Caplan on the Gas-Tax Holiday

by Don Boudreaux on May 8, 2008

in Taxes

Think the proposed gas-tax holiday is a wacky idea?  My GMU colleague — and EconLog‘s — Bryan Caplan gives you good reason to think again.

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{ 27 comments }

vidyohs May 8, 2008 at 7:53 am

Caplan says,
"This sounds cynical, but I’m just being honest. Politicians are constrained by public opinion."

Well I am even more cynical, I don't believe for a moment that politicians are constrained by public opinion. The evidence I have seen over my years is that when politicians bump up against public opinion, they simply mold a new public opinion, or simply outright lie about what they perceive as public opinion.

Furthermore, Caplan saying that the gas tax holiday might spur oil companies to seek new means of production is like him saying that he believes that oil companies do not seek new means of production unless they are spurred to do so by some real or imagined crisis.

I have news for Mr. Caplan, every oil company out there has a huge wing of their operations that does nothing but seek, every day-all day, new means of production, a way of squeezing more out of less.

We all know what needs to be done to ease our problems with high price per barrel of oil, and it doesn't involve anything more than overturning the socialist envirowhacko legislation that prevents extraction of the oil deposits that are under our own soil or control.

All other pretensions are just BS of the highest magnitude.

Yeah, we consumers would undoubtedly experience a short term benefit from a gas tax holiday if it actually reduces the price at the pump. But, in the long run that chicken will come home to roost as well, and we'll pay for it through decaying transportation infrastructure and probable future hikes in taxes to make up for the loss today.

David P. Graf May 8, 2008 at 8:35 am

Vidyohs,

Why would oil companies do anything to drive down the price of oil considering how good the current situation is for their bottom line? I think that Caplan has jumped the shark on this issue.

shawn May 8, 2008 at 9:16 am

dpg…because, given how insanely competitive gas pricing is (people will drive across town to save $.05), any savings in the production front could lead to a huge profit opportunity in undercutting your competition.

Hammer May 8, 2008 at 9:43 am

DPG: I don't think "jumping the shark" means what you think it means.
It is, however, amusing to see the Fonz referenced in an economic discussion.

Vidyohs has a good point. Most of the oil "shortage" faced in the world is artificial in nature. A limit on refineries and areas that can be drilled means there is a limit on what can be produced, and not one that is easy to work around.
We know where the oil is, and I don't mean "we as the human species". I mean we as in "any given 5 or 6 people who post here." Think about that for a second. Why are we complaining about high oil prices when Joe Layman here knows where there is plenty of oil to be had in and around America?

Oh wait, it's because it is illegal to get it from there. Whoops.

John Dewey May 8, 2008 at 10:54 am

In his earlier blog post on the gas tax holiday, Bryan argued that imports of refined gasoline might increase with the higher profit margin (crack spread) available in absence of the tax. I'm glad he didn't make that argument in the New York Times. As I pointed out over at Marginal Revolution:

Recent changes in EPA gasoline sulfur allowances – from 120 ppm in 2004 to 30 ppm today – have rendered gasoline imports from many foreign sources unusable for the U.S., according to a 2004 presentation from the U.S. Energy Information Agency.

Another 2004 report by the Congressional Research Service estimated the cost differential for imported European gasoline to be 14 cents. No doubt that cost differential has widened as ocean transport costs have increased the past four years. The gasoline cost differential for European suppliers serving U.S. wholesalers certainly now exceeds the 18 cent gasoline tax which Hillary and McCain propose to eliminate.

The supply of gasoline for the U.S. in 2008 is essentially fixed.

diz May 8, 2008 at 11:41 am

The supply of gasoline for the U.S. in 2008 is essentially fixed.

False.

Why don't people actually ever consult people who work in the industry and know these things?

I have actually built supply curves for refined products markets. They are far more complicated than you imagine in your philosophy. Refineries are not monoliths. They are collections of different units that convert different inputs into different streams of outputs. There is almost always more gasoline that can be squeezed out somewhere if the price is right. Unless you are at flat out full capacity on all units, which we are not.

Refining margin and utilization are moderate at best right now.

It seems silly on its face to argue supply is inelastic when refineries have idle capacity.

And, after that there are still things you can do to increase supply. You can also import components of gasoline and blend them into gasoline. You can reconfigure your operations to make more gasoline versus jet fuel, diesel of other products. You can import foreign gasoline (and if it is off-spec, which is not true of all foreign gasoline, you can treat it to be on spec.)

Here is a table of US gaoline imports:

http://tonto.eia.doe.gov/dnav/pet/hist/wgtimus2w.htm

Does it seem to support the claim it is no longer possible to import gasoline?

When we are importing record amounts?

David P. Graf May 8, 2008 at 2:42 pm

Shawn,

Given the cost of the gas it would take for me to drive over to the far side of town to get gas five cents a gallon cheaper, it doesn't make any sense for me to do that. Again – why should any of the oil companies even want to undercut their competitors or get involved in a price war considering how wonderful things are for all of them now. Their stockholders would have a fit.

vidyohs May 8, 2008 at 3:20 pm

David,

I am not sure just how to take your question, straightforward or tongue in cheek; so I will go with straightforward and answer that way.

Your question:
"Why would oil companies do anything to drive down the price of oil considering how good the current situation is for their bottom line? I think that Caplan has jumped the shark on this issue.
Posted by: David P. Graf | May 8, 2008 8:35:16 AM"

My reply is in the form of a question: Why do you equate the phrase "looking for ways to increase production" with looking for ways to drive down the price? I certainly did not say that.

What I said was that oil companies have research and development departments that do nothing all day, everyday, but look for ways to increase production. That's a fact. Now if you want to relate that to "drive down the price" be my guest, it is an assumption that you make but I did not say.

The sad part, David, is that oil companies, like food markets, are not allowed to compete freely. Federal government regulations force them to charge within pennies of their competitors so that the difference is negligible.

Our problem in this country is not big oil, it is big government…..great big huge socialist government.

vidyohs May 8, 2008 at 3:21 pm

BTW David,

I have no idea what "jumped the shark" means. Is it the equivilant of "gone off the deep end"?

OregonGuy May 8, 2008 at 3:52 pm

Diz,

Do me a favour, take a look at my post and give me the necessary beating, please.

http://tinyurl.com/653btz

Mr. Boudreaux, why is it that these rocket scientists never consider to how quickly changes in inputs are adapted by markets?

It's reminiscent, really, of Elmer Fudd telling the movie audience that "Shh…I'm hunting wabbits." It seems impossible for a politician to wrap his head around the immediacy of changes that would occur if taxes were dropped…through increased demand…and then…prices would go…(up? down?)

I guess another way of saying this is, would there be a shift in either the supply curve or the demand curve? And can we keep that a secret?

David P. Graf May 8, 2008 at 5:36 pm

Vidyohs,

Yes – jumping the shark means that someone has gone off the deep end. It's based upon a character from the show Happy Days named Fonzie who jumped over a shark in one of their later episodes. With this, the show had become a caricature of itself.

Bruce Hall May 8, 2008 at 6:43 pm

The issue of the federal gasoline tax is a convenient red herring for members of Congress to divert attention away from their own actions to limit domestic supply of oil and create massive obstacles for new refineries… both of which have created the perfect opportunity for speculators to drive up the cost of oil and gasoline… see below.

CNN – January 2, 2008 – It's been rumored Goldman Sachs has over $80 billion in the (oil) market, although the investment bank declined comment for this story.

CNN – May 7, 2008 – Oil hit record settlement and trading highs Tuesday after a Goldman Sachs analyst said crude prices could reach $150 to $200 within the next six months to two years.

On a related topic, the fact that gasoline prices are rising rapidly is exactly what is needed to implement Congress' distortion of the automotive marketplace through their mileage mandates. In fact, automotive company executives are completely against a reduction of either gasoline prices or gasoline taxes because high prices and taxes are required to sell the small, high-mileage vehicles that Congress has mandated the manufacturers must produce.

Congress is trying to have it both ways: put all the risk and blame on private industry for implementing or abiding by the very regulations and restrictions Congress has established.

Recently, Congress, led by Sen. Schumer, tried to pull the same stunt with regard to food prices… pointing fingers at farmers who were diverting some of their crops toward Congressionally-mandated ethanol production increasings… those same farmers who must pay higher diesel prices for their farm equipment because Congress makes refinery approvals so onerous.

vidyohs May 8, 2008 at 9:48 pm

Bruce Hall,

Please please do not mention Chuckie Schumer, you aren't aware (and probably don't care) that I go into total apolectic shock every time I see his name or his face. If ever there were a person that needs the egg-sucking dog treatment, chuckie is one.

vidyohs May 8, 2008 at 9:56 pm

Disclaimer, post not thread specific but transportation related.

When I read this:
http://www.chron.com/disp/story.mpl/nation/5762703.html

today in the Houston Comical, I didn't know whether to laugh or cry.

Notice China scored #2 for transportation for their use of bicycles and walking?

Gosh what a surprise! In a country of over 1 billion, about 998,000,000,000 don't have any choice as they are too stinkin'' dirt poor to afford shoes much less a bicycle or an auto, so the walk…….golllllleeee!

I feel so environmentally flawed.

Lord God I long for the days when people were concerned with concealing their stupidity not plastering it all over the world in stupid announcements!

Hammer May 9, 2008 at 9:01 am

DPG:
You are slightly incorrect about jumping the shark. It means something has peaked, and proceeded to go downhill. Going off the deep end means something slightly different, generally that someone has lost their mind.

You are very incorrect about what people are willing to do to get a lower price on gas, and how often service stations will undercut each other. People do drive across town to get a lower price on gas, particularly if they have a handfull of canisters to fill. (Or if they are not great at math, as you pointed out.) More to the point, in many places there are gas stations across the street from each other, and they will compete aggressively on price, often resulting in a line of cars at one and an empty parking lot at the other.

Go outside sometime and look.

rvturnage May 9, 2008 at 9:33 am

"The sad part, David, is that oil companies, like food markets, are not allowed to compete freely. Federal government regulations force them to charge within pennies of their competitors so that the difference is negligible."

vidyohs, Can you (or anyone else) point me towards the particular laws that regulate pricing in this manner? I had no idea…

John Dewey May 9, 2008 at 10:21 am

Diz: "Why don't people actually ever consult people who work in the industry and know these things?"

Hey, we agree on some points about oil(another blog) and disagree on others.

I recognize you probably know more than me about the energy industry, which I left 25 years ago. Until their deaths a few years ago, I did obtain refinery information from two career refinery employees – my dad (an operator) and my brother-in-law (a mid-level manager).

Diz, I did consult sources other than you before I made my argument. You may not agree with the credibility of my sources or my interpretation of their words, but please don't be condescending in your disagreement.

diz: "Does it seem to support the claim it is no longer possible to import gasoline?"

If you will reread my post, you will see that I made no such claim. I said that many – not all – foreign supplies are unusable in the U.S.

It was a U.S. Energy Information Agency presentation to the National Petroleum Refiners Association that led me to believe foreign refined gasoline supplies to the U.S. have been sharply reduced. The EIA argued that many foreign suppliers will be unable to produce the low-sulfur gasoline the EPA started requiring the past two years.

The Congressional Research Service stated that imported gasoline from refineries in Europe incur additional transport costs that ranged from 10 to 14 cents per gallon in 2001. This was based on another study from the EIA. These are averages, of course, and some European refiners are already able to overcome this cost penalty. But at the margin, European cost differential to export gasoline to the U.S. should now be greater than 18 cents a gallon. Thus my conclusion that an 18 cent reduction in gasoline taxes will not provide European refiners with sufficient economic incentive to meet the increased demand for gasoline.

diz May 9, 2008 at 10:46 am

States (okllahoma, I think) have gone after Walmart and a few others for selling gasoline too cheap. It's somewat true that you can get in trouble if you set your prices too low. The independent service station owners (and their lobby) raise a ruckus when they can't compete with the vertically integrated retailers.

But, generally, for the purposes of discussions like this, not much interesting happens in the retail side of the equation. If you look at the four main components of gasoline price they are crude oil price, refining margin, marketing margin, and taxes. Retail or marketing margin is the smallest and (other than taxes) the least volatile of these. It's just too competitive out there for a station to be able to afford getting too far off the market on price. Remember, a retail site is largely a fixed cost investment so incremental volume matters a lot. The product is essentially a commodity, all sellers have basically the same cost of goods, and prices are posted in big giant numbers out front, so demand at the street level is very elastic.

diz May 9, 2008 at 11:42 am

John Dewey -

My apologies for the tone. I posted in a moment of frustration.

I think the mistake you are making with respect to imports is to assume that the relevant relationships are constant.

Basically, if the US market is good enough versus the other alternatives on a netback basis, product will flow this way.

Of course, the ability for product to be transported tends to cause international markets to compete away arbitrages and equilibrate.

The first source of supply elasticity is generally going to be unutilized refinery units domestically. A refinery is a multi-billion dollar largely fixed cost asset. If I can squeeze a few more barrels through at a profitable margin, I want to go ahead and fo it. When I am not using all my capacity, it's a pretty good indication that I don't believe I can get positive contribution margin from running a few more barrels through my hydrocracker.

When gasoline prices go up, and I re-run my linear program with those higher prices, it will tell me to run more barrels at the margin. Ding, supply response.

John Dewey May 9, 2008 at 12:26 pm

diz,

I think I made another mistake in assuming that U.S. refineries were operating very close to capacity by late spring 2008. I remember arguments about very little excess capacity in the U.S. in the summers of 2006 and 2007. However, as I now understand it, summer 2006 was still burdened with Katrina-Rita outages. In the summer of 2007, BP's Texas City refinery was still not operating and Valero's Mckee refinery may also have been out of service (not sure of exact dates). Now that the unexpected refinery outages have ended, perhaps U.S. refining does have the excess capacity you refer to.

If I remember their explanation correctly, my close relatives believed that U.S. refineries in total could just not flex up much above 92% of capacity for more than a few weeks. I'm not sure if this is due to economic factors or operational factors.

Would refineries, like other manufacturing operations, incur high marginal costs at near-maximum capacities? If so, my argument is that the additional 18 cent per gallon available profit would not be sufficient to increase refinery utilization. But you know more about that than I do.

trevor May 9, 2008 at 1:01 pm

I don't know about Oregon, but here in Maryland government regulators are all about keeping gas prices artificially high (see: http://www.washingtonpost.com/wp-dyn/content/article/2005/05/05/AR2005050502032.html).

The corporate fascists who own the 'mom and pop'-type gas stations have succeeded in getting the state to subsidize their uncompetitive businesses at our expense (see: http://www.washingtonpost.com/wp-dyn/content/article/2005/05/05/AR2005050502032_2.html).

trevor May 9, 2008 at 1:02 pm

Sorry, Oklahoma..

diz May 9, 2008 at 3:18 pm

Would refineries, like other manufacturing operations, incur high marginal costs at near-maximum capacities? If so, my argument is that the additional 18 cent per gallon available profit would not be sufficient to increase refinery utilization. But you know more about that than I do

OK, first it helps to understand what refineries are actually collections of different units that do different things.

When people talk about "refining capacity" they are usually talking about the size of the crude tower or straight-run distillation unit. That crude tower distills a barrel of crude and gives you a bunch of intermediate product streams – Naphtha, Light Gas Oil, Kerosene, Heavy Gas oil, etc. Behind that I may have other units like a cat cracker, hydro cracker, hydro treater, alkylation unit, coker, etc. that take those intermediate streams and convert them to higher value products.

The amount and quality of each of those streams will depend on the type of crude oil I run. A heavy crude may give me lots of heavy gas oil bottoms to feed my coker, which can upgrade heavy gas oil to light products. If I don't have a coker, either buy a light crude or I run heavy and sell the heavy gas oil if there is a market availale.

Refineries run linear models containing all the different constraints imposed by their various unit sizes and the prices of all the various inputs and outputs they can create.

So, a refinery with a 200,000 barrel per day crude tower may be running it at 180,000 because it doesn't have enough downstream capacity to upgrade the last 20,000 barrels to a finished product given the most economic crude choice. For examle, those last 20,000 barrels of crude might get you 6000 barrels of gasoline, 3000 barrels of diesel and 11,000 barrels of heavy gas oil. If the market for heavy gas oil is low, your linear program will tell you the margin on running that unit full is negative and you won't run it.

So, now back to our topic. Ex post, you are running a slate of crude that optimizes the contribution margin across all your units. Now gasoline price goes up with all other things being equal. Unless you are flat out at capacity maximizing gasoline already on all your units, your linear program is very likely to tell you you now have a better option that involves producing more gasoline.

So, I think that a belief that there would be no supply response to a gasoline price increase requires a belief that (at a minimum, ignoring imports for now) the refining industry is flat out at capacity.

In such markets, refining margins tend to be very high. Capcity utilization numbers strain toward 100%.

We are not currently in such a market.

A quick review of recent headlines:

Valero Net Down 85% On Tighter Refining Margins
Tesoro swings to a loss as refining margins fall 52%
ConocoPhillips sees refining margin squeeze
Marathon profit falls with refining margins

vidyohs May 9, 2008 at 4:12 pm

"vidyohs, Can you (or anyone else) point me towards the particular laws that regulate pricing in this manner? I had no idea…
Posted by: rvturnage | May 9, 2008 9:33:32 AM"

I can not. I have only talked with service station owners and with food market owners and both have told me that they are only allowed small wiggle room on their pricesand if they over step their bounds the FTC or some govt agency shows up and threatens them. That is why you don't see gas wars anymore and why there isn't a tremendous difference in prices from supermarket to supermarket.

I am not saying there is no difference, just a narrow range and it is government regulated. If I were going to research this I would start with the Uniform Commercial Code (UCC) and the Fair Trade Commission (FTC).

Personally I am satisfied with the input from the people I have talked with who are in a position to be affected by the regulations.

David P. Graf May 9, 2008 at 7:25 pm

Hammer,

Things may be different where you live, but I haven't seen a serious gas price war for well over a decade. Of course, most of the local gas stations are owned by the chains and they're probably pretty happy with the way things are since they don't have much competition from independent gas station owners.

John Dewey May 12, 2008 at 1:07 pm

David P. Graf: "Of course, most of the local gas stations are owned by the chains and they're probably pretty happy with the way things are since they don't have much competition from independent gas station owners."

Are the local gasoline stations owned by chains or branded by chains? Large energy companies such as Exxon own few of the gasoline stations which carry their name. Further, the ownership of gasoline retail outlets is hardly concentrated. The U.S. Census Bureau reported in 2002 that the largest 20 firms owned about 17,000 of the nation's 121,000 gasoline retail operations.

Although a large refiners such as Exxon does establish wholesale prices to be charged to its branded retail licensees, I don't think the large refiner can legally set retail prices. Perhaps someone else knows better, but I think I have read that large refiners cannot prevent retail dealers from selling gasoline below cost.

John Dewey May 12, 2008 at 3:08 pm

Hammer and David P. Graf,

The degree of price competition may depend more on state laws than on concentration of marketing power. According to an OECD Economic Policy Roundtable on "Resale Below Cost", a majority of U.S. states have enacted laws preventing resale of various goods below cost (aka, RBC or SBC laws), with cost generally defined to include variable as well as fixed costs.

A University of Wisconsin – Whitewater study concludes that:

"One main benefit of SBC laws is that they protect the competitive structure of the market, where equally efficient, though less powerful, retailers are given the opportunity to compete."

On the other hand, a paper by Marie-Laure Allain and Claire Chambolle concludes that:

"The ban of below cost pricing for retailers enables producers to impose price floors to their retailers. This induces inflationary effects on the whole range of products sold by retailers and not only on those that would have been sold below cost."

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