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Three better alternatives to Biden's gasoline tax holiday

Jul 04,2022 - Last updated at Jul 04,2022

NEW YORK  —  US President Joe Biden has proposed a three-month suspension of the 18.4 cents-per-gallon federal tax on gasoline. The move, which would require approval by Congress, is intended to provide relief to American families struggling with the 60 per cent increase in gasoline prices from about $3 per gallon before the Russian invasion of Ukraine to nearly $5 per gallon now. But better policy options are available.

Congressional opposition aside, Biden’s proposal has several potential drawbacks. First, it is not well targeted. The outcomes of individual US states’ gas-tax holidays suggest that the savings would be only partly passed on to consumers in the form of lower prices at the pump. The rest of the foregone tax revenue would boost the bottom line of oil companies that are already reaping windfall profits from high international oil prices. Furthermore, relatively affluent Americans would likely benefit the most from lower gasoline prices, while only a small portion of the gains would go to low- and lower-middle-income households that need the most help.

Second, high oil prices have raised energy costs across the board. A small reduction in the gasoline price from $5 per gallon to, say, $4.80 is not that helpful when the rest of the household energy bill remains high.

Third, a gasoline tax holiday that reduces the revenue of the federal government’s Highway Trust Fund, an outcome that Biden is urging Congress to avoid, would affect the speed of future infrastructure construction or maintenance.

Finally, the three-month horizon is unlikely to be credible unless the Western sanctions on Russia are certain to be lifted within that time, or unless a severe enough global recession lowers global oil prices to pre-war levels. More likely, any tax holiday that is approved will be extended a few times, compounding the problem of lost revenue.

There are three better alternatives than a gasoline tax holiday. The first is to transfer cash directly to low- and lower-middle-income families using the same amount of government revenue that would be foregone as a result of a gasoline tax waiver (about $20 billion over six months, according to the Biden administration’s estimate). If Biden wants to highlight his concern about high gasoline prices in particular, he could issue a “gas cost offset coupon” equivalent in value to the uncollected gasoline tax, which recipients could use at gas stations or to pay utility bills. There is no need to forbid resale of the coupons.

Because all of the government spending under this program would go to families most in need, without subsidising already profitable oil firms, it would be much better targeted than Biden’s proposal. It is also more environmentally friendly as it does not necessarily encourage more gasoline consumption. Families receiving the transfer can instead choose to use the funds to cover other necessary expenditure.

A second alternative is to allow US oil companies and refineries to export only a portion of additional production above the pre-war level. In essence, this is a two-part policy in my previous column. On one hand, oil producers would be prohibited from exporting any output before their domestic sales reach pre-war levels. On the other hand, the lure of high international oil prices, which have surged since Russia invaded Ukraine, would encourage companies to increase production.

Most importantly, this policy would increase the quantity of petroleum sold in the US, induce a shift in the mix of crude used in refineries toward lighter varieties, and thereby push domestic energy prices to below their level on February 24. This would allow ordinary Americans to benefit indirectly from high international oil prices.

Policymakers can calibrate the share of new production that oil firms are allowed to export so that the extra profit from international sales still exceeds the reduction in profit from domestic sales. In other words, this scheme is designed to share the gains from higher international energy prices between US households and oil companies. Crucially, unlike Biden’s tax-holiday proposal, there would be no loss of government revenue and hence no adverse impact on the construction and maintenance of America’s highways and mass-transit systems.

A third option would be for Biden to combine a gasoline tax holiday with a windfall tax on oil companies. This would ensure that public money is not being used to subsidise highly profitable oil firms, and would avoid depleting the Highway Trust Fund. Most importantly, a well-designed windfall tax, such as a levy only on income from overseas oil sales, could lead to a greater reduction in domestic gasoline prices than would result from the sales tax holiday alone, and also generate more revenue than the government would forego by suspending the federal gasoline tax. The government would therefore have additional money to pass on to American families, while oil companies’ profits would remain above their pre-war level.

Of the three alternatives above, the second option, permitting US oil exports only when output exceeds the pre-war level, distorts production the least and does not increase the budget deficit. The other two options can more effectively target assistance to low-income households. But any of them, or some combination of them, would be better than Biden’s current proposal in terms of both economic efficiency and fairness.

Shang-Jin Wei, a former chief economist at the Asian Development Bank, is professor of Finance and Economics at Columbia Business School and Columbia University’s School of International and Public Affairs. Copyright: Project Syndicate, 2022.

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