Why gas prices are high – and the incoherent ideas to bring them down

Americans are deeply unhappy about the price of gasoline, and for good reason. Every fill-up offers consumers sticker shock, and fuel prices are driving up overall inflation both directly and indirectly, as $ 5 per gallon of gas increases the cost of transporting almost everything.

  • But the wave of frustration is creating some incoherent economic policy thinking in Washington, DC, and in many state capitals.

Why it matters: The central problem is too much demand for fuel and too little supply. But many of the policy ideas being floated to address high gas prices do not wrestle with that basic disconnect and may be counterproductive.

Driving the news: The Biden administration this morning called for a three-month suspension of the 18 cents per gallon federal gas tax and encouraged states to consider suspending their own gas taxes.

State of play: Americans are hitting the road. Refinery capacity is down 5.4% since 2019.

  • This mismatch is the problem. Refineries are at a nearly full capacity, meaning it will be hard to produce much more gasoline in the short-run.
  • High prices are essentially the way finite supplies are rationed. The alternative is artificially low prices, combined with shortages.

So to get at the underlying problem, a policy would need to either reduce demand or increase supply. Many approaches under discussion do not do that.

What they’re saying: President Biden’s proposed gas tax holiday would have limited benefits, analysts from across the ideological spectrum believe. “The substantive case for the policy is weaker than ever,” said Tobin Marcus, a strategist at Evercore ISI, in a research note.

  • “Subsidizing demand in a supply crunch would be counterproductive, the size of the tax cut relative to pump prices is marginal, and elevated refinery utilization means more of the benefit would be captured by producers rather than consumers.”
  • Marcus, as it happens, was a policy adviser to Biden when he was vice president.

There are similar problems with other policy ideas. California Gov. Gavin Newsom is advocating a $ 400 per vehicle gas tax rebate to help take the sting out of higher prices – but that would mean higher demand, not less.

On the supply side, some Congressional Democrats have advocated a “windfall profits tax” for energy companies. But if enacted, a policy like this could make companies more reluctant to invest in more energy exploration.

What might work better? On the supply side, Employ America has produced a creative, if legally dubious, proposal for the Treasury to use the “Exchange Stabilization Fund” to incentivize energy producers to ramp up output.

  • On the demand side, offering subsidies for mass transit – or other, more fuel-efficient means of riding – might help reduce gasoline demand.

The bottom line: In weighing policies aimed at reducing gas prices, go back to Economics 101 and think about how exactly they might help the supply and demand balance – or hurt.

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