Thursday, May 8, 2008

McCain's Ignorance
Mike Rappaport

With all of the focus on Hillary's endorsement of a temporary gas tax reduction, let's not forget that it was McCain who first suggested it.  McCain's proposal suggests that he does not understand how the economy works, as if we needed confirmation of this after the long string of regulations he has supported.   

Arnold Kling explains how the gas tax reduction would operate:

There is a wholesale market for gasoline, and there is a retail market for gasoline. Gas stations buy in the wholesale market and sell in the retail market, with essentially no profit margin.

If I'm a gas station selling for $3.18 a gallon, the instant that the tax is cut by $.18 I have an $.18 profit margin. That is not going to last. It is going to be competed away.

I might try to lower my price and sell more gas. If every gas station does this, then the price goes down and the consumer benefits. But in order to get more gas, I have to bid for it in the wholesale market. And we can't get more gas out of the wholesale market, because for the next few months the supply is essentially fixed. So what's actually going to happen is that the gas stations are going to bid up the price of gas on the wholesale market. In fact, this process is going to reach a point where in order just to keep my share of gas, I'll have to bid higher by $.18. The net result is that more money goes to refiners, my gas station pays less in taxes, but we pay more for gasoline wholesale, and the consumer gets no benefit.

But that is only part of the bad news.  If the price stays the same, despite the gas tax reduction, what would McCain do?  We can only guess, but I know what I would think would happen.  McCain would rail against the gas companies as special interests and monopolistic actors.  He would then support regulation, not out of any real understanding of economic forces, but because he believes it would be the sensible and fair thing to do.  The gas companies would have shown themselves to be untrustworthy.

My sense is that McCain has a set of moral principles that often leads him to support regulation.   And if the Republican President supports regulation of the gas companies, where does that leave the Republican party and the cause of freedom?  In a very bad place. 

That is why I currently believe the Republican party and cause of freedom are better off in the long run if McCain loses.

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Mike Rappaport


I keep hearing this argument--that a reduction in the gasoline tax would be completely absorbed into profits, leaving the retail price of gasoline unaffected--from people that I would otherwise assume to be quite intelligent. So perhaps those people could answer the following puzzling questions for me...

1) Why is gasoline so much more expensive in Europe than in the US?

2) Suppose the gasoline tax were *raised*, instead of being lowered. What would happen to the price?

3) Suppose it were then lowered again to its current level--or maybe even below--a few months after being raised. What would happen to the price?

I hope one of those highly intelligent folks who understand this whole business better than I do, can explain it to me--I'm afraid this economics stuff is just way too complicated for me to figure out.

Posted by: Dan Simon | May 8, 2008 11:03:28 AM

The short answer to your question is that the gas tax reduction is short term. So demand will rise, but supply will not. A long term reduction in the gas tax might lead to an expanison in supply and more of a price reduction.

Posted by: Mike | May 8, 2008 5:44:06 PM