by Jurgen Brauer, August 2005 [actually 2 September 2005]
Copyright: J. Brauer. No reproduction without permission.

It’s Friday afternoon, and the Governor of Georgia just signed an executive order, to be ratified by a special session of the Georgia House next Tuesday. The order suspends the state gasoline tax until the end of September. Supposedly, this is to assist the taxpayers’ pocketbook who are facing gasoline prices of $3.00/gasoline and more. The press release I saw quotes the Governor as follows: “In making this decision, I fully considered the fiscal implications. This moratorium will have no negative effect on the state budget ... the state moratorium will mean that consumers who were paying $3 per gallon at the pump will save more than 15 cents per gallon in taxes ... As we take this action, I want to stress to gas station owners that I fully expect the benefits of this tax moratorium to show up at the pump and be passed directly to consumers.”

In the wake of hurricane Katrina, Georgia's Governor suspends the state gasoline tax. Sounds like economic non-sense to me.

Sounds like economic non-sense to me. First, even the most elementary economics tells us that a lower price (via lower taxes) increases the quantity demanded. A lower price encourages people to drive more – not exactly what we want in the wake of hurricane Katrina and the ensuing national gasoline shortage. The good-hearted Governor, who of course has no politics at all in mind, is making things worse.

Second, the Governor “fully expect[s] the benefits of this tax moratorium to show up at the pump and be passed directly to consumers.” That won’t happen because it cannot happen. The underlying mathematics economic theorists use to prove this point is too involved to reprint here but the reasoning goes roughly as follows. Just as gas station owners cannot fully roll over an increase in gas taxes to consumers (because a higher pump-price reduces quantities demanded and thus puts downward pressure on prices), so likewise a decrease in gas taxes cannot be fully passed on because consumers react to the lowered price by driving more, and they thereby push up prices again. It is not the gas station owners who are the villains in this story; instead, it is the immoderate behavior of drivers that causes problems. So, if the gas tax is lowered by 15 cents/gallon, expect pump-prices to go down by less than that.

Third, the suspended gas tax, the Governor says, will have no effect on the state budget. Pardon me? If your employer takes your income away then it will have an effect on your budget. Likewise, if the state of Georgia receives less income (no gasoline tax receipts for a month) then it will have an adverse effect on the state budget. That effect can be mitigated by raising taxes elsewhere or by cutting state expenditures. Perhaps that’s what the Governor has in mind – but then he should say so.

Economic science is clear: The only function of prices is to regulate economic behavior. No mere Governor can suspend the laws of economics.

Economic science is clear: The only function of prices in a market economy such as ours is to regulate economic behavior. Higher prices signal shortages and people will moderate their consumption; lower prices signal abundance and people will consume more. No mere Governor can suspend the laws of economics.

There are a number of solutions available. Regrettably they are either politically unpalatable or mathematically complex and therefore difficult to explain in an 800-word column – or in a Governor’s press release. An example of the mathematically complex is the following proposition: keep the gas prices high but allow people to take the tax off their income taxes at the end of the year. The reason why this works is that the pricing-signal – the price that signals scarcity at the gas pump – remains undistorted. A high price tells people that there is a shortage; it tells people to moderate the amount of driving they do. When this idea was tried during the gas crisis of the 1970s, economists found that people’s demand behavior did respond to the price signal, and that they did drive less, even if they got reimbursed for the gas tax later on.

As regards politically unpalatable solutions, consider that Congress has never been able to pass an economically sensible, long-term national energy policy. Congress had a chance to prove its mettle just last month in fact but your elected politicians failed abysmally at the task: on the table was a proposal to raise the so-called CAFÉ standards which regulate the average fuel-economy of newly produced cars and trucks in the nation. After much wrangling (read: lobbying), the standard was raised by the most minimal amount. And so we drivers will continue to guzzle gas, inviting future crises.

Before Congress will come to its senses and pass a workable energy policy, New Orleans will have to drown several times over. Small comfort but at least Georgia’s Governor is not alone is this economic folly.