Cut the Electricity Tax, not the Gas Tax
A more effective way to help struggling families, without undermining climate goals.
You may have heard the growing talk in Washington DC and state capitals of temporarily suspending federal and state gasoline taxes during these times of higher-than-average, but not-close-to-record oil and gasoline prices. Conservative politicians are on board with everything about the idea except for the temporary part. Liberal politicians like the idea of reducing a regressive tax and partially offsetting recent price increases, but they are uncomfortable with inviting more GHG-spewing gasoline consumption. Nearly all seem to think that cutting gas taxes will make them a hero with voters.
From an economic viewpoint, this is a terrible idea. But I’m not convinced it’s a great political move either. Plus, in California and many other parts of the country, there is a better way to help low and middle income families without undermining climate policy.
What Makes Cutting Gas Taxes Bad Economics?
Let’s start with the awful economics of cutting gas taxes. First, burning gasoline creates air pollution and greenhouse gas emissions, costs that the motorist doesn’t bear. Jim Bushnell and I showed recently that in most of the country these pollution externalities are larger than the state and local taxes and fees. So, gas taxes are too low, not too high, to reflect the full cost of burning gasoline in those areas.
Moreover, our study was only looking at costs and benefits of switching from gasoline to electric vehicles, so we ignored two important negative externalities that all vehicles create: the added congestion when they squeeze into traffic and the increased accident danger for other drivers, cyclists, and pedestrians. Lower gas taxes increase not only pollution and GHG emissions, but also congestion and accidents. When you add all those together, gas taxes are too low everywhere in the country. That’s true in California even though suppliers here collect an additional Mystery Gasoline Surcharge, which remains about 30 cents per gallon.
What makes this idea an even worse policy choice is that some of the cut will end up in the pockets of producers, not consumers, just when oil suppliers are already hauling in huge profits. The tax cut increases the demand for gasoline, and thus for oil. That increased demand pushes up the oil price.
In normal times when the market is well supplied, consumers would get nearly all of the tax cut, because a small price increase is all it takes to get a big boost in supply. But these aren’t normal times. One way to tell is that the price of oil for delivery a year from now is more than $10 per barrel lower than today, indicating that traders think the market is in a temporary supply crunch. That means a small price increase won’t boost supply much right now. It will take a more substantial rise, which research shows will reduce the share of the tax cut that consumers get to keep.
So, the economics of a gasoline tax cut is bad, both because gasoline prices don’t reflect the full cost of burning a gallon even at today’s tax levels, and because the tax cut will go partially to oil producers instead of consumers.
What Makes Cutting Gas Taxes Good Politics?
None of that is news if you follow energy and environmental economics. What’s less clear to me is why cutting gasoline taxes is seen as such an obvious political winner. Sure, people don’t like to pay taxes and people who buy a lot of gasoline are feeling particularly squeezed right now. But I bet that most drivers couldn’t tell you how much of the price of a gallon is taxes, and they are unlikely to see a clear price drop that can be tied to a tax suspension.
Take for instance the discussion of suspending the federal tax, 18.4 cents per gallon. That entire tax is equivalent to about a $7 per barrel change in the price of crude oil. In the last couple of months, the price of crude oil has risen more than $20 per barrel. It could rise further or could decline a lot depending on what happens in Ukraine. Either way, it’s likely the tax suspension would be overshadowed. Of course, if the price of crude falls and gasoline follows, politicians would claim all of the decline was due to their brilliant tax suspension. Still, it seems equally likely that consumers will remain very unhappy about gas prices after the tax cut, and any politician who advocates for it will just look ineffective. “Where’s that cheaper gasoline that those politicians promised?”
And, if crude oil prices rise, it probably doesn’t play well for a politician who claimed they were going to lower your gas price by cutting taxes. One lesson from the last few years seems to be that “without my policies, things would have been even worse,” isn’t really a winning slogan.
The debate in California is even more baffling. Few people seem to know this important detail – and the first three news stories I pulled up didn’t even mention it – but the change under consideration is to delay a 3 cent per gallon increase for a year. Now who is going to stand at the station pumping $4.65 gas and say to themselves, “well at least the wise policies from Sacramento kept it from being $4.68”?
A Better Tax Cut
Besides, in California and most of the rest of the country there is another sort of energy tax that would make a much better target: the “tax” on electricity. OK, technically it’s not a tax, but rather very high rates attributable to various add-ons that don’t actually reflect the cost of supplying electricity, including low-income support programs, subsidies for rooftop solar and EV charging stations, climate change adaptation costs and many others we have discussed in other blogs. Instead of cutting gas taxes, how about helping the working poor by cutting electricity prices? Taking some of these costs out of electricity prices, even temporarily, would be more helpful to low and middle income households than cutting gas taxes. Plus, it would make electricity prices more closely reflect their true social cost. In California, unlike gasoline, electricity prices are way too high, according to many different studies.
The standard political take is that no one thinks about electricity prices, while gas prices are slapping consumers in the face every time they drive down a street. That may have been true in the past, but as rising generation costs, increasing climate adaptation expenses, and an expanding list of state programs cause growing electricity bill shocks, awareness of power prices is growing. A politician willing to step up to that challenge will be a real hero.
Keep up with Energy Institute blogs, research, and events on Twitter @energyathaas.
Suggested citation: Borenstein, Severin. “Cut the Electricity Tax, not the Gas Tax” Energy Institute Blog, UC Berkeley, February 8, 2022, https://energyathaas.wordpress.com/2022/02/28/cut-the-electricity-tax-not-the-gas-tax/
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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.
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The argument that increasing traffic lanes doesn’t reduce congestion ignores benefit that the road is now carrying a larger number of travelers. This is a benefit and must be included in any cost benefit calculation. The reason they eventually are congested again is that they many find them useful. What sense does it make to argue that, for example, the London underground or Bay Area BART system should never have been built because they eventually became congested, so shouldn’t have been built? Or that new additions to systems like this shouldn’t be built because they will simply entice more people to travel on them, and become congested? Obviously, it these systems, including road lanes, become congested, that must be because people find them beneficial. This should be included in any cost benefit analysis.
Frequently the false argument is made that instead of building more traffic lanes we should build more rail transit. New rail transit has proven to be so expensive that it not only requires a heavy subsidy but frequently is not useful for most travel, so doesn’t get congested. Should we build systems that are not that useful, so never get congested?
Unfortunately, the way those programs are funded would mean, a priori, the programs end during the period of the “tax holiday”.
Let’s use low income programs to illustrate the challenge. Low income rate discounts typically take a percentage of the cost off qualifying customers’ bills. The revenue requirement that isn’t recovered from these customers is distributed across all other customer classes (or sometimes just other, non-qualifying residential customers, depending upon that utility’s rate design). Hence, low income discounts would have to end for the period that the “tax” is foregone. The only variation on this theme would be if you were to suggest that for investor owned utilities that their shareholders now fund the programs solely without recourse to rate base to do so, however the courts are likely to see such an outcome as confescitory if not unconstitutional, were a state PUC to entertain teh notion.
I am sure that we all have a list for the allocation of the state’s surplus monies. With respect to Climate Change, and with focus on California’s energy needs, forget cutting the electricity or gas taxes. As Bill Gates has suggested” “Make bigger bets on high risk, high reward, R&D projects.” For example, fund: 1) Hydrogen production via electrolysis,using carbon free energy including nuclear; 3) Under grounding high voltage lines through high biomass fuel areas; 3) carbon sequestration,4) and direct air capture of carbon,
None of these technologies are going to make it if electricity is too expensive. Consumers make choices based in large part on incentives although perhaps not as quickly as some economists would like. (And undergrounding is extremely expensive and wasteful. There are better solutions.)
I completely agree. The idea of making electric ratepayers pick up the tab for public benefit programs like low-income assistance and climate change was political cowardice from the start. The success of solar programs and the pain that causes is a clear example.
While I agree that cutting electricity taxes, particularly for those using lower amounts of electricity, is a good idea, it still suffers from the problem that most consumers will not notice the tax decrease. Indeed, having added enough solar to our home and bought an electric car, our electrical bill is now unintelligible. I can now longer to accurately determine how much we pay per kwh. Most consumers do not even know what proportion of their bill is for gas and for electricity, but only the bill they pay.
“our study was only looking at costs and benefits of switching from gasoline to electric vehicles, so we ignored two important negative externalities that all vehicles create: the added congestion when they squeeze into traffic and the increased accident danger for other drivers, cyclists, and pedestrians”
It is easy to forget in a cost analysis that a proper cost/benefit analysis should be completed. Owning a vehicle has huge benefits, such as big increases in jobs available, lower cost comparison shopping, less time wasted in travel, etc. There are also costs associated in other modes of travel. We now have miles and miles of mostly empty bike lanes in California that the few cyclists didn’t pay for. (I should note that for many years I did commute by bicycle). Costs like that should be included in a cost/benefit of alternatives to driving, such cycling. If congestion is reasonably included as a cost, then congestion caused by adding bike lanes and removing a lane of traffic is also a cost to drivers. For example, dedicating a lane on the top of the Richmond San Rafael bridge for an insignificant number of cyclists is unlikely to have a beneficial cost/benefit analysis.
Whether adding lanes relieves congestion is questionable: https://www.bloomberg.com/news/features/2021-09-28/why-widening-highways-doesn-t-bring-traffic-relief