More Enthusiasm for Expensive Gas

And hey, sales of compact and subcompact cars are at an all-time high, with one in five cars sold in April now from this category, up from one in eight at the height of the SUV craze. And four cylinder engines are now more popular than six cylinder. Sales of SUVs and trucks are down between 25 and 35 percent (Vlasic, Bill, “As Gas Costs Soar, Buyers Flock to Small Cars,” The New York Times, 2 May 2008).

In my own observation, I have noticed that the slug lines in D.C. — namely the one on 14th between F and G — have grown quite competitive as of late.

Regarding taxes, many critics of the holiday proposal have answered that it would simply benefit the oil companies, not consumers. But on consumers is where the burden of paying the taxes falls, right? Not exactly. Empirical studies show that consumers and oil companies roughly split the cost of gas tax increases. For example, this study excerpted by Matthew Yglesias suggests the following:

Using the estimated coefficients, we can determine the incidence of federal and state specific taxes. An increase in the federal tax by 1¢ raises the retail price by 0.47¢ and decreases the wholesale price by 0.56¢. Thus, consumers and wholesalers each pay roughly half of the federal specific tax.

(Chouinard, Hayley and Jeffrey M. Perloff, “Incidence of Federal and State Gasoline Taxes,” Economics Letters, vol. 83, no. 1, April 2004, pp 55-60; Yglesias, Matthew, “Gas Tax Incidence,”, 2 May 2008)

These stories aren’t unrelated. Gas was hitherto imagined as one of those products for which demand was highly inelastic because it was largely a function of house purchasing and employment decisions — both factors not amenable to rapid readjustment. Consumers would only be able to adjust to increased fuel prices on the timescales in which they make house buying and employment decisions — that is, not very fast.

It turns out that consumer demand for gas isn’t as inelastic as it was previously thought. Many have pointed out that companies don’t pay taxes, they collect them. In other words, if the government taxes a corporation — they’re evil, they deserve it! — they will just pass the tax through to the consumer by building it into the price of their products. It turns out that the catch-phrase version of this story is too simple. The power of a company to pass a price along to consumers is dependent on elasticity of demand for their products. Where it’s highly inelastic, they can unproblematically pass it all on. Where consumers are more responsive, producers have less liberty and must to price with caution.

In the case of gas, it turns out that people can and do take steps to adjust their consumption — not enough that we’re going to achieve oil independence, but enough that oil companies have to think twice before passing along a price increase.

And this is all just the steps that are being taken now. I would expect urban density to begin to increase and the suburbs to start to depopulate over the next few years as those longer-term adjustments to fuel consumption come within the purview of people’s decision making.