Oil Company Holiday?

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The Clinton-McCain-proposed gas tax holiday is being panned by economists for any number of reasons, but this one may be the most persuasive:

Economists have a different take: They say the oil companies may end up the biggest beneficiaries, while the aid to families wouldn’t be enough to buy a $35 backpack.

The trouble with the plan, they say, is that oil prices are rising because of low supplies, and companies will continue to charge the average $3.60 a gallon and just pocket the money that would have gone to federal taxes.

“That’s $10 billion, and it’s going into the pockets of oil refiners,” said Leonard Burman of the Tax Policy Center in Washington. “The last time I checked, they didn’t need it.”

Supplies are “being cleared at the current price,” said Donald Parsons, an economics professor at George Washington University in Washington. “If you take away the tax, you’ll have the same number of consumers willing to buy the gas at the same total price.”

On one level this makes sense. If the market will bear $3.60/gal, then oil companies will seek to charge $3.60/gal. But doesn’t it also suggest a broken market? What the market will bear is only half the equation. In a functioning market, shouldn’t competition drive the price down to what it costs to produce a gallon of gas plus, ideally if you’re a producer, some profit? If the gas tax holiday were enacted, prices should settle at a level equal to the current price minus the excise tax, all else being equal.

I have a little familiarity with the retail gasoline business, and it is an extremely competitive business. So market dysfunction would have to be further up the pipeline. Is the gasoline wholesale market as resistant to competitive pressures as these economists suggest?

Late Update: A number of readers of responded with additional analysis, and the key point I didn’t mention is the inelasticity of supply, as explained by TPM Reader CS:

Is the gas market “broken” as you suggest? The short answer is no. You’re right that competition generally drives prices down, but that only works to the extent more product can be produced.

Where supplies are fixed — and oil/gas supplies, for all intents and purposes, are — it is the demand that determines price. One oil company could cut its gas prices, but it can’t sell anymore gas than it already is (because it already sells all the gas it has), so purchasers would have no choice but to get the rest of their gas from someone else. This leaves oil companies with no incentive for lowering prices. If I’m already selling out all my inventory, and I can’t make any more, lower prices cannot boost sales or take sales from someone else. All they can do is cut my profits.

Your model posits suppliers bidding against each other to sell gas. But with supplies fixed and limited, in effect what is happening is that buyers bid against each other to purchase gas.

Later Update: Some readers have chided me for a lack of knowledge of basic economics. So let me be clear: I wasn’t in anyway disputing the economists above, but rather noting that the dynamic they described spoke to a problem larger than merely the gas tax and whether you suspend it for time. Lack of supply, barriers to entry, and other non-competitive features of the market are what I meant by the market being “broken.” They all contribute to supply being fixed in the short-term (and arguably in the long term as well). They also set the conditions which make a gas tax holiday counterproductive.

Still Later Update: TPM Reader GC:

Please state Hillary’s position on the Gas Tax Holiday correctly. While McCain’s plan is a giveaway to big oil, Hillary’s plan imposes a “windfall profit” tax on oil companies to make up for the lost tax revenue. So Hillary’s plan breaks even. Instead of customers paying the tax, the oil companies pay the tax. The price of gas will stay the same.

But the bigger story is what a superior job Hillary did in neutralizing McCain’s announcement. Everyone knows this is just politics; this idea will never become law. So examine it on a political basis.

Imagine this issue came up in the general election and Obama is the Dem candidate. McCain and the Media echo chamber start asking the question, “Is McCain actually the campion of the little guy? Is Obama really an elitist who doesn’t understand the pain of poor folks?” Then Obama spends many news cycles “explaining” why it’s better to not cut the price of gas, it wouldn’t make much difference in the price anyway, this is just a gimmick,… You know the rule: If you are explaining, you are losing!

Clinton is focused on becoming the next president. Obama is overly concerned about being correct. Remember, this will NEVER become law. It is a political stunt by McCain and Hillary had the best counter punch.

Setting aside the political arguments GC makes, is there any reason to think that a windfall profits tax wouldn’t be passed on by the oil companies to consumers in prices at the pump? The fact that GC acknowledges pumps prices won’t change seems to concede the point.

Final Update: Let me bring this extended thread to a conclusion with this response from TPM Reader RS to my suggestion that the market is broken:

Actually, I would disagree on that interpretation. What exactly do you mean by a “broken market?” . . .

Barriers to entry often are viewed as something like patents or unfair competition or … However, the most common and most important barrier to entry is simply the size of the fixed costs and in a more general sense the shape of the cost curves. …

I would argue that the market is actually working as economists would argue that it’s supposed to under current conditions. That doesn’t mean that we’ll have cheap oil any time soon or that oil companies won’t have high profits, but it doesn’t necessarily mean that the market is broken.

Another part of the story here is that there are a number of different albeit linked markets. You have the market for crude (which you could break down into different types if you wanted); then you have the refinery market; and finally you have the retail market. The worldwide increase in demand for crude is driving the price trend upward and I don’t think that’s going to change any time soon. …

There are major barriers to entry in this market that simply cannot be overcome. Those that come right to mind: ownership of the essential materials – e.g. oil in the ground – and the costs of getting it out. I don’t think this market is broken. It’s just that we don’t like the results.

ABOUT THE AUTHOR

David Kurtz is Managing Editor and Washington Bureau Chief of Talking Points Memo where he oversees the news operations of TPM and its sister sites.
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