Although cutting taxes on gasoline may look like an easy solution with clear positive outcomes, the reality is different. Cutting taxes ultimately fails to deliver on broad social benefits and leads to other negative effects.
Gasoline prices have reached a record high. On May 10, 2022, the average price of gasoline across the country was $4.40, representing an increase of almost 50 percent since last year, with the average in all states surpassing $4.00 for the first time in history. Moreover, these skyrocketing gasoline prices accompany the highest levels of inflation in the past 40 years. Responding to concerns about the impact of rising gasoline prices on the already strained budgets of households, multiple states have proposed or passed legislation that eliminates or pauses gasoline taxes.
This type of tax-cutting policy may seem like a welcome relief to struggling households, but the solution is a double-edged sword. For one thing, this strategy requires states to dip into their budgetary surpluses. Maryland’s monthlong gas-tax suspension, for example, cost the state $100 million—money that otherwise could have helped fix crumbling infrastructure or fund other critical priorities. Additionally, when legislation cuts gasoline taxes, households that already can afford the higher gas prices have even less of an incentive to drive less or buy more fuel-efficient vehicles, which means the policy approach indirectly contributes to pollution and climate change.
Essentially, cutting gasoline taxes is a distortionary policy that does not adequately resolve inequities associated with rising gasoline costs during an inflationary period.
What Happens When Gasoline Prices Rise
Let’s consider for a moment what happens when gasoline prices increase. Economic research has shown that, as gasoline prices go up, the demand for more fuel-efficient vehicles rises, while the demand for less fuel-efficient vehicles falls. Using data from 1999 to 2008, Busse and coauthors find that a $1 upcharge in gasoline prices increased demand for the most fuel-efficient vehicles in both the used- and new-vehicle markets, markedly raising the price of these vehicles.
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> $4.00
The average price of gasoline surpassed $4.00 in every US state for the first time in history as of May 2022.
Though inflation also was high in 2008, our current supply-chain shortages, paired with gasoline price increases, likely will raise the price of new vehicles even more, as manufacturers are less able to adjust supply in response to the increased demand—and given the existing shortage of both new and used vehicles. This situation means that car owners wanting to adjust to the high gasoline prices by replacing their current vehicles with fuel-efficient alternatives will have to be wealthier, or have good enough credit, to afford the higher vehicle costs. Low-income households and households of color will have a harder time adjusting to higher gasoline prices. Thus, if policymakers are worried about the burden of higher gasoline prices, they need to target solutions toward helping the households that are least able to adjust to the increase in gasoline prices.
Compounding Inequities
These inequities are compounded by the fact that, although everyone faces rising gasoline prices, the burden of these costs is not equally distributed across income brackets. Lower-income households spend a significantly larger portion of their income on gasoline than wealthier households (up to three times more in 2013, according to the American Council for an Energy-Efficient Economy). Today, this discrepancy is likely to be much larger.
The burden of high gasoline prices also is not distributed evenly across geography. Some of our own research demonstrates that rural households and households with less access to public transportation (even in urban locations) are less able to respond to rising prices by doing things like taking public transit or reducing their trips. Because of these inequities, high gasoline prices will require an even greater tightening of budgets in low-income households and for those who happen to live in more remote or less connected areas.
Cutting gas taxes across the board makes gas cheaper for everyone but does not benefit everyone equally. Households that already are equipped to shift away from private vehicle usage or purchase more fuel-efficient vehicles nonetheless benefit disproportionately from the tax cuts, even as other, less flexible, households benefit less.
Environmental Impacts of Gasoline Tax Breaks
When gasoline prices rise, changes in demand lead to reductions in gasoline consumption. People purchase more fuel-efficient vehicles, begin carpooling, and shift to public transit, which reduces overall dependence on fossil fuels. This reduced dependence thereby improves air quality and reduces the negative impacts of climate change. The environmental benefits constitute a win for society and for communities of color across the country that are disproportionately affected by transportation pollution. In effect, cutting taxes on gasoline thus ends up reducing the environmental benefits of higher gasoline prices by maintaining the higher demand for fossil fuels.
Essentially, cutting gasoline taxes is a distortionary policy that does not adequately resolve inequities associated with rising gasoline costs during an inflationary period.
Of course, short-lived tax holidays (such as Maryland’s monthlong holiday) are much less likely to have a distortionary impact on driving or vehicle-purchasing behavior than those that last longer. But experts are predicting that high gasoline prices are here to stay, potentially fueling the implementation of longer, or indefinite, tax holidays—which in turn could lead to detrimental impacts on equity and the environment in the long run.
Alternative Solutions that Target Inequities
Fortunately, alternative solutions can help low-income households shoulder these high costs while preventing the distortions that come with cutting gasoline taxes. In our 2017 paper, we describe how states can use their gas-tax revenues to reduce known inequities. Specifically, states can refund a portion of the gas-tax revenues to specific households based on income and location, while still maintaining a revenue stream that can be invested in roadways and other aging infrastructure. Essentially, the government can send checks or provide tax rebates to low-income and less connected households (even those that don’t drive), helping to offset some of these increasing gasoline costs while avoiding the depletion of surplus budgets and avoiding the distortion of incentives that otherwise would encourage households to reduce their driving and take public transit.
Gas-tax revenues also can be used to give targeted subsidies to low-income and racial- or ethnic-minority households, so they can purchase fuel-efficient vehicles. As RFF Senior Fellow Joshua Linn has shown, these targeted subsidies are not only more equitable but also more effective than providing broad-based subsidies to any potential vehicle buyer.
Win-win solutions do exist. They just require a willingness on the part of policymakers to be creative. Cutting gasoline taxes may look like an easy solution, but in reality, cutting these taxes ultimately fails to deliver the desired social benefits and leads to other negative effects.
