You can’t cut gasoline prices by increasing demand
Gasoline prices in the United States have yet again hit record highs at $4.59 per gallon. Naturally, the 83 percent of Americans who drive cars regularly are heavily impacted, and politicians are scrambling to find solutions to dull the pain. Unfortunately, many of these solutions would trade near-term relief for long-term pain, and one of the worst policy ideas proposed recently is gasoline rebates. Politicians, ever incentivized to hurry up and do something, are ignoring basic economics, which in this case means pursuing policies that would transfer wealth from taxpayers to fossil fuel companies—something that under most circumstances would be universally understood as a very bad idea.
That is why it is puzzling that some members of Congress are pursuing efforts that would give people credits to buy gasoline—a sure way to increase gasoline prices through government subsidies. California and New Jersey have both pursued gasoline rebate bills, neither of which are exemplars of gasoline affordability.
Consider the economic implication of such a policy. Suppose the government gives everyone a $500 gift card to purchase hot dogs. Any individuals who were not already spending $500 on hot dogs will now be incentivized to do so, and they have no reason not to consume the full value of the gift card. This then raises the demand for hot dogs, and hot dog sellers would have to increase prices to balance their limited supply with the demand. The winners in this scenario are the hot dog sellers because they are now selling huge amounts of product at higher-than-normal prices. The losers are all of the taxpayers who have to pay taxes that essentially fund hot dog producers instead of letting them keep their money to buy whatever type of food they prefer.
It is the same with gasoline; consumers who would otherwise be incentivized to limit their consumption are delivered the reverse incentive with a rebate, as they are then incentivized to consume the full amount that the government is willing to subsidize. Increasing consumer purchasing power will increase the price of products. California, New Jersey and federal legislators are looking to exactly the wrong solutions.
High gasoline prices today are being caused by a multitude of conflating factors that can be described as a perfect storm. The world’s second largest oil and gas producer, Russia, is embroiled in a war. Western nations are—correctly—pursuing policies to limit their imports of Russian products to enhance the effectiveness of their sanction regimes, increasing demand from non-Russian suppliers. COVID-19, now combated with vaccines and more effective antiviral treatment, has reached a point where its suppressing effect on travel demand is being mitigated.
The global economy, plunged into a deep recession by the pandemic, has been on a recovery—albeit unsteady—that further increases petroleum demand. China, which pursued harsh lockdowns as part of a zero-COVID-19 strategy, is now easing lockdowns and has rising petroleum demand. U.S. oil producers are not yet back to pre-pandemic levels of production, as the record-low oil prices seen during the early part of the pandemic forced them to curtail operations and investment, and we are now feeling the effects of refining-capacity shortages. And, as a cherry on top, the Organization of Petroleum Exporting Countries, a cartel that manipulates oil prices, is refusing to increase its output and artificially constraining supply.
The best way to address gasoline prices is to increase supply or reduce demand. Gasoline demand is typically considered highly inelastic because much of the travel that consumes it is essential. Even during the early lockdowns of the pandemic, vehicle traffic in the United States never fell below 25 percent of pre-pandemic levels and typically was about half of pre-pandemic levels in most metro areas. In the long term, electric and alternative fuel vehicles may reduce gasoline demand, but in the near term, demand will remain high because—even at current prices—Americans are willing to pay. The best bet for bringing prices down is to increase supply; something that environmentally focused politicians have been reluctant to pursue and that the Biden administration has taken considerable flak from gas-price-focused politicians for with regard to its delays on oil and gas leasing.
For a real-world example of how subsidies will only worsen supply constraints, we can look to college tuition. The government offers unlimited loans for students, ensuring that every student is able to get a loan for a degree, even if they may not be able to repay the loan. The effect has been to allow colleges to charge whatever price they want, even if the value of the degree is below cost of the tuition. They are able to do this because the government has ensured that students are able to pay tuition at any price—even if they cannot repay the loan. In 2019, college tuition was 183 percent more expensive than in 1998. The only other comparable cost increase seen in this timeframe was that of hospital services, which increased by 211 percent and is also subsidized through the policies of the Affordable Care Act (Obamacare).
If politicians want to make gasoline prices look like college tuition or healthcare costs, then they should pursue gasoline rebates. If they don’t want to enrich fossil fuel companies with taxpayer money or want to avoid price increases, they should avoid gasoline rebates. The rebates are paid for by taxpayers—the same people buying the gasoline—so the policy is not going to reduce the overall financial burden for consumers. Directing taxpayer funds to increase individuals’ purchasing power of specific products is going to raise the costs of those products; it is that simple. Unfortunately, political demands too often trump common sense.
Image: kittisak
