A Gasoline Tax Compromise for California – Energy Institute Blog

Eliminate the tax now. Replace it with one that ratchets up when the price of oil falls.

While elsewhere in the country drivers express outrage at $5 gas, Californians are pining for it.  Prices between $6 and $7 per gallon here are creating serious financial pain for many low- and middle-income families.  Some in the state legislature are calling for suspension of California’s $0.51 per gallon gas tax (scheduled to go up to $0.54 on July 1).  Gov. Newsom has countered with a proposal to send $400 to the owner of every registered vehicle (up to two cars per person).

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Other lawmakers point out that gas prices are not the only financial stress these households face, and for many not the largest. Families are also getting hit by fast-rising utility bills and rents, among other daily costs.  This group of legislators also tends to be concerned about the environment and worried that cutting gas taxes will just encourage more emissions. Most of them support a proposal to rebate $200 per person to every household below a moderate income cut off, such as $100,000 per year.

Still, gas prices are very salient for drivers – and therefore for politicians – so there is far greater focus in Sacramento on pain at the pump than other financial challenges. 

If the goal is to help Californians hit specifically by high gas prices, nothing will be nearly as well targeted as a gas tax holiday. As Jim Sallee has shown in his important paper on compensating policy losers, attempts to base compensation on correlates of gasoline usage are likely to be much less effective at targeting those most impacted by high gas prices.

But here’s an alternative gas tax that could potentially give all sides much of what they are looking for: a price-stabilizing gas tax that moves inversely with the price of gasoline. This tax would disappear when crude oil prices are high, just as the tax suspension advocates are now calling for (though some of the savings might still go to producers).  And it would ratchet up as the price of crude oil drops, putting a break on the inevitable tendency to jump back into beefy SUVs, as those of us who are worried about climate change fear. A win-win.

It’s an idea I detailed in a 2008 working paper.  Unfortunately, the paper didn’t come out in mid-2008 when crude prices were above $170 per barrel in today’s dollars, but in December 2008, after prices had crashed to below $60. Bad timing.

Just as in 2008, oil prices are not likely to stay at these inflated levels. Futures markets predict today’s $120 per barrel oil price will fall to $100 in a year and to $80 in three years, though that’s far from certain. Still, if we make real progress towards getting off oil, prices will very likely crash to far lower levels 5 or 10 years from now.  At that point, just as in late 2008, advocates for keeping gasoline “affordable” will be enjoying the low prices and will be very resistant to raising them back up with a gas tax increase. 

The figure above presents an illustration of how the price-stabilizing gas tax would work, showing both the tax level and the approximate retail price, assuming that other costs and fees – and the mystery gasoline surcharge – remain where they were in May. The tax would be set to increase 2.4 cents for every dollar per barrel the price of crude is below some benchmark level, $100 in this illustration. (The benchmark price could be set to adjust with inflation.) The 2.4 cents is the standard pass-through of crude oil prices (per barrel) to wholesale gasoline (per gallon). So this tax would be zero whenever the price of crude is above $100, $0.24 per gallon if the price of crude is $90, $0.48 if it’s $80, and $1.68 if the price of crude hits $30, which is where I think it is likely to be (or lower) if the world really takes a big bite out of oil demand.  

This commitment to stabilize the price of gasoline would mean that the demand for electric vehicles and high-efficiency conventional vehicles wouldn’t evaporate when the price of crude oil plummets, as we saw happen in 1998, 2009, and 2015, among other times.

There are details to work out, many of which I addressed in 2008: What would be the benchmark oil price? How often would the tax be adjusted? How to deal with border issues if the tax is way out of line with neighboring states? 

Perhaps most worrying to some policymakers would be increased volatility in gas tax revenues. But that misses the larger California budget picture. Annual gas taxes are about $7 billion of over $200 billion in state tax revenues, so it would have a small impact on overall volatility. Furthermore, the price-stabilizing gas tax would actually reduce uncertainty of the state’s total tax revenues, not increase it. The current gas tax generates revenues that are positively correlated with other tax receipts, because gasoline sales increase when the state’s economy is strong and is also generating high income and sales taxes. The price-stabilizing gas tax would generate revenues that are negatively correlated with the state’s economy, because the tax would fall when oil prices rise, which is typically when the state economy is also strong. Essentially it would be a tax revenue hedge, albeit a small one.

Let’s seize the opportunity current gas prices present, rather than watching them tumble in six months or a year and wishing we had cut a deal while it was possible.  Maybe it could even be a model for a similar deal at the federal level, where there is pressure to reduce the 18.4 cent national gas tax (even though it hasn’t risen since 1993).  Another opportunity for California policy leadership!

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