As gasoline prices have skyrocketed over the last few weeks, we are all feeling the pain at the pump and would appreciate some relief. The price of gasoline has a direct impact on the other goods we buy and as a result on the inflation rate, which is the highest it has been in 40 years. How will some relief on the gas tax front play out? Well, it's complicated. This is due to the concepts of supply and demand, the "incidence" of a tax, and the concept of "elasticity." As a result, there is no guarantee that a decrease in the federal/state gas tax will directly benefit consumers as intended. My comments here are purely economic.
It is the supplier who gets the immediate relief of the tax decrease, and it is up to that supplier to then pass some or all of that decrease on to the consumer. How much is passed on depends on price elasticity, which is how people react to the change in price - the more the reaction, the more elastic. Inelastic means a small reaction to the price change. The more inelastic the demand, the more the supplier retains and the less savings is passed on to the consumer. The supplier controls the price at the pump, with the consumer controlling only the amount he or she chooses to buy. It is near impossible for a consumer to control the price of a product that he or she has to buy anyway.
Let's apply this concept of elasticity to gasoline prices. The demand for gasoline is inelastic in the short run. It is one of those goods that people tend to consume anyway as its price changes, because there are few substitutes and it tends to be a necessity. Gasoline prices tend to be inelastic, because as the price of gasoline rises, demand for gasoline does not decline significantly. Even as gas prices rise, people may not necessarily drive any less, although with significant increases, people begin to carpool or use public or alternative means of transportation, if they can.
Recently, as gasoline prices have risen, policy makers have considered a decrease in the federal and/or the state gas tax. Certainly viable alternatives. There is only one small problem with that: a decrease in these taxes does not mean that gasoline prices will be reduced by the amount of the tax. Nothing prevents the supplier from capturing most of that decrease and not passing it on to the buyer because the demand will still remain high for this product, which has few substitutes and tends to be a necessity for many, because it is price inelastic.
The incidence of a tax is an economic concept that describes who ultimately pays the cost of higher taxes or benefits from the lowering of a tax. This payment or benefit is not always direct. The basic question is, who bears the burden or gains the benefit or decrease of the tax? The supplier (business) or the consumer? This is complicated, and not all economists agree on tax incidence, because it depends on a variety of factors, including but not limited to the reaction consumers have to the tax. Let's assume that we eliminate the federal gas tax. For example, if the price of gasoline decreases by the tax rate of, say, 20 cents, will gasoline prices decrease by 20 cents? Not likely, because the supplier will capture a portion of that decrease and consumers will still pay more than the 20 cents decrease. The supplier keeps a portion, say, 10 cents, and passes the rest on to the consumer. Effectively, the consumer ends up saving only 10 cents, the supplier gains 10 cents, and the government loses all 20 cents, which then does not go toward the government services they were originally used for. In short, tax revenue would be decreased, the supplier gains a portion, the consumer gains a smaller portion than intended.
The bottom line is, there are so many factors when it comes to passing a gas tax on to consumers through suppliers; it's not that simple. It is complicated.
Kojo A. Quartey is president of Monroe County Community College and a former professor of economics.
This article originally appeared on The Daily Telegram: Kojo Quartey: Economics of a gas tax decrease - winners and losers