Record Gas Prices Add Pressure to Already Squeezed Consumers

Prices at the pump have now soared to $3.51 per gallon for regular gasoline, according to the Energy Information Administration, easily shattering an inflation-adjusted record that has stood since March 1981. As gasoline prices rise quickly, consumers’ spending is further squeezed, driving them deeper into debt.

Yet consumer credit is not as readily available as it used to be; consumers will eventually have to cut spending on other consumption items. When this happens, already weak retail sales growth will further decrease, and the economy will find itself in a deeper rut than it is right now since consumer spending makes up more than two-thirds of the economy.

Over the past 12 months, gasoline prices have risen by 23.3 percent, and they could very well keep on going higher. Oil prices have risen by 80.3 percent—or almost four times as fast as gasoline prices. That is, gasoline prices may still go up substantially higher to catch up with the rise in oil prices.

Not that the recent price increases aren’t already painful enough for consumers. In the fourth quarter of 2007, the last period for which data are available, consumers spent 3.8 percent of their after-tax income on gasoline and fuel, up from 3.1 percent in the fourth quarter of 2006. To put this in perspective, over the course of one year, spending on gasoline, oil, and fuels rose by $91.1 billion. Not a single other large spending category rose by an amount this large.

And this increase was not isolated to the past year. From March 2001, when the last business cycle ended, to the fourth quarter of 2007, consumer spending on gasoline, oil, and fuels rose from 2.7 percent of disposable income to 3.8 percent. This increase in total consumer spending for gasoline, oil, and fuel was four times larger than the increase in spending on housing, 88.4 percent of the increase in spending on credit service, and 56.4 percent of the increase in spending for medical care during the same time. The sharp increase in gasoline spending, in absolute terms, due to higher prices adds as much strain on consumer spending as other, much larger spending items.

With all of this added pressure, what are consumers doing to relieve the stress? One thing is clear. Driving less is not an option. The vast majority of people drive to work. According to the Census Bureau, 79.3 percent of workers drive themselves to work, and another 9.1 percent carpool. Also, other trips—to the grocery store, to the doctor, to school—are hard to avoid or change significantly at short notice.

So how do consumers afford these rising expenses? During the most recent upturn in gasoline prices and gasoline spending, consumers saved less. From the fourth quarter of 2006 to the fourth quarter of 2007, the decline in savings alone covered 55.8 percent of the increase in gasoline spending. The rest came from less spending on cars and furniture.

Yet at the same time, households borrowed more than was necessary to cover the increase in gasoline price increases. This allowed consumers to not only spend more on gasoline, but also afford the rising costs of health care, for instance.

This is not a new phenomenon. From 1947 to 2007, 11 percent of all quarters can be characterized as periods of extraordinarily large gasoline expenditure increases.1 Lower saving covered 63.1 percent of these spending increases on average. Increases in consumer debt covered five times the increase in gasoline spending, leaving enough additional resources available for more spending on health care, housing, food, and transportation—all large consumption items that required more expenditures as they became more costly or more people were driving to work.

But right now, as gasoline prices continue to rise, the escape route of more consumer debt may be closed off. Consumers can no longer tap as freely into the equity in their homes as they once did. The signs of a slowdown in the consumer debt boom are already there. From the fourth quarter of 2006 to the fourth quarter of 2007, total consumer debt rose by 1.6 percentage points relative to disposable income. This was the slowest year-over-year increase in consumer credit since the third quarter of 2000.

Just to be clear, the other typical escape route—to save less—is already closed off. In the fourth quarter of 2007, the personal saving rate was zero percent.

This leaves very few other areas where consumers can make sacrifices to accommodate the pressures from higher prices at the pump. Traditionally, more spending on gasoline was also associated with less spending on cars. People are already buying fewer cars and smaller cars as the cost of driving goes up rapidly. And eventually, families will spend less on gasoline simply because there are fewer jobs to drive to.

With all of these added pressures, many more families will find themselves in an untenable financial situation. This will be especially true for lower-income and moderate-income families who spend disproportionate shares of their income on gasoline and fuel. These also tend to be the same families who feel the brunt of an economic slowdown first. Targeted income relief to lower-income and moderate-income families in the form of an expanded Earned Income Tax Credit, an improved Unemployment Insurance benefit, among other measures, could help to address the pain from the pump where it hurts most.

1. Periods of rapid gasoline expenditures are defined as increases in gasoline spending relative to disposable income that are greater than one-third the standard deviation of gasoline spending to disposable income.

Christian E. Weller is a Senior Fellow at the Center for American Progress and an associate professor in the Department of Public Policy and Public Affairs at the University of Massachusetts, Boston.