There is a lot of talk about how John McCain and Hillary McClinton are calling for a gasoline tax holiday to ease the financial pain American's are feeling. Obama is saying that this tax holiday is a political gimmick and it will not work.

The following is my analysis of why the tax holiday will:

lower prices at the pump in the short-term
lead to increased oil company profits in the mid-term
shift of the tax burden from drivers to non-drivers in the long-term
cause higher overall gas prices in the long-term

High prices are caused due to increased demand for fuel. The supply of fuel is very limited in the long run due to market forces. For example, if we discovered a huge pool of oil under Camden, NJ (yes, that is what you smell), we would still need to pump it out of the ground and build new refineries to turn it into gasoline. This would likely take one or two years. In other words, the supply of oil is rigid. In America, it is rigid to about 400 Million gallons per day.



With this much gasoline in our country, the fuel market currently equalizes the demand for this supply of gasoline at around $3.60/gallon (there are small fluctuations due to speculation, but our supply remains the same). As the graph shows, we can move our demand curve up, if we want to pay more money, or we can demand less gas and prices will drop (oil companies could slow there production down if we stopped buying it) but the supply line cannot move toward the right (more gallons) in the short-term..

The proposed tax holiday will reduce the price of gas by eighteen cents per gallon for the summer.




The above graph shows the current situation. We consume 400 million gallons per day at the price of $3.60 per gallon. In the next graph, the US government declares that for one day only, it will knock off a dimes worth of tax for every gallon of gas that you purchase.

As the gray square shows, in 24 hours, the US government will loss nearly half a million in tax revenues. These taxes are paid directly by drivers to pay for roads, bridges, etc. The beauty of this tax is that if you don't drive a car, you don't pay it. (Actually, you do pay it to a lesser degree, it is added to the price of everything that is shipped to the store before you purchase it). Thats fair, right? The problem is, lowering prices drives up demand (if you draw out the price line at $3.50 you can see that Americans will demand around 625 million gallons). BUT, there is no more gas to sell, remember, the whole issue is that building new refineries takes a long time. So, smart gas sellers/oil companies, knowing that they can sell no more gallons tomorrow than he/she can today, will see the line of cars outside their window and...you guessed it, raise the prices .

The next graph depicts this phenomenon. The same area that represented the loss of tax revenue in the last graph, now becomes excess profits for the oil companies (in fact, if you shifted up the demand at the new price the result shows you that the oil company can shift up the price to $3.70 per gallon, if we bought gas guzzling cars because the government fooled us with cheap gas, the oil co. will pocket between 400,000,000 - $800,000,000).




The next day, the McCain and McClinton wake up with there heads pounding with the smell of cheap oil company CEO, perfume in their clothes. They exchange uncomfortable flirtation as they slink back into their rumpled clothes. They notice that they accidentally spent $400,000,000 of tax payers money (gave it to the oil companies).



Unless McCain/McClinton make the government spend $400,000,000 less every day that the tax holiday is in effect, then the loss of tax revenue must be made up somewhere. The problem here is that if they wanted to make sure that only drivers paid the tax, then they would have to add it back onto the price of gas. Without getting to much into it, making up the lost revenue becomes damn near impossible as it drives prices higher and higher (can you imagine a politician calling for an increase in gas taxes?), this then drives demand for the expensive gas lower and lower. The other way to make up the revenue is to tax something other than driving/gas such as groceries or by cutting government outlays such as mass transit. Either way, you must shift the tax burden away from drivers to someone else.