The Case Against Oil Subsidies

The stubbornly high oil price (and its follow impact on prices all through the economy) is leading to some pretty rather wild reactions and policy proposals from politicians feeling the political heat.

Foreshadowing some of this, we had a reader ask the following cheeky question to an earlier edition of this newsletter:

When will there be gas stimmies?!

By which he meant, we think, when will there be stimulus measures to help regular Americans feel less pain at the petrol pump?

As if on cue, it was announced that some of the Democrats are considering a Federal Tax Holiday for the (already exceptionally meager) tax on US gasoline.

The aim is to "pause" the tax for the next year until January 2023 to give consumers a break.

Now, various points on this proposal:

  1. The current tax rate on gasoline is 18.4 cents a gallon has not been raised since 1993, which is problematic in and of itself.

  2. But taxes on fuel are already far, far cheaper than elsewhere around the world. For context, many European prices are around $7 a gallon.

  3. Truly, how temporary will this "pause" likely be? As we have recently seen with eviction moratoriums and student loans, subsidies often have a habit of becoming permanent or at least political difficult to remove.

  4. It is also very not clear that removing the tax will directly a) lead to cheaper gas or b) end up helping average Americans.

The last point above is particularly important to keep in mind.

It doesn't even have to be nefarious oil corporations raising prices to make up for the lack of the tax baked in.

As we have detailed in earlier editions of this newsletter, when something becomes marginally cheaper you are really just incentivizing its use. This is known as the Jevons Paradox and suggests that cheaper gas might just encourage more driving and therefore more demand.

And demand has already been exceptionally high!

One of the under discussed aspects of the current global energy market is the fact that various bodies keeping revising global demand up. For instance, the Paris based IEA recently surprised investors by substantially revising 2021 oil demand upwards, reinforcing the idea that the market has far less oil than Covid headlines suggested was probable.

Where does this leave us? Well, in short:

This is a terrible idea.

It is a very general but also reliable rule that, if you want to discourage the use of anything you tax it, if you want to increase its use you subsidize it.

Thus, it is critical that the US (and other nations) find a way to tamp down inflation and protect the economy without either tipping the economy into recession or locking the country into extremely expensive subsidies for fossil fuels.

Threading that needle will be difficult and it is likely that the Democrats and President Biden will likely pay a heavy price in November. But they must first heed the Hippocratic oath and do no further harm to the US fossil fuel dependence or the planet by incentivizing exactly the opposite of their stated goals: a carbon free future.

Globally, the image of a US administration trying to convince poorer countries to consume fewer fossil fuels (and remove their own considerable subsidies) while doing the exact opposite at home might simply end the already tenuous attempt to limit the amount of carbon emissions.

Finally and most ironically, the US Federal gasoline tax has traditionally helped pay for the country's infrastructure via the Highway Trust Fund. The rebuilding and refurbishment of infrastructure is one President Biden's greatest successes from the last year and it would make little sense to celebrating your accomplishments with one hand and harming them with the other.

The President could and should double down on that accomplishment and make an effort to talk about how the investments he and his administration have made that will build a greater country.

This may not accomplish much in the midterms but defeat may prove pretty inevitable there. The historical track record of midterm elections is very tough for the party in power - any party in power - and not muddying the waters on a key accomplishment may ultimately be the best the Democrats can hope for over the longer term.

For now, they must keep the pressure on Russia over Ukraine and hope that high prices gradually tempt more and more oil producers into drilling more wells over the short term.

Let the market do its work and don't add any further terrible incentives that will likely do little and possibly harm a lot.


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