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Pump Prices Fail to Fall by Full Amount of Gas Tax Cuts, MIT Sloan Expert Says
CAMBRIDGE, Mass.-(Business Wire)-May 6, 2008 - Price-pained drivers hoping that proposals to suspend state gasoline taxes will mean at least limited relief at the pump will likely be disappointed to see that gas prices fall by significantly less than the full amount of the actual tax cut, according to an MIT Sloan professor who adds that gas station owners stand to benefit from the tax cut as much if not more than consumers. Recent calls to suspend the federal excise tax would likely have an even smaller effect.
"There is a common misperception that if a state tax of 5 percent per gallon is eliminated, then the price at the pump will fall by 5 percent," says Joseph Doyle, Jon D. Gruber Assistant Professor of Applied Economics at MIT Sloan. "In fact, our research suggests that retail gas prices drop by as little as 3 percent following the elimination of a 5 percent sales tax. Given tight supply and demand conditions, the benefits of a tax holiday are shared by station owners and consumers. For the federal excise tax, we would expect a reduction in prices at the pump on the order of 10 cents." The research was published in the Journal of Public Economics in April.
Doyle, who is also a Faculty Research Fellow at the National Bureau of Economic Research, and his fellow researcher, Krislert Samphantharak of UC San Diego, based their findings on a unique dataset of daily, gas station-level data collected during temporary suspensions of state gasoline taxes put into effect by Illinois and Indiana during the summer and fall of 2000 in the wake of gasoline price spikes the previous spring. "We were able to determine that suspending the 5 percent sales tax led to a decrease in retail prices of just 3 percent compared to neighboring states," Doyle says. "When the tax was reinstated, retail prices rose by roughly 4 percent."
The reason consumers don't reap a gas tax cut's full benefits is the basic economic law of supply and demand, he explains. Lower prices lead to increased demand for gas by drivers, which in turn reduces the competitive pressures on retail gas stations to reduce their pump prices by the full amount of the gas tax cut.
"We found that suspension of the gasoline tax benefited gas station owners two ways," said Doyle. "The quantity of gas they are selling is likely to go up, and their profit margin increases as well."
On the other hand, service stations immediately across the border from states where gas taxes were suspended took some financial hit, Doyle added — they often had to reduce prices to stay competitive with stations across the state line.
Even if gas stations passed through the full amount of a gas tax cut to drivers, the actual pocketbook effect would still be rather limited, Doyle notes. "Suspending the federal excise tax for the summer would result in $10-$20 in savings over the course of the summer for the average motorist," he says. "These proposals would have the effect of lowering gas prices, but not by very much. The benefits should also be compared to the costs of later taxes used to rebuild our nation's infrastructure."
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