Tuesday, May 6, 2008

I’m not an Economist who supports a gas tax reduction, but one theory how it could help.

First I repeat I’m not an economist who supports Hillary Clinton and John McCain in their call to reduce the gas tax. I have covered the issue in a previous post, but I think my fellow economist should try to think outside the box. So here is one possible way that a gas tax could help give a boost to the US economy. I tried as a thought exercise to think of a scenario where I would support a gas tax removal.

First, I would bet that the average American would be able to tell you on a given day within 10 cents what is the current price of gas. That is because we see giant signs that advertise it. Next, it would not surprise me if many Americans based their feeling on how well the economy is doing on the price of gas. Recent works in behavioral economics suggest people use heuristics that is general sign to make judgments. If the price of gas were to go down (which it might not too much with the gas tax reduction), it might increase consumer confidence. If the government can use this policy faster than rebate checks, it might be a short term stimulus to consumer confidence and provide a little jolt to the economy.
Now this idea requires the following.

1.) People must be influenced by other economic decisions by changes in gas prices more than changes in other good prices. (maybe, but not unlikely if you talk to non-economists)

2.) Eliminating a gas tax would actually have to substantially decrease the price of gas.
This paper suggests that a 5% decrease in the Illinois tax led to a decrease in price of about 3% in 2000. I would guess supply is a little less responsive to price now so the drop would probably be lower.

3.) The increase in consumer confidence would have to be reasonably large to create a temporary surge in spending. (doubtful)

So my fellow economists, what evidence do we have about the relationship between gas prices and consumer confidence? I have looked and not found a lot. Gas prices may be related to other factors in the economy that also impact consumer confidence, so I’m wary of just comparing the two.

I think the possibility of this being true is 1/100(0?), but that is the best I can come up with.

I think the important lesson is that as economists we must try to continue to explain our thinking and hold our ground in the face of this…(clicking here is recomended)

But as Krugman suggests maybe its time to chill out.

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1 comment:

rjgitter said...

Just one other point to consider. Currently, the federal gasoline tax is 18 cents a gallon. In the last few days, I have seen gasoline sell for anywhere between $3.35 and $3.65 a gallon. (My best guess is it will trend up this summer and later trend down.) But if one wants to put forward the idea that the tax holiday will make a large difference in consumer confidence, I would have to argue against that as the tax cut would not be enough for people to notice. If the price of gas this summer is $3.70 rather than $3.88, I don't believe this will affect consumer confidence much.

As Seth's father, I can tell a story a two. When he was young and gasoline price had hit the unbelievabille price of $1.40 a gallon, it had fallen back to 99 cents. I used to show this to Seth and his brother and tell them to look closely as they would never see gas under a dollar again. They enjoyed the occasions through the years when Dad was wrong and gas once fell again below a dollar.

I think I can safely say they will never see gas below a dollar again. Below three dollars? Hmmmm.

Bob Gitter/Dad