WAILIN WONG, HOST:
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WONG: This is THE INDICATOR FROM PLANET MONEY. I'm Wailin Wong.
DARIAN WOODS, HOST:
And I'm Darian Woods. The average gas price in the U.S. - I probably don't need to tell you - is almost $5. If you're in Illinois or on the West Coast, you're paying over that. In California, it's over $6.
WONG: High gas prices are such a visceral part of the economic pain that so many people are feeling at the moment, and they're a hot-button political issue. Last month, President Biden called for a federal gas tax holiday from July through September.
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PRESIDENT JOE BIDEN: Today I'm calling on Congress to suspend the federal gas tax for the next 90 days through the busy summer season, busy travel season.
WOODS: Now, if you're getting a sense of deja vu, it's because the notion of a federal gas tax holiday has been floated many times before. Here's John McCain running for president in 2008...
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JOHN MCCAIN: I propose that the federal government suspend all taxes on gasoline now paid by the American people from Memorial Day to Labor Day of this year.
WOODS: ...And by Hillary Clinton that same year.
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HILLARY CLINTON: Let me tell you why I believe that we should, if we pay for it, have a gas tax holiday.
WONG: On the surface, the idea of a gas tax holiday sounds amazing. The tax goes away. The price at the pump falls by the same amount, right?
WOODS: Well...
WONG: No (laughter).
WOODS: It doesn't quite work like that, though, because tax savings actually get split between the consumers and oil companies. This is because of an economic concept called tax incidence.
WONG: So today on the show, we nerd out on tax incidence and how it explains why a tax holiday is not a simple fix for high gas prices.
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WOODS: The federal gas tax is 18 cents per gallon. It's been at this level since 1993. Oil companies pay that 18 cents per gallon, and they pass some portion of that tax down the line to consumers.
WONG: Federal taxes account for just a small slice of the price you pay at the pump. There's also state taxes and the cost of crude oil and distribution and marketing.
WOODS: If you think about all the complex dynamics that affect the price of gas, you see why some economists devote their entire careers to studying energy markets and policy - economists like Sam Stolper at the University of Michigan's School for Environment and Sustainability.
WONG: Are you just thinking about, you know, the economics of gas prices all the time, every time you fill up your car?
SAM STOLPER: Since I started to study tax incidence, I started being a lot more attentive to gas prices. And yes, when I see price is different in one place versus another, I start to wonder, why is that?
WOODS: And Sam used our econ vocab word of the day - tax incidence. This is a term that describes how a tax burden is ultimately shared between different groups, like between consumers and oil companies.
STOLPER: The question is really, if the tax goes up, who bears the burden? If a tax goes down, who reaps or experiences the benefits?
WONG: What makes tax incidence fun for economists and for us is that the burden or benefits of a tax change are not shared equally. It depends on whether consumers or corporations have more relative power in the market.
WOODS: And the way that economists measure this market power is by looking at how consumers and companies behave when prices change.
ZHELI HE: It's basically a kind of competition between how responsive are suppliers and consumers to the changing prices.
WOODS: Zheli He is an economist at Penn Wharton budget model. This is a group that studies the economic impacts of public policy.
HE: I actually don't know how to drive myself, but I'm just really fascinated by the economics of the gasoline market.
WONG: So in the gasoline market, we have consumers on the demand side and oil companies on the supply side. Let's look at consumers first. The U.S. is a nation of drivers. People drive to work and to school and to run errands, whether it's because they love their cars or because they live in places with lousy public transportation.
WOODS: So they're still buying gasoline. The demand for gas doesn't go down by much, even when prices rise. In econ vocab terms, consumer demand for gas is inelastic, not very responsive. And oil companies know this.
STOLPER: Consumers don't respond too much to price changes and that sort of allows or incentivizes suppliers to pass on some of their higher costs to those consumers.
WONG: But the supply side, the oil companies, is also inelastic, not very responsive to price changes. And that's because there's no way to, you know, quickly set up a new oil rig or open a new refinery if oil prices go up.
HE: It actually takes a lot of time and also investment for companies to open more refinery plans and also take old ones back online. So they cannot react very quickly to the price changes in the market.
WOODS: So both sides are not particularly responsive to price changes. Now, the economics of tax incidence dictates that whichever side is less responsive, that is a side that will get hit more when taxes go up. They've got less options.
WONG: And when it comes to the gasoline market, economists have found that traditionally consumers are the less responsive side. They have less wiggle room than oil companies to respond to price changes. So when taxes go up, oil companies have enough market power to pass most of the higher tax burden on to consumers.
WOODS: Now, the flip side to this scenario is when taxes go down, which is what President Biden is proposing now.
WONG: Sam Stolper says the oil companies would love to keep all that tax relief to themselves. But when a tax goes down, there's enough space between the retail price and their cost of production that one company could lower their price a little bit and take business from the others. So companies have to pass on some of that tax relief to stay competitive, and consumers benefit. In fact, Zheli He and her colleagues looked at three states that recently did state gas tax holidays, and the data did favor the consumers. More of the tax savings went to drivers than to oil companies. For example, in Maryland, they got rid of the state gas tax of 36 cents a gallon, and most of it - around 70% - got passed to consumers. That's 26 cents of savings.
WOODS: All right. So let's naively apply that to the federal gas tax holiday proposal, so 18 cents of tax getting removed. That would mean - what? - a lower price of 13 cents a gallon? It's not nothing.
WONG: Well, now we got to move into Caveat Town because both...
WOODS: Caveat Town - least favorite town.
WONG: It's where we spend all of our time. Both Zheli and Sam offer some caveats here. They say that the state examples might not translate that well when you're talking about the federal gas tax and that even the small windfall we saw in some states might disappear under a federal tax holiday. And that's because these are unusual times for the gasoline market. It's not clear that consumers are still the less responsive group. The oil companies, with everything going on in the world right now, might be even less responsive.
STOLPER: The supply of gasoline is at capacity in the United States. We have only so many refineries in the United States, and they're operating at capacity.
WOODS: Some refineries were hit by natural disasters. Others shut down during the pandemic when demand for gas plummeted, and it hasn't come back online. Also, it's kind of a hard sell to say that we're going to invest in a new refinery when it looks like the economy is going to transition to a lower carbon future. In other words, they can't supply more gasoline at the moment.
WONG: So if oil companies are now the less responsive side, that means they're the ones that will pocket more of the savings from a federal gas tax holiday. For consumers, prices at the pump might not go down that much.
WOODS: Sam Stolper says some economists are projecting the savings would be mere pennies per gallon - not much of a morale boost for people struggling with gas at $5 a gallon.
STOLPER: Part of this is a - is politically motivated. The administration would like people to feel some relief, and it's hard to feel relief when prices are already this high.
WONG: So it's possible that this gas tax holiday idea will join the graveyard of all the doomed proposals that came before it.
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WONG: This episode is produced by senior producer Viet Le with engineering from James Willetts. It was fact checked by Catherine Yang. Our editor is Kate Concannon, and THE INDICATOR is a production of NPR.
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