The False Lure of Lower Gas Prices

The debate among the three candidates for president over a "gas tax holiday" is a timely reminder of the dilemma that has haunted U.S. energy policy since the first oil crisis in the early1970s. Is our goal lower gasoline prices? Or is it greater efficiency, fewer miles traveled, increased reliance on non-petroleum fuels, and lower emissions?

In principle, we shouldn’t have to choose between the two. If we can take a big bite out of petroleum demand through more efficient vehicles and other measures, gas consumption and prices should in theory drop, and consumer energy bills should decline. But this happy result will not happen overnight.

The transition to a low-petroleum future is a long-term undertaking that requires far-reaching changes in technology, capital investment and consumer behavior. Thus far, despite fits and starts, hopeful rhetoric, and thoughtful policy proposals, this bright future has eluded us.

In the meantime, the economic and political pressures of higher gas prices have become more and more insistent. With prices at the pump nearing $4.00 per gallon and the price of crude nearly doubling in just a year, the economic pain to families and small businesses is palpable. No politician should be insensitive to this pain, particularly at a time when unemployment is rising, foreclosures are increasing, and health care costs are climbing.

With the political stakes so high, candidates or elected officials who emphasize only long-term solutions are at risk of being perceived as uncaring and out-of-touch. But how should politicians respond to the real and immediate hardship caused by high prices?

The most effective approach is to provide financial relief to consumers who are experiencing an erosion of real income and purchasing power from high energy costs amid overall increases in the cost of living and stagnant wage gains. There are many ways to provide this relief. One is a program of income tax credits for middle- and low-income consumers, which would increase their disposable income by $500 to $1,000 a year.

In lieu of (or in addition to) these tax credits, Congress could provide a "fuel price reliefbate” of up to $450, with low-income consumers receiving the largest benefits. This mechanism, proposed last week by my CAP colleagues, could be funded through a repeal of oil industry tax breaks or a windfall-profits tax on the industry.

But as we ease the financial pain of hard-pressed Americans, we need to be careful not to hold out the hope that gas prices will decline. Driving down prices by trying to change the operation of energy markets is a strategy that has been in vogue since President Nixon imposed price controls in the 1970s. Since then, politicians of all stripes have proposed a variety of price-lowering devices, yet crude oil and retail gas prices have climbed to levels unimaginable just two years ago.

The gas tax holiday proposed by Sens. John McCain (R-AZ) and Hillary Clinton (D-NY) is in a long tradition of well-intentioned but ineffectual measures to halt the increase in gas prices. The U.S. federal gas tax of 18 cents per gallon represents just 5 percent of the current retail price of $3.60 per gallon. Eliminating the tax would not come close to offsetting the increase in gasoline prices of nearly $1.00 per gallon just over the last year.

If crude oil and retail gasoline prices continue to climb, these further price increases could exceed the small savings from suspending the gas tax. What’s more, the industry is adept at reaping additional profits from volatile oil and gasoline prices, with a tax holiday offering a prime opportunity to raise prices a bit more amid overall rising prices.

Even worse, a temporary suspension of the gas tax could become permanent, since politicians will undoubtedly be afraid to reinstate the tax if, as is likely, retail prices continue to move upward. In that case, we would need to find another large revenue source for highway and bridge repair, always a tricky proposition in a difficult budgetary and economic environment. The result would be no real relief at the pump, a gaping hole in our ability to maintain the nation’s infrastructure, and thousands of construction laborers out of work due to lost funding for these essential infrastructure projects.

At a time of rising oil and gas prices, it’s particularly important to ensure that markets are working efficiently, and to prevent manipulation and collusion in the oil and gasoline distribution sector. We should police markets aggressively; price gouging and other predatory practices at the retail or wholesale level should not be tolerated. And we should enhance transparency in the oil futures markets to minimize the role of speculation in driving up prices.

In addition, we should use whatever legal or political leverage we have with oil producing countries, recognizing that U.S. economic and diplomatic influence over these countries is waning in the wake of the Iraq war. In the same vein, postponing further additions to the Strategic Petroleum Reserve may have a moderating effect on prices since U.S. oil supplies would increase slightly as a result.

But as we explore these tools, our expectations should be very modest. We should remember that increased prices are largely due to factors beyond our immediate control. The decline in the dollar, due to high levels of U.S. debt and Fed policies to cut interest rates, is making oil imports more expensive. The U.S. oil industry accounts for an increasingly small portion of world output, most of which is in the hands of sovereign oil companies in countries with economic and political agendas that differ from ours. And yields from developing new oil fields in the National Arctic Wildlife Refuge and Outer Continental Shelf—a favorite bromide of U.S. oil companies, Republican members of Congress, and President Bush—would be too low to change the supply-and-demand balance in world oil markets.

Around the world, major new reserves are becoming more difficult to find. The cost of extracting oil from inaccessible locations (even with the latest technology) is growing, and there is often no distribution system to bring this oil to market. Most importantly, demand for oil is surging in China and other rapidly growing economies, straining supplies, and putting pressure on the price of crude that will not soon abate. Given these forces, anything we could do to lower prices would be tinkering at the margin.

The danger is that, by pursuing elusive reductions in U.S. gas prices, we will be distracted from the tougher but ultimately more meaningful challenge of reducing demand. This is a goal that is in fact aided by high prices, which create incentives for more efficient vehicles, less driving, and alternative fuels. Although we have a long way to go, there’s evidence that high prices are having positive effects.

The New York Times recently reported a dramatic shift in April to fuel-efficient vehicles, with light-truck sales declining by 17 percent while car sales increased by 5 percent. Among the big winners were cars with fuel efficiency of 30 miles per gallon or more, including such mainstays of U.S. automakers as the Ford Focus, with sales up by 32 percent, and the Chevy Malibu, whose sales were up 43 percent.

Buyers of these cars will realize substantial financial benefits. A simple calculation comparing a subcompact with 30 miles-per-gallon efficiency to an SUV getting 10 mpg illustrates this point. At a gas price of the $3.50 per gallon, a subcompact driver logging 3,000 miles during June-August would spend $350 for fuel; the SUV driver logging the same distance would spend $1,050. The savings of $700 by the subcompact owner would be at least 20 times greater than the savings from a gas tax holiday over the same period—even assuming, contrary to what many economists believe, that the gas tax savings would be passed on to consumers.

Of course, not all consumers can afford to purchase new vehicles. But the potential savings suggest that the government would get far more bang for the buck by offering consumers tax incentives to replace inefficient vehicles than from a gas tax holiday—and would be stimulating auto production and creating jobs in the bargain.

Now that we have finally begun the long-overdue process of reducing demand, we must maintain our momentum. The increases in corporate average fuel economy, or CAFE standards, for U.S. automobiles recently enacted by Congress are a start, but we may need to go much further if gasoline prices continue to rise. New technologies such as plug-in hybrids can dramatically reduce oil consumption, which is why the federal government must boost research and development for these technologies, and provide other incentives to jumpstart production. Our efforts in this area have been much too timid. We also need to provide more incentives for telecommuting, bike-commuting, ride-sharing, and public transportation. These are all steps that should have been taken years ago. They are now more vital than ever.

Most importantly, the debate over gas prices needs to be placed in the larger context of the urgent need to address global warming, a problem that has been created in large part by steadily rising consumption of petroleum and will only be solved if petroleum use is stabilized and then dramatically curtailed. All three presidential candidates support a carbon cap-and-trade program to reduce greenhouse gas emissions. By putting a price on carbon, this program will inevitably increase the price of fossil fuels. While estimates of the impacts vary, all studies predict some resulting increase in consumer energy costs, including for gasoline as well as electricity and home heating.

There is reason to believe that these price increases will be mitigated over time by gains in efficiency and new low-emitting energy technologies. But consumer energy bills may still go up before they go down. If this prospect produces knee-jerk opposition by some politicians to global warming measures before they have had a chance to work, then we will take a giant step backward. That’s why any cap-and-trade program must be accompanied by effective programs to help low- and middle-income Americans cope with rising prices.

Indeed, as we rightly worry about the pain of high gas prices, we should be looking over the horizon to the bigger and more difficult debate on global warming legislation that will begin in just a few short weeks when the Lieberman-Warner Climate Security Act comes to the floor of the Senate. This legislation, co-sponsored by Sens. Joseph Lieberman (I-CT) and John Warner (R-VA), includes a robust cap-and-trade program so central to combating global warming.

Conservatives will inevitably invoke high gas prices to paint a frightening picture of the consequences of climate change legislation for strapped consumers. Proponents of strong global warming measures need to recognize this threat and address it head-on. The wrong response is to pretend that energy costs will not rise. The right response is to acknowledge the potential harm to financially strapped consumers and the need to relieve their plight.

This means tax relief for low- and middle-income Americans alongside direct assistance to hard-hit consumers whose energy bills will increase. Some of the revenues from the auctioning of emission allowances should fund this need. If the Lieberman-Warner bill auctions off a greater proportion of allowances, then there will be more resources to assist the least well-off.

We also need to stress that transitioning to a low-carbon economy will impose costs, but also holds the long-term promise of a more efficient, low-carbon energy system less dependent on imported fuels and global market forces that will only become less friendly to U.S. consumers over time. This dramatic change in how we meet energy demand may be our best chance to provide low-cost energy to consumers in the long run.

A sober and objective discussion of the realities of world energy markets and the limited options available to reduce gas prices is a lot to expect in a presidential campaign. But maybe the debate over a gas tax holiday has helped improve public understanding of some hard truths, and the challenging but ultimately rewarding path we need to follow to reduce petroleum demand and address global warming.

Robert Sussman is a Senior Fellow at the Center for American Progress. To read more about the Center’s policy proposals in this arena, please go the Energy and Environment page on our website.