How To Make A Gas Tax ‘Holiday’ Make Sense For The Long Term

Yesterday, as widely expected, President Biden called on Congress to implement a three month suspension of the federal gasoline tax.

Observers of all stripes have argued that the move is unlikely to offer consumers much relief, and could even be counterproductive. Economists have suggested that suspending the 18 cent per gallon tax could modestly stimulate gasoline demand at a time of constrained supply, providing a boost to consumption and padding oil company profits. Climate policy advocates worry about the carbon emissions impact of subsidizing consumption. And given the role of the gas tax in supporting the federal Highway Trust Fund, others are raising red flags about starving infrastructure investment of much needed revenue.

Still, it’s understandable that policymakers feel compelled to take action as U.S. gasoline prices soar to record highs, threatening the broader economic recovery. It now seems quite possible that the average household will spend an extra $1,000 or more on fuel compared to 2019 spending levels, and policymakers do not have a ton of good options for addressing the rise.

Yet, if Congress and the administration are going to wade into the notoriously difficult politics of the federal gas tax, they should take a broader view and seize the opportunity to implement a long-term, sensible reform that will reduce U.S. exposure to future price shocks and benefit the climate as well. The suspension of the federal gas tax should be paired with the implementation of a sliding scale in the tax that effectively puts a floor on the price of gasoline. In times of high oil and gasoline prices, the tax would adjust toward zero, providing relief to consumers. But in times of low oil and gasoline prices, the tax would adjust higher, sending a consistent price signal to drivers and car buyers alike.

Such a policy would produce several benefits.

First, it would likely increase purchases of more efficient vehicles and vehicles powered by non-petroleum fuels, like electric vehicles. When gasoline prices are high, economics research has convincingly demonstrated that consumers respond wisely by making such investments. But when prices crash, consumers inevitably revert to purchasing highly-inefficient vehicles that increase their exposure to the next price shock and also produce higher carbon emissions.

Recent U.S. experience provides a clear example of the risks of this dynamic. From 2011 to 2013, global oil prices averaged more than $100 per barrel for three consecutive years. During this period, the share of the U.S. auto market that went to purchases of highly-inefficient SUVs and pick-up trucks averaged roughly 50 percent, the lowest level since the late 1990s. But in 2014, oil prices collapsed and remained low through 2021. The result? Gains in fuel efficiency stalled as Americans went on a light-truck buying bonanza that drove the truck share of the market to more than 80 percent, a historical high. The International Energy Agency (IEA) now says the global boom in SUV sales during this period was the second largest source of worldwide carbon emissions growth.

A sliding tax that sent a consistent price signal to consumers, even when gasoline prices were low, would lead to more efficient choices by consumers, benefitting energy security and the climate. Buyers entering auto showrooms would be incentivized to choose vehicles that can travel farther on less fuel. Commuters would have an added incentive to use public transit rather than pile onto roads at times of highly inexpensive gasoline. Over time, the oil intensity of U.S. transportation would drop, leading to few carbon emissions and a less vulnerable economy during times of high prices.

Second, the revenues collected from such a policy would be highest during times of low oil prices, and could be either partially or fully refunded to consumers during times of high oil prices. This would provide the government with a reliable means of policy relief that, unlike current approaches, would be consistent with U.S. climate and energy security goals.

Of course, for such a policy to be effective, it must be well calibrated. The high end of the tax must be sufficient to incentivize consumers to invest in efficiency without being economically damaging. While this decision will ultimately reflect political realities, it is important to note that economics research provides justifiable benchmarks. Notably, recent analysis suggests that the climate damages of carbon emissions are at least $125 per ton. Applied to gasoline consumption, this equates to roughly $1.22 per gallon. Given that this figure does not reflect any of the increasingly apparent energy security costs of U.S. oil dependence, it could provide a useful benchmark for the average level of the tax over time. Other analysts have outlined more specific ideas.

My former Mayor, Rahm Emanuel, is credited with saying, “You never want a serious crisis to go to waste. And what I mean by that is an opportunity to do things that you think you could not do before.” Economists have long suggested that the federal gasoline tax could be one of the most effective tools the federal government has to efficiently reduce U.S. oil dependence. But it has been politically impossible to modernize the tax. Perhaps policymakers are now being presented with a once-in-a-generation opportunity to do so. Let’s hope they take it.