A Gasoline Tax Compromise for California
Eliminate the tax now. Replace it with one that ratchets up when the price of oil falls.
While elsewhere in the country drivers express outrage at $5 gas, Californians are pining for it. Prices between $6 and $7 per gallon here are creating serious financial pain for many low- and middle-income families. Some in the state legislature are calling for suspension of California’s $0.51 per gallon gas tax (scheduled to go up to $0.54 on July 1). Gov. Newsom has countered with a proposal to send $400 to the owner of every registered vehicle (up to two cars per person).
Other lawmakers point out that gas prices are not the only financial stress these households face, and for many not the largest. Families are also getting hit by fast-rising utility bills and rents, among other daily costs. This group of legislators also tends to be concerned about the environment and worried that cutting gas taxes will just encourage more emissions. Most of them support a proposal to rebate $200 per person to every household below a moderate income cut off, such as $100,000 per year.
Still, gas prices are very salient for drivers – and therefore for politicians – so there is far greater focus in Sacramento on pain at the pump than other financial challenges.
If the goal is to help Californians hit specifically by high gas prices, nothing will be nearly as well targeted as a gas tax holiday. As Jim Sallee has shown in his important paper on compensating policy losers, attempts to base compensation on correlates of gasoline usage are likely to be much less effective at targeting those most impacted by high gas prices.
But here’s an alternative gas tax that could potentially give all sides much of what they are looking for: a price-stabilizing gas tax that moves inversely with the price of gasoline. This tax would disappear when crude oil prices are high, just as the tax suspension advocates are now calling for (though some of the savings might still go to producers). And it would ratchet up as the price of crude oil drops, putting a break on the inevitable tendency to jump back into beefy SUVs, as those of us who are worried about climate change fear. A win-win.
It’s an idea I detailed in a 2008 working paper. Unfortunately, the paper didn’t come out in mid-2008 when crude prices were above $170 per barrel in today’s dollars, but in December 2008, after prices had crashed to below $60. Bad timing.
Just as in 2008, oil prices are not likely to stay at these inflated levels. Futures markets predict today’s $120 per barrel oil price will fall to $100 in a year and to $80 in three years, though that’s far from certain. Still, if we make real progress towards getting off oil, prices will very likely crash to far lower levels 5 or 10 years from now. At that point, just as in late 2008, advocates for keeping gasoline “affordable” will be enjoying the low prices and will be very resistant to raising them back up with a gas tax increase.
The figure above presents an illustration of how the price-stabilizing gas tax would work, showing both the tax level and the approximate retail price, assuming that other costs and fees – and the mystery gasoline surcharge – remain where they were in May. The tax would be set to increase 2.4 cents for every dollar per barrel the price of crude is below some benchmark level, $100 in this illustration. (The benchmark price could be set to adjust with inflation.) The 2.4 cents is the standard pass-through of crude oil prices (per barrel) to wholesale gasoline (per gallon). So this tax would be zero whenever the price of crude is above $100, $0.24 per gallon if the price of crude is $90, $0.48 if it’s $80, and $1.68 if the price of crude hits $30, which is where I think it is likely to be (or lower) if the world really takes a big bite out of oil demand.
This commitment to stabilize the price of gasoline would mean that the demand for electric vehicles and high-efficiency conventional vehicles wouldn’t evaporate when the price of crude oil plummets, as we saw happen in 1998, 2009, and 2015, among other times.
There are details to work out, many of which I addressed in 2008: What would be the benchmark oil price? How often would the tax be adjusted? How to deal with border issues if the tax is way out of line with neighboring states?
Perhaps most worrying to some policymakers would be increased volatility in gas tax revenues. But that misses the larger California budget picture. Annual gas taxes are about $7 billion of over $200 billion in state tax revenues, so it would have a small impact on overall volatility. Furthermore, the price-stabilizing gas tax would actually reduce uncertainty of the state’s total tax revenues, not increase it. The current gas tax generates revenues that are positively correlated with other tax receipts, because gasoline sales increase when the state’s economy is strong and is also generating high income and sales taxes. The price-stabilizing gas tax would generate revenues that are negatively correlated with the state’s economy, because the tax would fall when oil prices rise, which is typically when the state economy is also strong. Essentially it would be a tax revenue hedge, albeit a small one.
Let’s seize the opportunity current gas prices present, rather than watching them tumble in six months or a year and wishing we had cut a deal while it was possible. Maybe it could even be a model for a similar deal at the federal level, where there is pressure to reduce the 18.4 cent national gas tax (even though it hasn’t risen since 1993). Another opportunity for California policy leadership!
Find me @BorensteinS most days tweeting energy news/research/blogs.
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Suggested citation: Borenstein, Severin. “A Gasoline Tax Compromise for California” Energy Institute Blog, UC Berkeley, June 21, 2022, https://energyathaas.wordpress.com/2022/06/21/a-gasoline-tax-compromise-for-california/
Severin Borenstein View All
Severin Borenstein is Professor of the Graduate School in the Economic Analysis and Policy Group at the Haas School of Business and Faculty Director of the Energy Institute at Haas. He received his A.B. from U.C. Berkeley and Ph.D. in Economics from M.I.T. His research focuses on the economics of renewable energy, economic policies for reducing greenhouse gases, and alternative models of retail electricity pricing. Borenstein is also a research associate of the National Bureau of Economic Research in Cambridge, MA. He served on the Board of Governors of the California Power Exchange from 1997 to 2003. During 1999-2000, he was a member of the California Attorney General's Gasoline Price Task Force. In 2012-13, he served on the Emissions Market Assessment Committee, which advised the California Air Resources Board on the operation of California’s Cap and Trade market for greenhouse gases. In 2014, he was appointed to the California Energy Commission’s Petroleum Market Advisory Committee, which he chaired from 2015 until the Committee was dissolved in 2017. From 2015-2020, he served on the Advisory Council of the Bay Area Air Quality Management District. Since 2019, he has been a member of the Governing Board of the California Independent System Operator.
Embedded in your article, Dr. Borenstein, is the assumption that gas tax receipts find their way into the General Fund. I believe that it is a separate source of revenues for the following (lifted from a CBS8 TV (San Diego) article):
“What does the gas tax go to? It is comprised of three major parts:
Base tax: 19.4 cents per gallon goes to pay for state highway maintenance, rehabilitation, and related administration.
Incremental tax:18.7 cents goes to the state highway account for truck weight fee revenues.
Senate Bill 1 tax: 13 cents goes to fund active transportation, bridge and culvert repairs, and transportation research.”
There is a general recognition (by me at least) that transportation infrastructure is one of the necessary foundations of a vibrant economy. Continued investment also imporves operational safety, saving lives. Therefore I suggest that you extend your economic analysis to include the impact of revenue loss on our economy, highway safety, as well as other externalities (like emissions). When gas tax revenues were taken by the CA legialature, in the past, our infrastructure deteriorated as did safety. So there is data on this.
Reduction in the tax during high prices is only half the story–the tax also INCREASES when prices rise, so on net over time the total revenues remain the same. Because both capital investment and maintenance can be timed and deferred, and the revenues to the fund can be used as collateral for debt, roadway spending will be little impacted, if at all, by this proposal.
The transfer of the tax revenues to the General Fund is a completely different issue and not relevant to this discussion.
I see the argument for the price-stabilizing gas tax IF this is going to be the primary vehicle used by the legislature, and cash payments to households are off the table. But in the future, the escalating nature of this scheme seems like it will disproportionately harm those who are stuck depending on oil–poorer people who live farther from work and can’t buy a more efficient ICE or EV. Those who do have resources for a more efficient (and highly subsidized) vehicle will see lower costs through efficiency and electrification. It seems the escalating tax would ensure a high floor of transportation costs for the poor, who aren’t likely to be in a position to react to price signals or cut their gas consumption.
Posted to Haas Energy blog 2022-06-21:
Is there good data on past gasoline tax holidays and whether this actually reduces gasoline prices at the pump? Normally, in a classic demand and supply model it is the price that is limiting the demand to the available supply. Just reducing the taxes may simply cause oil companies to keep the price at the pump the same to limit demand to supply, resulting no benefit to consumers and just higher profits for oil companies. Usually this would result in an increase in supply, but in the current situation this is doubtful. Would the tax not charged be just added to the California mystery surcharge?
As to a price-stabilizing tax on gasoline: We must ensure that the money is actually spent on cost effective projects. Some years ago, I attended a Metropolitan Transport Commission’s https://mtc.ca.gov/ open house where they were getting public input on where transport money should be spent. Attendees could choose roads, bike lanes, high speed rail BART extensions etc. All without the cost per passenger mile for any of these projects! I said I wanted to carry the greatest number of people at the lowest possible cost with consideration of the cost per tonne of CO2 saved. I was amazed when MTC staff open houses staff thought this was a good idea they had never thought of!! With incompetence like this it is no wonder that thousands of millions of dollars are being spent on projects that area not cost effective, such as high-speed rail, expensive BART extensions, empty bike lanes, etc. If gasoline taxes are indeed to be raised it is imperative that the money be effectively spent.
We really do not need to impose another tax nor refund taxes paid. Rising gas prices have had a dramatic impact on the consumer because of frequency of the purchase, Unfortunately, it is only one of many impacts from inflation. If we really wants to address this economic mess, then we must re-sort our priorities.
The question isn’t about imposing or refunding a tax–it’s about whether price stability at a high level that avoids the dips that appear to mislead consumers into buying fuel guzzling vehicles is preferable over price volatility. It seems that consumers have short memories and overly optimistic expectations that past price spikes are not indicators of future volatility.
I am attracted to this idea, and in fact recommended something similar to the Washington State Legislature in 1979 during the second oil embargo. At the time, I was a Research Analyst for the Washington State Senate Transportation Commission.
But I am quite surprised to see it come from Dr. Borenstein.
Clearly the best thing that we can do to bring about a reduction in gasoline prices is to consume less gasoline. Reduced usage will reduce the market pressure driving prices up. RAISING the gas tax in the U.S. to European levels ($1.50 – $3.00/gallon) would help reduce US consumption, which in turn would help our European allies now facing the uncomfortable choice between limited supplies of non-Russian oil, and the purchase of oil from Russia by freeing up some of the supply now serving the U.S. That is obviously a conflation of economic policy, defense policy, and foreign policy.
Our European allies use that revenue to fund universal health coverage. While there is almost no connection between gasoline consumption and health care costs, many economists favor “taxing bads” in order to subsidize “goods.” And many of us think that universal health care is a good thing.
While the elasticity of demand with respect to price is quite low in the short run for energy, it is not zero. Dr. Borenstein has elsewhere advocated pricing of electricity with reference to short-run marginal costs, but here is proposing a very different approach to gasoline taxation, with gas taxes going DOWN when short-run marginal prices go UP.
His “revenue stabilization” argument seems to have it backwards. The gas tax revenue actually goes DOWN at times like this, because people buy a little less gasoline, and it is taxed per-gallon, not a percentage tax like the Sales Tax. Fewer gallons means lower revenue. Sensible people who have a choice of two vehicles are now using the more fuel-efficient one for most of their driving. Others are combining trips. Every one of us should check our tire pressure (low tire pressure costs you 2-4 miles per gallon).
All of this leads to less gasoline consumption. Gasoline demand in the US was running above 2021 levels through March, and has since dropped very slightly below last year (consistent with low, but not zero short-run price elasticity. https://www.eia.gov/petroleum/weekly/gasoline.php
Pragmatically, the cost of road repairs goes UP when the cost of oil goes up, because road repair involves asphalt and truck travel. So Borenstein is actually advocating a policy to reduce our ability to provide road repair services in a timely fashion. Which we pay for in the long run with lower tire life, more front end alignments, and more traffic accidents.
Now, there is a better focus for this concept. California is one of relatively few states that collects a state sales tax on gasoline. This is separate from, and in addition to, the per-gallon gasoline tax. It’s not big — only 2.25%, much lower than the sales tax rate on shoes for walking or bicycle tires for cycling. But that tax IS generating extra revenue to the state General Fund as gas taxes are high, and that increased revenue truly is a windfall to the state. Returning that extra revenue to voters makes sense. But the sales tax is only about $.13/gallon. Not enough to make a serious dent in the $2/gallon increase in the cost of gasoline.
I agree with the political element of his proposal — that the voting public sees the price of gasoline as a big deal when that price is high. I actually prefer Governor Newsom’s proposal: a lump sum payment. That is emulating how California IOUs are treating the value of carbon allowances under the state cap-and-trade law for electricity. It gets money back to the people, but NOT in proportion to how much gasoline they buy. They can use the check to get a tune-up, buy new low rolling resistance tires, buy an E-bike, or even pay for a payment or two on a more fuel-efficient car.
Rewarding gasoline consumption with a gas tax holiday is not good for the economy, it’s not good for the environment, and it’s not good for promoting world peace. It’s a cheap trick. Roads still get potholes and need to be fixed. That’s what the gas tax pays for.
This is the worst idea I’ve ever heard! The oil companies will charge what the market will bear. Period.! The only thing this does is take money away from road maintenance budgets
California also adds the state sales tax to gasoline including taxing the per gallon excise tax of $0.51. The last I checked no other state double taxes gasoline. The combined excise and sales tax is close to $1.25 per gallon in California.
This is a good idea. By being relatively volatile, the state will be more likely to spend the funds on one-time capital projects rather than ongoing expenses, which would be better for road upkeep. The key is the willingness of the Legislature to index the benchmark oil price…
I like simple solutions, fewer chances of unknown effects. The state is rolling in $$$ so send every person $ x. as a refundable tax credit, for AGI below a certain level. So what that a few hundred thousand who don’t need it get it.