March 23, 2009

A gasoline tax to.... reduce prices???

These days everyone wants to be an economist. With the U.S. economy "falling off a cliff" it seems that more and more people know just what to do to fix all our problems. CNN is on this list of so-called economic experts. Their specialty today: Gasoline prices. The CNN article, by Steve Hargreaves, states that there is some evidence (although he does not cite or reference any of these findings) that shows people are not using the decline in gas prices to buy food or health care, but in fact, to drive more. This in turn will force demand up and increase the price of gas all over again. Wow, this must be shocking to many Americans who had no idea they affected the market in such a negative way. Good thing Steve is here to tell us what to do... Impose a gasoline tax to decrease demand and stabilize the price. It seems only obvious!

Goodness. Does CNN actually require its economy journalists to actually have taken an economics class? Apparently not. Although there may be evidence to support the basic claim that people are driving more due to a decrease in gas prices, there is another reason why Steve here wants to impose a tax on gasoline; Global warming. Where global warming issues may see this tax as a big win, American's wallets will not. This article shamelessly tries to bring about an economic reason in which it would be "smart" economically to impose a tax, in a horrible attempt to sway public opinion. Steve explains that "While it [a gasoline tax] is likely to raise prices immediately, the tax would also simultaneously act to reduce consumption, so the market price for gas would likely fall. That would mean less money for OPEC or Exxon Mobil." Can you hear the public cheering yet?

But let us look at what a gasoline tax would actually do, although it pains me to be so obvious. In the short run supply will decrease, and yes OPEC and Exxon Mobil will produce less and profit will decrease, however at a higher price to the consumer. This will knock the market off equilibrium and people who cannot afford the tax (the poor) will not be able to buy it. If they loose their jobs because they cannot get to work... oh well. Ride the bus. In the mean time the rich, who can afford to drive more, still will. Global warming? Well, maybe there emissions will be offset by the poor who can no longer drive. Gosh Steve, this plan is really working out! The first part of this analysis checks out. Gas prices will rise, and consumption will fall. Let us look at the second part: due to the fall in consumption market prices will 'likely' fall as well and we will all be happy.

In the short run, part of this tax will be shifted to the consumer and the other part to the sellers. However, the multi-billion dollar oil industry is likely to adapt faster than average citizen. Thus, we move into the long run. If we assume a constant cost industry, in the long run, long run average costs and marginal costs will have shifted up by the amount of the tax. Will this increase lead to a fall in prices as Steve has predicted??? No. In fact, it will lead to the full amount of the tax being shifted to the consumer, aka an increase in price. Mmmmmmm. So when exactly will the consumer be better off? Well you might just have to ask Steve.

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