What Were They Thinking???

by Len Burman and Eric Toder

Senator McCain proposed today to suspend the 18.4 cents per gallon federal excise tax on gasoline between Memorial Day and Labor Day this year. For a moment, forget about whether encouraging fossil fuel burning makes sense during a time of global warming, whether we should raid the highway trust fund when bridges are collapsing for lack of maintenance, or the disconnect between the proposal to cut gasoline taxes and the candidates’ endorsement of “cap-and-trade” limits that would raise gasoline prices.

Even in this alternative reality, there’s a problem. Refiners run near capacity every summer as families rack up miles on family vacations. That’s one reason why gas prices jump in the summer. If McCain’s excise tax cut translated into lower prices, we’d all want to drive more, which would push up the demand for gasoline. Since the refiners can’t produce much more without building new refineries, the price has to go back up.

Higher prices might stimulate a little more production and we might import more gasoline from our neighbors. But the price will have to increase by almost the amount of the tax cut. Otherwise, there will be shortages. Unless the plan’s aim is to boost short-term profits for petroleum refineries, the proposal makes no sense.

Another problem is that even if it were a good idea in principle, it would be an administrative nightmare for the IRS and create huge compliance headaches for taxpayers. For one thing, it’s a bad idea to turn a major tax off in May and back on again in September. 

For another, there are transition issues at both ends. Retailers expecting a tax holiday may decide to deplete their stocks in anticipation of the Memorial Day tax cut. Similarly, if retailers expect the tax to be reinstated, they might stock up to avoid the Labor Day tax increase. Either response could produce temporary spot shortages or higher prices. To avoid this, the government has always imposed a “floors stocks” tax or provided a rebate when the tax was scheduled to increase or decrease. In this case, it means a subsidy for inventories held when the tax is suspended followed by a tax on inventories when the tax is reinstated. The costs of such rules would be very high relative to any benefit from such a short-term program. The IRS could also face challenges in monitoring which inventories qualify for the subsidy or should be subject to the tax.

And, finally, of course, in addition to all the economic and administrative issues, there are also the questions of political practicality. Congress would have to enact the law before Memorial Day—warp speed in legislative terms—and then sit tight as the tax is restored just 60 days before the elections.

So we guess it is just empty rhetoric—maybe not surprising during a campaign, but a little disappointing from the straight-talk express.

PS, Paul Carons provides a pithy capsule summary of Sen. McCain's tax proposals on his TaxProf Blog.  For a side-by-side comparison of candidates' proposals, see TPC's tax plan matrix.