Gasoline Taxes and Rising Fuel Prices in the Aftermath of Katrina

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In the aftermath of Hurricane Katrina, there have been proposals both to cap gasoline prices (e.g., Hawaii) or to suspend the collection of state or federal gas taxes (e.g., Georgia) as a response to rising gas prices. Lowering prices artificially through caps or suspension of gas taxes could actually exacerbate the situation since taxes are not to blame for current high prices. High prices are currently a response to the decreased supply of gasoline and indeed partially curtail demand. If prices are lowered artificially with price caps, we can expect shortages and potentially a return to the gas lines of the 1970s. If gas taxes are removed, it is not clear that the decline would translate into lower prices for consumers versus increases in pre-tax prices and higher returns to gas stations. If only some states remove taxes and if retail (after-tax) prices in these states fell, it could lead to a shift in demand across state lines, costing not only the state suspending its taxes funds but also lowering revenues for neighbor states as well.

From January to July, retail gasoline prices increased from an average of $1.78 per gallon to $2.22 per gallon (as of June 27, 2005), marking an all-time high in nominal gasoline prices and the highest real prices since 1985. In the last week, these prices have spiked to a U.S. average of $3.07, an all-time high in both nominal and real terms. Figure 1 shows average prices across states. Prices in most states neared or surpassed $3.00, with Louisiana having the lowest average price ($2.74) and Washington, D.C., having the highest ($3.35). Table 1 compares average prices by state at the end of June and the period following Labor Day.

Gasoline taxes, however, have varied little in nominal terms throughout the past decade and they have even fallen after adjusting for inflation. Figure 2 shows the composition of gas prices from 1968 to 2005 in 2004 dollars. Since 1997, the federal tax has remained at 18.4 cents per gallon (cpg) while the average state gasoline excise tax increased from 22 cpg to 25.6 cpg. Factoring in inflation, the real value of total gasoline taxes has fallen from 58 cpg to 43 cpg (in 2004 dollars) since 1968. The share of total gasoline prices attributable to taxes has also declined (table 2). In 1995, taxes accounted for approximately 33 percent of gas prices; in the first half of 2005, taxes accounted for 22 percent. If gasoline taxes had remained constant in real dollars at 1968 levels, we estimate that gasoline consumption would be about 7 percent lower than current levels. Approximately a third of the effect would have been due to decreased driving while two-thirds would have represented a shift towards more fuel-efficient cars.¹

Notes from this section

1 This is based on elasticity estimates from Agras and Chapman (1999).

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