Tax Increases Won’t Lower Gas Prices At The Pump

Governor Gavin Newsom believes California’s gas prices are too high. And he is correct. However, his claims that he can lower gasoline prices by forcing consumers to pay higher taxes will make a bad situation worse.

He would not likely couch his statements in this way, and it is important to note that as of this writing the governor has not made any specific legislative proposals. Nevertheless, just like President Biden, he continually asserts that an increase in the gasoline excise tax is needed because oil producers are earning “windfall profits”.

Oil company profits were high last year; for example, according to ExxonMobil’sXOM
financial statements, they earned over $23.0 billion in 2021. But when do profits magically transform from ordinary profits into windfalls? The answer is entirely subjective.

The President and Governor believe windfalls occur if profits are above some unknown threshold in any given year. But during the height of the pandemic in 2020, ExxonMobil lost $22.4 billion. It is just as logical to take a multi-year view when deciding whether companies are earning windfall profits. If the 2020 losses are considered, then investors essentially earned no profits over the last two years. Based on a two-year earnings perspective, where’s the windfall?

Alternatively, based on a one-year perspective, if $23 billion in profits warrant a windfall profits tax, shouldn’t the near reciprocal losses in the previous year warrant a windfall loss subsidy? After all, just as President Biden claims that the profits are not due to the company’s actions, the losses created by the pandemic were not due to any actions by management.

Without sound answers to these questions, the “windfall profit” concept is meaningless.

More important, Governor Newsom’s rhetoric neither correctly diagnoses the causes of California’s high gas prices nor provides a rational solution that would offer needed relief to residents of the state. To understand why, just look at the historical gas price data.

The chart below presents California’s monthly average gasoline prices relative to the average prices in the U.S. between July 2000 and November 2022. The more than 22 years of data demonstrate that gasoline prices in California have consistently been more expensive than the national average.

Prior to 2015, the premia (e.g., how much more expensive gas prices were in California compared to overall U.S. prices) averaged around 12%. This premium was caused by California’s unique formulation requirements and the state’s higher gasoline excise taxes relative to all other states. In fact, California now has the highest gasoline excise tax in the nation today according to the Tax Foundation.

The chart also shows that something changed in 2015. California’s average gasoline prices increased relative to the average gasoline prices in the U.S. and have been, on average, nearly 33% more expensive since.

Providing sustainable relief to drivers in the state requires an understanding of what happened 7 years ago to drive up California’s prices relative to the rest of the country. One of the important changes that occurred was the increasing stringency of California’s low carbon fuel standard.

Meeting California’s stricter formulation requirements has become more onerous due to these regulations. When coupled with restrictions on building new energy infrastructure, binding supply constraints unique to California have ensued. Tight supplies relative to market demand, when coupled with the state’s rising excise tax burden, has caused gasoline prices to become relatively more expensive.

Put more succinctly, California’s gas prices are stratospherically high thanks to the policy environment that California has implemented, which includes costly regulations, effective prohibition on infrastructure investments, and high excise taxes.

With this background, the folly of Newsom’s windfall profits tax is clear. The governor is ignoring the role that the state’s policies have played in driving up gasoline prices for the residents of California. Instead, he is doubling down on the same policies that have caused gasoline prices to be so unaffordable in the first place. His response is the quintessential definition of insanity.

According to the governor’s logic, increasing the highest in the nation excise tax on gasoline – that is already driving prices higher – will, somehow, lower gasoline costs for consumers. He justifies this non sequitur by claiming that the state could return all the excise tax revenues raised back to consumers.

However, even if all the excise tax revenues collected were distributed back to those who paid the taxes (an impossible goal), the policy is still fundamentally flawed.

The evidence demonstrates that higher gasoline excise taxes will increase the costs for consumers at the pump. Therefore, proposals based on the governor’s statements would simply increase gasoline prices at the pump and then refund this money back to consumers through tax rebates. At best a complete wash that does nothing to promote greater affordability.

In any realistic scenario, consumers will not be fully compensated for the increased excise tax costs they will have to pay. Consequently, Californians will pay more for gasoline in the short term. And it only gets worse from there.

The policy creates an additional signal to oil producers that they should not invest in California. The reduced investment will further increase gasoline prices in the long term as future gasoline supplies will fall further behind expected demand.

Governor Newsom is right to focus on California’s unaffordable gas prices, but his approach is incapable of improving gasoline affordability. The state’s historical experience demonstrates that raising excise taxes – even in the name of windfall profits – will cause gasoline to become even less affordable. Ultimately, it is consumers who will pay the costs.