. Obama -- where is your optimism?

Update: The author responds to readers:

Let's be clear: Clinton's gas tax holiday is an exceedingly modest proposal. Its value is mostly symbolic. Even if enacted, which is unlikely, it would not do anything to solve our long-term energy problems. At best, it would slip a few bucks into the pockets of America's hard-hit motorists, and poke a finger in the eye of Big Oil.

My article aimed to look at the bases for Obama's attack on the plan, which to me looks just as "political" as Clinton's advocacy.

Obama claims he learned a lesson from the failure of the 2000 Illinois gas tax measure -- that the oil companies would inevitably pocket 100 percent of any federal tax relief in the form of higher prices. He infers from his Illinois experience that a federal tax holiday would also be doomed. But Obama's claim is not supported by the facts: The only empirical study I could locate found that at least 60 percent of the Illinois and Indiana tax relief actually did go to consumers. Is there any evidence out there otherwise? Let's hear from Obama's economic advisors.

A few readers have pointed out that the 2000 Illinois moratorium and Clinton's proposed moratorium involve two different kinds of taxes -- the former was a state sales tax, imposed at point of sale; the latter is a federal excise tax, which would be imposed at point of production. So it could be that the tax incidence is structurally different, a point I did not address -- but neither did Obama and his advisors.

I am not an economist (as more than a few readers have pointed out) and won't try to opine on how the difference between an excise and a sales tax might affect the economic analysis. I did come upon a study addressing the difference between state and federal tax pass-through, however: It found a higher incidence of pass-through of state taxes than federal taxes. (Here is a PDF of the study.) Perhaps that means that oil companies would pay a larger share of a federal tax imposed on all Americans.

George Frost

George Frost is an attorney who lives in Berkeley, California. At his former law firm he represented Alaska, Louisiana and other states in major tax and royalty litigation against oil companies, and represented the state of Hawaii in an antitrust case against Chevron and other firms accused of gasoline price fixing. He currently serves as general counsel at CivicActions LLC, and is counsel to several other tech and green energy companies in various stages of development.

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2008 Elections Barack Obama Hillary Rodham Clinton U.s. Economy