Thursday, April 28, 2011

Who gets the gas tax cut?

Bill O'Brien's proposed gas tax holiday has at least one thing going for it-- the tax cut will actually be passed on to consumers.

Some commentators intuitively suspected that gas companies will receive the tax break (including myself, to be honest), probably drawing on the reaction to a very similar proposal from Hillary Clinton and John McCain during the last presidential primaries. (See Megan McArdle's discussion for background.)

But this intuition commits a fallacy of composition. The reaction of markets to a gas tax cut on the state level will not mirror the reaction to a cut on the federal level.

While it's true that the supply of gasoline is inelastic for the country as a whole, the supply of gas to New Hampshire in particular is very elastic, even in the short run. This is because gas can easily be shifted from one state to another. A quick search for empirical evidence bears this out.

So consumers get the tax cut.

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