Democratic Presidential Candidate Barack Obama has proposed a plan to ease the pain of high gas prices by granting an emergency $1000 tax rebate to consumers. Intending to finance it with a windfall profits tax on oil companies, Senator Obamas plan may be astute politics, but it is bad economics.
Obamas proposal was designed to counter Republican Presidential Candidate John McCains plan to expand offshore drilling. He has criticized the McCain plan, which would ultimately increase the amount of oil available and therefore reduce gas prices. In contrast, basic supply and demand analysis shows that Obamas plan is likely to have little if any effect on the burden of high prices. In fact, demand for gas after the rebate will lead to a price increase, all other things equal, which is the opposite of what Obama is intending to achieve.
As our take-home pay increases, our demand for certain goods and services will increase while our demand for others will decrease. People tend to drive and consume more when they have additional money, so gas is one of those goods for which demand is likely to rise. When taken at face value, Obamas plan to offer a $1000 tax rebate is not necessarily objectionable, but it will only increase our demand for gas. And of course, it will increase gas prices.
With the federal government facing a half-trillion dollar deficit, there is little room for further entitlements. The tax rebates have to be financed either through spending cuts or tax increases. Curiously, Obama proposes fixing high gas prices by making it more expensive to supply gasoline. He proposes taxing oil producers, who are precisely the people you dont want to tax if your end goal is to lower gas prices. On net, Obamas plan will subsidize gas consumption by taxing gas production. This plan will not reduce gas prices. All other things equal, it is a recipe for higher gas prices and greater pain at the pump.
This is not the first time in this election season that a presidential candidate has proposed a solution to high gas prices bound to be ineffective at best. During the primaries, Hillary Clinton and John McCain independently proposed suspending the federal tax on gasoline between Memorial Day and Labor Day in order to ease consumers fuel cost burdens.
Economists of all ideological persuasions went on record to correctly point out that because the supply of and demand for gasoline are inelastic in the summersmeaning that they are relatively unresponsive to price changesthe tax rebates would not translate into lower prices. When pressed on the issue, Clinton chose to disparage these economists instead of reexamining her proposal. While Obamas ideas on oil have drawn similar criticism from economists, how he will respond remains to be seen.
Perhaps more importantly than basic supply and demand, policies like those proposed by Obama create an institutional climate in which investment is less attractive than it otherwise would be. Such proposals reduce the expected profitability for people entering industries such as oil and gasoline. In the long run, they will result in less economic development and higher prices, as firms are less willing to invest in extra production.
As economic historian Robert Higgs argues, anti-market, anti-business rhetoric created the regime uncertainty that facilitated the unnecessarily long lasting Great Depression. If we arent careful, we may allow similar rhetoric to guide our decisions and stifle our economy. Quite obviously, proposing policies that will make us all poorer is no way to promote economic growth.
Inadvertently, Senator Obama has inspired a homework assignment and a test question for Econ 101 this fall: Using appropriate diagrams, show how a tax on gasoline production and a subsidy for gasoline consumption will affect gas prices. Heres a hint: the answer isnt prices will go down.
Art Carden is a Research Fellow at the Independent Institute in Oakland, California and an Associate Professor of Economics at Samford Universitys Brock School of Business.