In a recent Washington Post article, conservative commentator Charles Krauthammer called for a $1 per gallon hike in the gas tax. His main points are that a higher gas tax—coupled with payroll tax rebates—would boost the economy, and that reduced U.S. consumption would strike a blow against hostile foreign regimes. The first point is simply wrong; even with a payroll tax swap, a higher gas tax would hurt the economy on balance. And if reducing world oil prices is the geopolitical goal, then removing barriers to North American production is far more effective than starving U.S. consumers.
Even a Revenue-Neutral Gas Tax Hike Would Hurt Economy
First let’s deal with Krauthammer’s claim that his proposal would stimulate the economy:
The [gas tax] hike should…be…$1. And the proceeds should not be spent by, or even entrusted to, the government. They should be immediately and entirely returned to the consumer by means of a cut in the Social Security tax.
The average American buys about 12 gallons of gas a week. Washington would be soaking him for $12 in extra taxes. Washington should therefore simultaneously reduce everyone’s FICA tax by $12 a week. Thus the average driver is left harmless. He receives a $12-per-week FICA bonus that he can spend on gasoline if he wants — or anything else. If he chooses to drive less, it puts money in his pocket. (The unemployed would have the $12 added to their unemployment insurance; the elderly, to their Social Security check.)
The point of the $1 gas tax increase is not to feed the maw of a government raking in $3 trillion a year. The point is exclusively to alter incentives — to reduce the disincentive for work (the Social Security tax) and to increase the disincentive to consume gasoline.
It’s win-win. Employment taxes are a drag on job creation. Reducing them not only promotes growth but advances fairness, FICA being a regressive tax that hits the middle and working classes far more than the rich.
Krauthammer’s analysis sounds plausible on the surface, to a non-economist at least. But anyone who has studied tax analysis knows that it is utterly wrong.
First, let’s use a trick from the minimum wage debate, which I’m sure Krauthammer and other Fox contributors will appreciate. When a progressive says how great boosting the minimum wage to (say) $10/hour would be, the easiest way to show the weakness in the argument is to ask, “Okay, then why not boost the minimum wage to $100 per hour?!” It’s not that this is the end of the story, period, but the rhetorical question shows that the typical progressive hasn’t even considered the downsides of the proposal, and thus is caught flat-footed when challenged in this way.
We can use the same rhetorical device against Krauthammer. In his article, he doesn’t list a single downside of raising the gas tax. It is safe to assume that he pulled that $1 per gallon figure out of thin air—it’s not the result of a careful weighing of pros and cons. So the wise reader can go back and plug a $10 per gallon tax on gasoline into Krauthammer’s piece, and see if it still makes sense.
Here’s a hint: It won’t. With such a punitive gas tax, Americans would cut way back on their driving (eventually), meaning the new tax wouldn’t raise nearly as much revenue as Krauthammer thinks. That means there wouldn’t be as much money to refund to workers through Social Security refunds. In the end, a punitive gas tax would simply take the option of driving off the table for millions of lower-income working Americans. How in the world would that help the economy?
Now it’s true that later on in his article, Krauthammer talks about climate change and pollution, but he treats those issues as icing on the cake—his “strongest” upfront argument is that a gas tax plus Social Security refund would obviously (he thinks) boost economic growth, and I’ve just shown that Krauthammer’s logic can’t possibly be right.
Pinpointing the Specific Error in Krauthammer’s Argument
Earlier I showed that something must be seriously wrong with Krauthammer’s breezy argument for the economic benefits of a stiff gas tax, because there was nothing magical about his choice of “$1” per gallon, and his argument is clearly nonsense if we plug in a much bigger number.
But what specifically is wrong with his case for a gax tax? Economists who formally model tax policy report that as a general rule, if the government wants to raise a target amount of revenue from the taxpayers, then the way to minimize the harm to the economy is to make the rate as small as possible by levying it on the widest possible base. To be sure, no matter how the government levies a tax, it will hurt the economy, but the point is that there are smarter (and dumber) ways of doing it.
Well, trying to raise revenue with a huge tax on gasoline—in the case of an additional $1 surcharge, that would make the effective federal tax rate on gas a whopping 60 percent—is a really dumb way to do it. The “tax base” on gasoline is much narrower than on labor in general, and that effective tax rate in the neighborhood of 60 percent is far, far higher than the current payroll tax rate on labor (which is 15.3 percent if you combine Social Security and Medicare, and add both the employer and employee sides[1]). That means raising such-and-such billions of dollars through a high gas tax, even if we then refund the revenue through reductions in payroll taxes, ends up hurting the economy far more than it helps.
Let me make the case from a slightly different angle: In a previous IER post, I summarized the peer-reviewed research on carbon taxes, which showed that the only way it’s even theoretically possible to get a boost to the economy is if the proceeds from a much broader carbon tax are devoted to shifting the burden of taxes away from capitalists and onto workers. (This is because taxes on capital hurt economic growth more than taxes on workers.) So clearly, Krauthammer’s proposal of a much narrower tax—aimed just at gasoline rather than the broader base of carbon dioxide emissions—coupled with a refund to average workers, rather than capital, will be very inefficient and reduce economic growth.
It is frustrating that a small group of conservative pundits in recent years keep telling Americans that a tax on carbon, or gasoline, coupled with payroll tax cuts will be a “win-win” that boosts economic growth. No, the best research says it wouldn’t, and this is more obviously true once we factor in the real-world fact that the federal government would surely spend some of the new billions in receipts rather than faithfully returning it all to taxpayers.
To Weaken Oil Exporters, Unleash North American Producers
The other main plank in Krauthammer’s call for a gas tax is to stick it to hostile regimes:
The beauty of the [gas] tax — as a substitute for a high world price — is that the incentive for fuel efficiency remains, but the extra money collected at the pump goes right back into the U.S. economy (and to the citizenry through the revenue-neutral FICA rebate) instead of being shipped overseas to Russia, Venezuela, Iran and other unsavories.
Which is a geopolitical coup. Cheap oil is the most effective and efficient instrument known to man for weakening these oil-dependent miscreants.
In the context of his article, it seems clear that geopolitical concerns are the central driver of Krauthammer’s analysis. (Unlike progressives who focus front-and-center on climate change and conventional air pollution, Krauthammer relegates those issues to the end of his piece, and acknowledges that conservatives are skeptical of such matters.) Yet even on his own terms, Krauthammer’s recommended policy would do very little.
The United States is rapidly losing its dominant position as a consumer of oil. According to the most recent projections put out by the EIA, the United States’ share of consumption of “petroleum and other liquids” goes from 21% in 2010 down to 15% by 2040. The drop in the U.S. fraction of global demand is made up by China’s share, which rises from 11% in 2010 to 17% by 2040. (In the projections, China overtakes the U.S. as the world’s largest petroleum consumer in the year 2035.)
In terms of absolute consumption (measured in BTUs), the U.S. is projected to slightly drop from 2010 through 2040, whereas China grows a whopping 116% while India surges 111% over those three decades. Africa’s consumption rises 83% over that same period.
It is true that an artificial reduction in U.S. demand for petroleum products would make the world price of crude lower than it otherwise would be. However, as the above figures indicate, the U.S. is already poised to be a shrinking consumer on the world market, both in absolute terms but especially as a share of the total. We must also keep in mind that if the U.S. were to significantly curtail its consumption at an even faster rate than the current trends indicate, it would also accelerate the growth in consumption elsewhere. This is because shrinking U.S. demand → lower world crude price → increase the quantity of crude demanded in China, India, and so on. In other words, by effectively refusing to buy oil from OPEC nations, Americans would not ruin their markets; instead they would simply sell that oil to other buyers, at lower prices of course.
Rather than punishing U.S. consumers with a gas tax as a way to reduce world prices, a much more sensible approach would be to reward U.S. producers by removing obstacles to production. This includes approving the development of oil and gas resources on federal lands, both onshore and offshore, but also eliminating the anachronistic ban on crude oil exports. Getting the federal government out of the way of international pipelines would be another way to foster the development of a North American energy bloc that would greatly reduce the economic power of OPEC nations. Best of all, these policies really would be pro-growth and make Americans richer.
It’s important to note that one of the reasons oil prices have dramatically fallen over the past year is because of pro-growth policies on private and state lands that lead to the massive expansion of domestic oil and natural gas production. In other words, we have already seen countries like Russia, Iran, and Venezuela take a massive financial hit, but that occurred in large measure to growing domestic oil production, not massive taxes on oil, such as taxes in Europe.
Conclusion
Charles Krauthammer’s call for a large hike in the gasoline tax is based on faulty economics. It would make Americans poorer, and ironically would hit working class Americans (for whom gas is a large part of their budget) harder than the wealthy. A gas tax is also an incredibly blunt tool to try to reduce world crude prices, as Americans are falling behind as consumers of oil. A much better way to reduce crude prices—while helping U.S. producers and oil consumers all over the globe—is to eliminate federal roadblocks on North American energy development.
[1] Purists might worry about the fact that labor income is also subject to federal (and possibly state) income tax, meaning that the effective marginal labor income tax rate is much higher than 15.3 percent. In some cases that is definitely true, but it wouldn’t be for millions of Americans who have a low income and (at the federal level) are primarily taxed through Social Security and Medicare taxes.
