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WebMemo #451 on Taxes

March 18, 2004

An Increase in the Gas Tax Would Hurt Consumers and Slow the Economy

By and

Some leaders in Congress want to increase the federal tax on gasoline by 5.45 cents per gallon, for the first year, and then index it to inflation. They would use the revenue from this tax increase to finance additional spending on highways and other transportation projects, which they say will benefit the economy. Macroeconomic analysis performed by the Center for Data Analysis at the Heritage Foundation, however, shows that increasing the gas tax would depress economic activity and the incomes of millions of Americans. It would also raise significantly less revenue than its proponents project. The President should be commended for his firm stand against raising the federal gasoline tax, and Congress would do well to abandon proposals to increase the gas tax and instead focus on spending highway dollars more efficiently, ideally by turning them back to the states.[1]

 

The Real Cost of the Gas Tax

Analysts in the Center for Data Analysis (CDA) estimated the economic and fiscal effects of a higher gas tax using a well-known econometric model of the U.S. economy.[2] The model allows analysts to vary the gas tax and simulate the effects of higher spending on infrastructure construction, if adequate details about that construction are available. Because such details were not available, CDA analysts instead used the additional revenues from the higher gas tax to pay down national debt, which is an alternative way of infusing government spending into a segment of the economy that is tightly aligned with investment decisions. [3]

 

This macroeconomic analysis found that:

 

  • Personal savings would average $8 billion less per year from 2005 to 2014.
  • $82 billion of the $131 billion increase in federal revenues over 10 years would be financed out of foregone or lower personal savings.
  • Gross Domestic Product would decline by $6.5 billion per year, in real terms, from 2005 to 2014. In other words, this $131 billion in government revenues would shrink the economy by $65.5 billion.
  • There would be, on average, 37,000 fewer job opportunities each year. That works out to one lost job for every $351,000 in new taxes, which is equal to 11 years of work at average yearly wages.[4]
  • Total federal revenues would fall short of gas tax proponent's projections by $3.7 billion.
  • Family disposable income would be, on average, $2.5 billion less per year, in real terms. That's equivalent to the cost of sending 532,600 students to college each year. [5]

Congressman Don Young (R-AK) proposed an increase of the federal gas tax from 18.4 cents per gallon to 23.85 cents per gallon in the first year as part of the 2004 highway bill. While this twenty-nine percent tax increase has not generated major support, Congress should not bring the gas tax increase back as a policy proposal. While raising the gas tax would increase government revenues, it would only do so at the expense of economic growth, jobs, and family income.

 

Some of these negative effects are due to Americans' mobility needs. Academic research on the relationship between the gasoline tax and demand for gasoline indicates that gasoline consumption would not decrease significantly in the short run if the tax were increased.[6] For every one percent increase in the gasoline price, usage would decline by .26 percent in the short run and .86 percent in the long run. In other words, consumers are willing to make other sacrifices instead of driving less. On average, an increased gas tax would cost families who drive $54 per year, which would come out of savings and consumer spending.

 

This table shows how much more consumers in each state would pay for gasoline if Congress were to increase the gasoline tax as proposed.

 

Methodology

CDA Analysts used the Global Insight, Inc. (GII) macroeconomic forecasting model to identify, the economic and fiscal effects of the potential gas tax hike by increasing only the federal gas tax variable in the model. The federal gas tax was increased by 5.45 cents in the GII model for calendar year 2005, and was indexed to inflation for the next five years. The model showed that many key economic indicators, including savings, disposable income, and GDP, would experience slower growth due to the tax increase. The decline in nominal private savings would total over $82 billion between 2005-2014. This means that the average American family would save $100 less each year because of higher gas prices.[7]

 

Better Options

Instead of raising revenue for additional spending-which would negatively affect all levels of the economy-Congress should make current transportation spending more efficient. By eliminating wasteful programs and streamlining other transportation projects such as Amtrak, Congress could make better use of the taxpayers' money and free up funds for new projects that it deems essential. Another option would be to use temporary tolls on federal highways to pay for specific projects. The best option, though, would be for Congress to "turn back" highway maintenance and funding to the states, which are better placed to assess local transportation needs.



[1] Utt, Ron, "Yes, Mr. President, Veto the Highway Bill," Heritage Foundation Backgrounder No. 1725, February 13, 2004, available at http://www.heritage.org/Research/SmartGrowth/bg1725.cfm .

 

[2]CDA used the Global Insight, Inc., U.S. Macroeconomic Model to conduct this analysis. The methodologies, assumptions, conclusions, and opinions in this report are entirely the work of Heritage Foundation analysts. They have not been endorsed by and do not necessarily reflect the views of the owners of the model.

 

[3] The additional revenues stemming from the increased gas tax are used in the GII model to pay down debt. That is, revenues above baseline expenditures in this model are assumed to reduce total federal debt unless the users of the model explicitly assume otherwise. Debt reduction increases the income of debt holders, which results in increased investment and consumption. CDA analysts could have assumed that increased outlays would positively affect economic performance by enhancing private sector income and private employment. However, that assumption would have required relatively greater detailed knowledge about the mix between the expansion of existing construction projects where the income and employment elasticities are very low and the initiation of new projects requiring significant reallocation of resources and labor, where elasticities would be higher. Such details are not available. Thus, the prudent approach is to allow the increased revenues to flow proportionally to capital and labor, and to investment and consumption, throughout the economy through the modeling simplification of debt repayment.

 

[4] U.S. Department of Labor, Bureau of Labor Statistics, National Compensation Survey: Occupational Wages in the United States, July 2002 (BLS Bulletin 2561: September, 2003): Table 1-1.

 

[5] According to The College Board, the average cost of tuition and fees at a four-year public college for the 2003-2004 academic year was $4,694. See The College Board, Trends in College Pricing 2003, available at http://www.collegeboard.com/prod_downloads/press/cost03/
cb_trends_pricing_2003.pdf
.

 

[6] Dahl, Carol and Sterner, Thomas "Analyzing Gasoline Demand Elasticities: A Survey," Energy Economics (July 1991).

 

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