A Radical Solution to the Price of Gas: Raise Gas Taxes

I know, I know, taxes are the liberal plot to enslave the masses into socialism but if you dare to read past the purposefully provocative title we may get somewhere in this country on energy policy. Under a normal economy increasing the tax on something would naturally result in higher prices for said item. This tax would be a servicing fee attached to the cost of doing business that would need to be passed on to the consumer. Yet I still contended that this would largely result in less pain at the pump, or at least it would have a greater chance of decreasing the cost of oil then say drill baby, drill.

The problem with gas prices now is it has become totally divorced from the rules of real supply and real demand and moved into the mostly hypothetical realm of possible supply vs possible demand. This difference is very meta, but understanding it is the key to understanding why the price of oil is over $100 per barrel. Investors are looking at the oil market and are saying here is this finite and diminishing resource, oil, located in increasingly unstable and difficult locations (the middle east, underneath the ocean floor, in the frozen north) and are saying this is the likely supply. then they look at the remained insatiable appetite for oil in this country and the inevitable desire of china and india and other new likely global players and saying here is the likely demand. Based on this they speculate that the oil commodity is undervalued. To their credit this is a completely logical conclusion, especially considering how the Fukushima disaster reminded everyone of the difficulty of using nuclear power increasing reluctance to use it as an oil alternative.

The problem is these investors have in some ways jumped the gun a bit. They are right that the price of fuel should increase over time, just not at the aggressive rate they’re estimating. As a result people are claiming this is wild and reckless speculations. Suggestions are being bandied about to implement greater regulation on speculators. While I think speculators should have increased scrutiny and that would help, I don’t think it would address the long term problem. The fact of the matter is if the speculators stopped tomorrow there would be a temporary dip in the price of oil but sooner rather than later supply constraints would increase the price of oil back to these levels.

To figure out how increasing taxes would help we need to dive a bit deeper into the price of products. For any product there is an ideal price. This ideal price is the one that achieves the maximum profit. This is not necessarily a fixed number. To achieve this ideal price companies look at the demand curve. The demand curve will give you the number of people who will purchase your product at a given price. Balancing the costs of making the product with the profit curve will give you the ideal price. A good example of playing with this balance is the price of the new ipad. The new ipad costs more to make than the ipad 2, however it is priced exactly the same as the ipad 2. Apple is assuming they will make up for the decreased profit margins by moving more units.

What does this have to do with the price of gas in topeka? The demand curve is malleable. The demand curve is determined by you and me. While a Lamborghini arguably costs a lot of money to make, it’s price is largely determined by the fact that enough people will spend that much money on it. When the price of a product becomes too expensive the demand abates. This is true even for a resource as vital as gasoline. When gas prices last broke the $4.00 a gallon mark the sticker shock forced many people to reconsider their vehicle choices as a result we saw increased interest in fuel efficient cars vs large trucks and sports cars. This contributed to an overall demand decrease in america, we are now using less gas than we were a few years ago. This combined with the collapse of the economy led to the price of oil falling. Now though that the economy, specifically the investment economy, is improving we are again seeing a rise.

By increasing the tax on gas sticker shock will continue to degrade the demand curve. as demand subsides prices would begin to fall. Now there is a problem. This would be a tax increase on americans, a definite problem in a struggling economy. This is particularly a problem for working americans who need to use their cars to travel to and from work. To address this problem it would be best to reduce the payroll taxes of americans to offset the increased cost of gas. To make sure it targets only those in true need of relief you could cap the payroll tax deduction on the first 150-250 thousand dollars of earnings.

This would easily be infinitely more useful than drilling in more dangerous and or environmentally vital locales. The reason is two-fold: First oil is sold on the global market, and second we consume much more oil than we produce. The fact that oil is sold on a global market is important because it means an increase in production in the US is simply added to the global pool of oil. A high estimate of the US oil reserve is 10% of the oil in the world. this means a 10% increase in US oil production only results in a 1% increase in the global oil supply. Conversely a conservative estimate of US oil consumption is 20%. A 5% reduction in consumption would result in a 1% decrease in global demand. In other words there is far more to gain focusing on US consumption then there is on US production.

The benefit of this plan is that it attacks the real problem which is our perspective of the role of oil in the american life. By increasing the tax on gas americans will continue to think about what to prioritize with vehicle purchases. As demand waned Investors would look to other industries for capital growth. Meanwhile more money would pour into efficient consumption as opposed to greater exploration.

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