Tuesday, May 27, 2008

More on gas tax holiday--everyone wants to go to heaven but no one wants to die.

From a former student:
We all know that the consumer would never see the benefit of this reduction. The oil companies would move the price of gasoline up to capture this revenue along the supply and demand curve. The consumer would actually suffer due to the lasting effects of under funding our aging infrastructure.... [But] some states are seriously considering this proposal.
The question of whether consumers will see a price reduction from a gas tax holiday can be answered theoretically or empirically. Theoretically, you have to choose between two models, perfect competition vs. oligopoly, and then compute the pass-through rates. The advantage of perfect competition is that it gives you a definite answer (less than 50% pass-through); the disadvantage is that it is not very realistic. Oligopoly models are much more realistic, but the pass-through rates depend on the "curvature" of demand, something that is very difficult to estimate.

My preference is to go with the empirical estimates, like the Illinois gas tax holiday. There we saw a pass through somewhere between 60-80%.

On the policy side, Governments are caught between inconsistent consumer preferences for both a government policy to slow global warming and against higher gas prices.
And for the most part, the politicians favor cap and trade because it is an indirect tax. A direct tax – say, on gasoline – would be far more transparent, but it would also be unpopular. Cap and trade is a tax imposed on business, disguising the true costs and thus making it more politically palatable. In reality, firms will merely pass on these costs to customers, and ultimately down the energy chain to all Americans. Higher prices are what are supposed to motivate the investments and behavioral changes required to use less carbon.

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