On April 1 the state of Connecticut joined Georgia and Maryland in suspending its excise tax on gasoline. The stated purpose of Connecticut’s bipartisan legislation of its 25 cent excise tax holiday: to relieve consumers from inflationary pressures attributed to record high gasoline prices. Meanwhile, governors of six states are asking the federal government to suspend its gasoline excise tax and legislation has been introduced in the House and Senate. Concerns about the regressive nature of an excise tax and how it squares with concerns to fight climate change aside, this temporary cessation in the excise provides a useful tool to test economic theory in action.
According to a classic demand and supply model of a good, such as gasoline, there will be a difference between who pays for the tax, or economic incidence, and who is legally obligated to pay the tax, or statutory incidence. Politicians can claim that they want to increase taxes on firms all they want, but the obvious reality is that if a legislature places a 10 cent statutory tax on the sellers of chewing gum, stores can simply pass some or all of that tax on to consumers. The question of how the tax burden is shared depends on the flexibility or sensitivity of consumers and producers to prices, which alters demand and supply, respectively. This is flexibility elasticity. The less elastic side of the market, that is to say, the less flexible side of the market ultimately bears a majority of the tax.
This implies that the removal of a 25 cent gasoline excise tax in Connecticut will not cause a 25 cent decline in prices. Each gas station will choose, all else the same, to decrease prices by some amount between zero and 25 cents, giving some relief to consumers while simultaneously increasing its margins. Previous research confirms the forgoing, with estimates settling around 70% of an excise gas tax holiday going to consumers. As a result, this corresponds to an expected 18 cent decline in prices after a 25 cent statutory decrease in the excise tax.
The Connecticut gas tax suspension provided us with an excellent opportunity to test the hypothesis that the statutory incidence is greater than economic incidence for consumers. We teach in the economics department at the University of New Haven, so we sent our students out to see how much gas prices actually changed between March 31 and April 1 by recording prices at the same stations.
The resulting dataset of 31 stations is an illuminating example of the uses of economic theory and disparity between economics and optics and politics. While there was some variation, the vast majority of Connecticut gas stations did reduce prices by 25 cents. Several stations decreased prices by only 5 cents, but only one decreased its price by 15 to 20 cents, which economic theory predicts.
So what happened? Are the owners of Connecticut gas stations unusually magnanimous, to the point that they recognize the potential harm high gas prices can have on the United States economy and are willing to take one for the team? Doubtful. Politics plays a key role. On the same day the gasoline tax holiday went into effect, Attorney General William Tong stated that any gas station that does not lower its prices by 25 cents will be subject to investigation and penalties under the Connecticut Unfair Trade Practices Act. Tong called on consumers to file complaints for investigation requesting, among other things, receipts, the address of the station, the date and time of the purchase, and the price paid. Our best guess is that station owners took the warning to heart, which is why many stations decreased prices by 25 cents, some even more than 25 cents. Looking at national prices also supports this theory. Prices outside of Connecticut, including surrounding states, decreased by one to two cents overnight, so although local stations decreased prices by a full quarter, in reality, some station owners are keeping that extra penny or two.
Leaving aside the ethics of threatening business for setting its prices well within current economic norms, this illustrates the role that government plays in altering the gasoline market and, more generally, the energy market and the economy. The bigger question, and harder to track, will be whether gas stations continue to forgo even a modicum of the benefits of the sales tax holiday. Arguably, even if station owners continue to forgo any benefits associated with the excise tax holiday, consumer benefits are de minimis given the temporary nature of the holiday.
We expect station owners will not continue to forgo all of the tax holiday benefits (further reducing consumer benefits), especially as market conditions change. Time will tell, but the cost to Connecticut, the reduction in revenue, has been estimated to be $90 million, which could also explain the reason other governors are seeking a federal tax holiday rather than a state tax holiday. It is long overdue for a reexamination of state and U.S energy policy, including crude oil production and renewable energy. Gimmicks might satisfy the optics and politics, but not economics.
Patrick Gourley is assistant professor, department of economics and business analytics, University of New Haven. Brian A. Marks is executive director entrepreneurship and innovation program and senior lecturer, department of economics and business analytics, University of New Haven.