Wednesday, April 16, 2008

Gas Tax benefits do not trickle down

Presidential candidate John McCain called for gas tax holiday over the summer months. The idea is that reducing taxes increases the disposable income people have and will lead to higher consumer spending which leads to income growth as a function of Keynesian multiplier. McCain is correct in that this is like a fiscal stimulus which will lead to expansion.

Gas Tax is not a percentage of gas price we pay at the pump. It is fixed at 18.4 cents per gallon. According to 2007 data, US consumes 388.7 million gallons of gas a day. Rounding it to 400, this translates to a lost revenue to the Government over this tax holiday to be, $6.6 billion.

The first question to ask with any fiscal stimulus package is, "How are you doing to fund it?"
One way would be to reduce Government spending. In the election year, even the self described fiscal conservative like McCain would not agree to cut in spending. So this would be deficit funding. Right on the heels of $145 billion fiscal stimulus approved by the Congress, the additional tax reprieve will hurt the deficit.

Another important question McCain should ask is, "What is the source of the gas price increase?". Unlike previous oil price shocks the source of the current shock is the higher demand for oil from China and India. So reducing the gas tax may entice the US consumer to consume more gas, increasing the demand further and hence the price at the pumps, creating effects that are opposite of what McCain wants.

The other source of the gas price increase is the weak dollar. Since US is a net Oil importer, it has to pay more of its weak currency and that gets passed on to the consumer. An increased consumption due to gas tax holiday may funner more US dollars to the oil producing countries, there by decreasing net exports and hence shrinking the economy.

It is very easy to see that McCain and his economic team understand this and know full well this is not going to happen. They also know that the democratic candidates would come out strongly against this tax holiday. This is just a way to get political mileage with more ammunition to describe his opposition as tax happy spenders.

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