Particularly through mid 2022, inflation was rampant across the United States – not just as an economic indicator. Politically, voters caught on as the country’s economic woes posed a key concern, potentially bringing down the Democratic Party’s support among the electorate.
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Due to the high demand recovery post-Covid, the diminished supply of gas from the pandemic-induced recession caused a substantial shortage, driving up gas prices. Gas supply was, of course, further reduced due to Western sanctions on Russian gas in response to the War. The gas price hikes were significant, rising to a staggering $5.107 per gallon in June 2022, an almost twofold increase from the $2.9 average since 2018. As a crucial commodity, this led to rampant inflation nationally, increasing the cost of living for many Americans. The Consumer Price Index (CPI),which measures the average change over time in prices for a market basket of consumer goods and services, reached as high as 9.1% in June 2022. It was markedly clear that gas prices were the cause behind that, as the CPI for it increased by 41.6%, while that of the second runner-up, food, only raised by 10.4%.
In fact, the ubiquitous role of gas in supply chains, both upstream in delivering raw materials and downstream in delivering final products to the consumer products, caused its price hike to impact prices of many other goods. Clearly, the contagion of the gas price spike necessitated urgent government attention.
Naturally, citizens were dissatisfied with the economic conditions that affected their cost of living. While many blamed the liberal agenda, it is worth examining whether other factors played a more defining role in the cost-of-living crisis. One such stakeholder would be the forces directly behind the supply chart – America’s oil and gas companies.
These companies are arguably part of the only sector that benefited from the inflation crisis, as the unnaturally raised prices boosted their revenue. Naturally, however, this begs the question: facing such high demand, why are these countries not increasing their supply? This would further increase revenue earned through more sales, and the oligopolistic nature of the market may warrant the delaying of price drops from the increased supply.
This is a result of the wait-and-see phenomenon, whereby these firms do not see value in boosting supply due to a variety of reasons. Specially, they face an uncertain economic outlook, that leads them to believe that further investments would prove unprofitable in the mid-long run. Two main factors include: in the mid term, the government’s unfavorable policy approach towards the sector, and in the long term, society’s gradual shift away from fossil fuel reliance.
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To fulfil the needs of voters that got him elected into office, Biden’s tough approach of having banned new federal drilling leases, and yielded little investor confidence, as they are uncertain of its outlook politically.
This was compounded by the difficulty and level of investment involved in expanding supply. Being an infrastructure-heavy sector, the construction of new oil rigs and transportation of drilling machinery involve ludicrous costs that further necessitate caution and calculation when making further investment decisions.
Therefore, amidst the doubts for reliable returns on investment, gas companies have decided against expanding oil and gas supply, and instead have chosen to simply “wait and see”, and make further choices after more certainty is established through policies and macroeconomic conditions over time.
In retrospect, one should consider: is it really the government’s fault, or were there phenomena that simply could not be stopped? Definitely, it is safe to say that the firms have been acting in self-interest, as any rational firm in any capitalistic society would do. In this case, these actions have been against the direction of the government, and therefore, the government was already placed in a position of opposition against the government. Then, if the government was on the side of the firms, would there have been a better outcome? Clearly, through the extremely favorable policies of the Trump Administration, gas prices have been much lower, and firms have been freely investing, resulting in better living standards for all.
Only in the short term, from the Biden Administration’s perspective, as climate protection is a very important issue as well.
Therefore, this simplistic dilemma is presented, with no easy choice, politically and personally. We should also assume, for purposes of policy discussion, that both options are to be made in the interests of the American People.
How, then, should this problem be resolved?
For purposes of this discussion, we will zone in on economic solutions targeted solely at price inflation. It must, however, be noted that beyond the Midterm victory for the Democratic Party, the reaffirmation of their pro-climate stance may make this increasingly unlikely.
Two strategic thrusts can be considered: bolstering sector certainty, and redistributing the excess profits of the firms.
In these two aspects, one solution that many have discussed is to tax and redistribute these windfall profits enjoyed by firms. This minimizes the inequitable effects of the more-than-affordable gas prices imposed as the redistribution benefits consumers, specially the less affluent.
Similar policies have already been explored in other countries, especially across the Atlantic in Europe. For example, the United Kingdom has distributed 650 pounds each to 8 million lowest-income households under the Energy Profits Levy, following expectations of a gas price hike resulting from a 25% windfall tax. Meanwhile in Spain, the government has utilized the €7-billion-in-two-years profits from their newly-imposed windfall tax on banks and energy companies to fund its free train travel scheme. This measure is particularly worth looking at, as it kills two birds with one stone through not just effective income redistribution towards the needy (as they usually take more public transport), but also aids the country in fulfilling its pro-climate commitments as public transport pollutes less.
The UK Energy Windfall Tax is expected to result in market uncertainty and disincentivize investment in expanding supply.
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The design principles of the tax are also worth looking at. One potential limitation, as anticipated by the European countries aforementioned, is that the imposition of profit taxes will see conservative investment decisions by gas companies, as it increases the uncertain outlook of the market, and firms will see less incentive in profit-maximizing.
On the other hand, alternative ways to generate tax revenue without aggravating the uncertainty in the market would be to impose a tax on economic rents rather than economic profits of the company. This means that instead of a tax that takes away the firms’ profits, it permanently receives money from the firms, and that sum is not dependent on the level of investment made by the company. Therefore, while the firm is still penalised and the government is still earning tax revenue, investment specifically is not disincentivized.
One issue, however, that also must be addressed is the specific case study of those in the transport sector. As current society still largely runs on fossil fuel-driven vehicles, the imposition of gas taxes may, in most cases, place an upward pressure on gas prices. This would then adversely impact the cost of living for many of these transport workers, who also happen to be at the lower income brackets of society. While the tax revenue may then be redistributed back to them, in most cases, we can expect a general decrease in their economic profiles through this transaction. If anything, the silver lining in this, though, is that it at least spurs on the sector’s transition away from fossil fuel reliance and towards “greener” power sources.
Other solutions, such as a gas tax suspension, can also be pursued. The economic outcome of this is simple: remove the federal / state tax on gasoline, and the total cost of purchasing the commodity drops by a definite margin. Since gasoline is a necessity, the cost of living will then be reduced.
After Hurricane Katrina hit the state of Georgia in 2005, impacted regions faced power outages, prompting the then Governor Perdue to suspend the state gas tax. Prior to the suspension, the effective gas tax was 15 cents per gallon, taxed from the distributors and suppliers. Research suggests that an estimated two-thirds of cost savings due to the gas tax suspension was passed down to consumer in the form of lowered prices (Alm & Sjoquist, 2007). Considering the relatively high demand for gas during the crisis, a two-thirds cost saving was higher than expected. Interestingly, to combat rising gas price inflation in 2022, the Georgia state legislature also chose to suspend the gas tax, specifically the state motor fuel and locomotive fuel tax. The suspension has cost the state government approximately $150 million a month; this has played a significant role in allowing Georgia to obtain the lowest average gas price in the United States. However, many states benefited from large budget surpluses due to the Covid-19 federal aid.
Tax suspensions, however, while direct in consequence, may be too simplistic in design. Given the high quantity demanded for gasoline, a very marginal (<10%) federal gas tax suspension will do little to reduce the quantity demanded for the good, especially given its low price elasticity of demand. Resultantly, prices will easily return back to before, and then, not only will the government have lost another form of revenue (which, in the case of the United States, funds the Highway Trust Fund, which is used to service roads), but also seen increased gasoline consumption levels. The politically regressive move is hence not easily accepted, especially amongst the pro-climate liberals.
All in all, two dilemmas are now presented. The first, and most directly relevant one, would be whether the climate is to still be prioritized by the liberal agenda in the face of politically destabilizing economic inflation. Secondly, whether foreign political involvement is even necessary. In America’s case, the decision to sanction Russian fossil fuels in an attempt to cut off their cash inflow, which also resulted in a significant reduction of supply, was made with the inflationary knowledge. In this case, should the government sacrifice economic standards of living for geopolitical reasons?
On a broader scale, should the American People be more directly involved in the decision-making process through direct voting procedures such as a referendum for immediate, urgent issues where Congressional elections are not in time for the voice of the People to be reflected? How will that look like?
References
Alm, J., & Sjoquist, D. (2007, February). The Price Effect of Georgia's Temporary Suspension of State Fuel Taxes (pp. 1–29). Atlanta, Georgia: Fiscal Research Centre. https://cslf.gsu.edu/files/2014/06/price_effect_of_georgias_temporary_suspension_of_state_fuel_taxes.pdf
Bloom, N., Bond, S., van Reenen, J. (2007, April) Uncertainty and Investment Dynamics. JSTOR. https://www.jstor.org/stable/4626145
Kovski, A. (2022, April 19). Federal onshore royalty rates to jump to 18.75% for new leases . Oil and Gas Journal. Retrieved from https://www.ogj.com/general-interest/government/article/14275058/federal-onshore-royalty-rates-to-jump-to-1875-for-new-leases-interior-says
Mengle, R. (2022, March 14). Will a gas tax holiday or suspension lower gas prices near you? Kiplinger.com. https://www.kiplinger.com/taxes/604395/gas-tax-holiday
Parry, P., Phadke, N., Robbie, A., Scalise, J. (2022, June 14) How Energy and Resource Executives Think about the Transition. Bain & Company. https://www.bain.com/insights/how-energy-and-resource-executives-think-about-the-transition-enr-report-2022/
Trading Economics. (n.d.). United States Inflation Rate. https://tradingeconomics.com/united-states/inflation-cpi
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