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What Can We Do about Gasoline Prices?

March 15, 2011

Tags Free MarketsInterventionism

Rocketing gasoline prices are causing consumer unrest. Government officials blame oil speculators, corporate greed, and OPEC, anyone but themselves. However, the US government has spent decades implementing policies that drive up gasoline and oil prices. From the oil-price controls of the 1970s to the windfall-profits tax of the 1980s to George W. Bush's order to purchase oil for the Strategic Petroleum Reserve, the aim of government policy appears to be to hurt gasoline buyers.

Because government is a main cause of high gasoline prices, the solutions for alleviating this problem are obvious; stop government intervention in energy markets and allow private markets to determine oil and gasoline prices.

First, the federal and state governments should eliminate the gasoline tax. The federal gasoline-excise tax is 18.4 cents per gallon and the combined federal and state gasoline taxes run from 26.4 cents per gallon in Alaska to 66.1 cents in New York. Federal and state taxes average 48.1 cents per gallon.Download PDF Increases in the price of gasoline do not have a large effect on the volume of gasoline purchases, so most of the gasoline taxes result in higher gasoline prices for buyers.

Even though gasoline sellers are legally liable to pay the tax, the tax burden is shifted onto the buyers in the form of higher prices. Therefore, eliminating the gasoline taxes would result in an average savings of nearly 48 cents per gallon. Of course, eliminating these taxes would result in a reduction in state- and federal-tax revenues. Given the bloated state of the government budgets, this would be an additional benefit of ridding ourselves of these taxes.

The next issue is the government policies that restrict oil production. Before I discuss these policies, I would like to point out the hypocrisy of our government officials. Our political leaders criticize other countries, particularly the OPEC countries, for restricting their oil production in order to drive up oil prices. But many US government policies restrict US oil production. Beyond the hypocrisy in this issue, it's important to point out that US policies seem to be geared to helping OPEC maintain high oil prices.

It's estimated that oil costs are 68 percent of gasoline prices.Download PDF Lower oil prices would lead to lower gasoline prices. So the second necessary reform would be the elimination of oil taxes. Many of the oil-producing states impose heavy taxes, called severance taxes, on oil production. Alaska leads the pack with top rates that exceed 25 percent of oil revenues. Severance taxes are taxes on revenues, not profits. If an oil well has a 5 percent profit margin, but the severance tax rate is 7 percent, then that well is no longer profitable. Such wells are plugged and abandoned. The tax also results in fewer wells being drilled. Eliminating severance taxes would increase oil production, leading to lower gasoline prices.

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My third recommendation is to lift the drilling bans on federal lands and offshore areas. The federal government owns about 650 million acres of land — nearly 30 percent of all of the land in the United States — and much of this land contains oil reserves. While drilling is allowed in some of these regions, in some oil rich areas, such as the Arctic National Wildlife Refuge, drilling is off-limits.

The federal government also claims to own the "submerged lands" up to 200 nautical miles off of the coast of the United States. Because it owns these lands, it can ban drilling in the outer continental shelf. These areas should be opened for offshore drilling. If the drilling, either in the OCS or in ANWR, violated anyone's property rights, say in the form of oil spills, the offending parties should be required to pay the victims for any damage to their private property.

Even if these areas were opened up for drilling, it would take years to develop this production. Nevertheless, we would see the benefits of this drilling before any oil was actually produced. Oil markets are forward looking. If oil producers anticipate increased production in the future, this will tend to lead to lower prices today. Producers will want to sell more of their oil today instead of holding it until prices are lower in the future.

We see the reverse occurring today. Part of the reason that oil prices are rising is that sellers anticipate higher future prices. If they anticipated lower future prices, today's prices would tend to be lower.

Fourth, the oil in the federal Strategic Petroleum Reserve should be sold and the SPR program should be abandoned. The SPR was started in the 1970s in response to the Arab oil embargo. Since then, the government has purchased oil and stored that oil in this reserve. The reserve currently has about 730 million barrels worth more than $70 billion at current oil prices. The purported purpose of the SPR is that it is to be used in case of an emergency in the oil markets. However, instead of using it to relieve us from the burden of high oil prices, it has sometimes been used to keep oil prices up. When the price of oil started to fall during the Bush regime, George Bush ordered an increase in the SPR in order to "stabilize" oil prices.

The SPR program is ridiculous: Oil companies invest in drilling oil wells. They pump the oil out of the ground. The federal government then uses tax dollars to purchase the oil and pump it into salt caverns 2,000–4,000 feet beneath the ground. If we want to use the oil, we will have to pump it out of the ground a second time. We pump oil out of the ground, pump it back into the ground, and then pump it out again. It would be more efficient to store the oil in its original underground formation and allow private oil companies to decide when to pump it out.

The government should sell the oil in the SPR and use the revenues to reduce the deficit. I recommend that they announce that they are going to sell one million barrels a day. At a price of $100 a barrel, that sale would generate $100 million of revenue daily that could be used to reduce federal borrowing by an equivalent amount.

The million barrels a day of SPR sales will offset the decrease in oil production cause by the political unrest in Libya. Regardless of what happens in Libya, however, the feds should continue to sell one million barrels a day. In two years, the SPR would be empty and the federal government would be out of the oil business. The two-year time horizon would give oil producers time to adjust their production decisions based on this change in government policy.

So, if the government removed the taxes on gasoline sales, eliminated the severance taxes on oil production, allowed drilling in the areas where it's now banned, and sold the oil in the SPR, we would actually get some lower oil prices.

Other government policies, such as destroying the value of the dollar and fighting wars in and around Middle Eastern oil-producing countries, also drive up gasoline prices. But that is a discussion left for another day.


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