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December 28, 2008

How a Gas Tax Increase Can Help Economic Recovery

One of the few economic bright spots is the historically low prices of gasoline; it's even possible that the amount Americans are saving both by buying less and paying less for the gallons they do buy will let us replenish our damaged balance sheets quickly enough to avoid a prolonged downturn.

So what kind of idiot would want to raise pump prices with a gas tax increase? Well, me, for one. So would the editors of the New York Times and Tom Friedman (but that doesn't mean that any of us are right). The trick is how to raise these taxes without further cratering the economy; read on for the Fractals of Change proposal.

Friedman writes:

"Have a nice day. It's morning again — in Saudi Arabia.

"Of course, it's a blessing that people who have been hammered by the economy are getting a break at the pump. But for our long-term health, getting re-addicted to oil and gas guzzlers is one of the dumbest things we could do."

A gas tax is highly regressive; this is not the time for sucking money out of the bottom of the economy so it can trickle down from the top. Friedman and I agree that any increase in gas taxes must be rebated immediately, probably through reduced social security taxes (he says "payroll").

The Times recommends a tax which raises prices up to the four or five dollar level but diminishes and disappears when and if untaxed prices approach this level on their own. Sounds like a good idea but it isn't. This plan is an invitation to OPEC and friends to raise oil prices since pump prices'll stay level thanks to the diminishing tax and demand won't be further reduced. The extra dollars Americans pay will flow overseas again rather than back into our own pockets. We've been there. On the other hand, if the tax is additive to any "natural" increase in the price of oil, producers will have a strong incentive to keep their prices low.

Here's the trick, Mr. Obama: announce a $1.50 gallon gas tax increase to take effect eighteen months from now with appropriate rebates through payroll taxes and a schedule of further $.25/gallon increases every six months for a while. This doesn't disturb the positive dynamic at the pump today but gives us the proper advance information to use when we decide to buy a new car. If we don't need a truck (some people really do), we won't buy one. We'll look for economy. We'll even buy the cars that Detroit has promised Congress it'll make instead of switching to foreign-made SUVs.

Assuming that fuel-efficient cars will include a healthy mix of plugin hybrid electric vehicles (PHEVs) and pure electrics, it'll make economic sense both to upgrade our electric grid and bring on new sources of electricity including solar, wind, nuclear, and clean coal. The economics of each of these improves against $4.00/gallon gasoline even without continuing subsidies. And we really don't want continuing subsidies since government then needs to decide what and whom to subsidize – not something it does very well. See corny ethanol.

A new fuel-efficient auto fleet, a rebuilt smart electric grid, new generating facilities – all equal lots of jobs. Government can and should kick start this some by building required infrastructure; but we won't get back to sustainable prosperity until private investment once more kicks in. We will draw private investment back by making clear what the future price of gasoline and diesel (and eventually home heating oil) will be.

With 20-20 hindsight, one of the biggest mistakes of the Bush administration was not recognizing that a gas tax would have been an appropriate response to 9/11. Friedman points out that gas prices today are almost exactly what they were back in 2001 (actually lower because there's been inflation in the meantime). He says:

"Today's financial crisis is Obama's 9/11. The public is ready to be mobilized. Obama is coming in with enormous popularity. This is his best window of opportunity to impose a gas tax. … But if Obama, like Bush, wills the ends and not the means — wills a green economy without the price signals needed to change consumer behavior and drive innovation — he will fail."

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