A Gas Tax Compromise for California – Energy Institute Blog

Remove tax now. Replace it with one that shoots up when the price of oil drops. While drivers elsewhere in the country are expressing outrage over $5 gas, Californians crave it. Prices between $6 and

Remove tax now. Replace it with one that shoots up when the price of oil drops.

While drivers elsewhere in the country are expressing outrage over $5 gas, Californians crave it. Prices between $6 and $7 a gallon here are creating serious financial hardship for many low- and middle-income families. Some members of the state legislature are calling for the suspension of California’s gasoline tax of $0.51 per gallon (expected to rise to $0.54 on July 1). Governor Newsom countered with a proposal to send $400 to the owner of each registered vehicle (up to two cars per person).


Other lawmakers point out that gas prices aren’t the only financial stress these households face, and for many, not the most important. Families are also being affected by rapidly rising utility bills and rent, among other day-to-day costs. This group of lawmakers also tends to be concerned about the environment and fear that cutting gasoline taxes will only encourage more emissions. Most of them support a proposed rebate of $200 per person to each household below a moderate income threshold, such as $100,000 a year.

Still, gas prices are very salient to drivers — and therefore to politicians — so there’s far more focus in Sacramento on pain at the pump than on other financial challenges.

If the goal is to help Californians specifically affected by high gas prices, nothing will be as well targeted as a gas tax exemption. As Jim Sallee showed in his important paper on compensating political losers, attempts to base compensation on the correlates of gasoline use are likely to be much less effective in targeting those most affected by high gasoline prices.

But here’s another gas tax that could potentially give all parties what they’re looking for: a price-stabilizing gasoline tax which moves in the opposite direction to the price of gasoline. This tax would disappear when crude oil prices are high, just as proponents of tax suspension now demand (although some of the economies could still go to the producers). And that would rise as the price of crude oil falls, ending the inevitable trend back to beefy SUVs, as those of us worried about climate change fear. A win-win.

This is an idea that I detailed in a working document 2008. Unfortunately, the paper did not come out in mid-2008 when crude prices were above $170 a barrel in today’s dollars, but in December 2008, after prices crashed below $60. Bad timing.

Just like in 2008, oil prices are not expected to stay at these inflated levels. Futures markets predict the current oil price of $120 a barrel will fall to $100 in one year and to $80 in three years, although this is far from certain. Yet if we make real progress towards getting out of oil, prices will most likely fall to much lower levels within 5 or 10 years. Then, as at the end of 2008, proponents of keeping gas “affordable” will take advantage of low prices and will be very reluctant to raise them with a gas tax increase.

The figure above provides an illustration of how the price-stabilizing gasoline tax works, showing both the tax level and the approximate retail price, assuming other costs and fees – and the mysterious surcharge for gasoline – remain where they were in May. The tax is expected to increase by 2.4 cents for every dollar per barrel the price of crude falls below a certain benchmark, $100 in this illustration. (The benchmark price could be set to adjust for inflation.) The 2.4 cents is the standard pass-through of crude oil prices (per barrel) to wholesale gasoline prices (per gallon). So this tax would be zero whenever the price of crude is over $100, $0.24 per gallon if the price of crude is $90, $0.48 if it is $80, and 1.68 $ if the price of crude hits $30, which I think is likely to be (or lower) if the world really takes a big chunk out of oil demand.

This commitment to stabilize the price of gasoline would mean that the demand for electric vehicles and high-efficiency conventional vehicles would not evaporate when the price of crude oil fell, as we saw in 1998, 2009 and 2015, among others.

There are details to sort out, most of which I covered in 2008: what would be the benchmark oil price? How often would the tax be adjusted? How to deal with border issues if the tax is very far from neighboring states?

Perhaps most worrisome for some policymakers is the increased volatility in gas tax revenues. But that misses the larger picture of the California budget. Annual gasoline taxes represent about $7 billion of over $200 billion in state tax revenue, which would have little impact on overall volatility. Moreover, the price-stabilizing gasoline tax would actually reduce uncertainty about total government tax revenue, not increase it. The current gasoline tax generates revenue that is positively correlated with other tax revenue because gasoline sales increase when the state economy is strong and also generates income and sales taxes students. The price-stabilizing gasoline tax would generate revenue that is negatively correlated to the state’s economy because the tax would decrease when oil prices rise, which is usually the case when the state’s economy is also strong. This would essentially be a tax revenue hedge, albeit minimal.

Let’s seize the current opportunity in gas prices, rather than watching them fall in six months or a year and wishing we had a deal when we could. Perhaps this could even be a model for a similar deal at the federal level, where there’s pressure to lower the state gas tax by 18.4 cents (even though it hasn’t increased since 1993) . Another opportunity for California political leadership!

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Suggested citation: Borenstein, Severin. “A Gas Tax Compromise for California” Energy Institute Blog, UC Berkeley, June 21, 2022, https://energyathaas.wordpress.com/2022/06/21/a-gasoline-tax-compromise-for-california/