Gas and Payroll Taxes

Raise one, lower the other


The Federal gasoline tax currently stands at 18.4 cents per gallon, and the diesel tax stands at 24.4 cents per gallon; these taxes have been set at this level since 1993 and collectively brought in $35 billion in fiscal year 2014.

Federal payroll taxes amount to 15.3% of wages for most workers (half of which is “paid” by the employer without worker visibility, and half of which shows up explicitly on a worker’s paystub), and brought in $1.02 trillion in fiscal year 2014.

So here’s a wacky idea for the incoming Trump administration: Triple the Federal fuel tax rates while knocking a percentage point off the payroll tax, specifically the part that shows up on paystubs. This would be approximately revenue neutral in the short term — about $70 billion more in gas taxes offsetting a $67 billion reduction in payroll taxes — with a lot of long-term upsides. At $2.15 per gallon, gas prices are lower than they’ve been in years, making this the least painful time to do it.  A few years ago, people would have killed to see gas prices as low as $2.50 per gallon. And of course, even after such a move, we’d still have the cheapest gas of any first-world country: Canada is a bit over $3 per gallon these days, and Great Britain is somewhere around $5.50 — all because of incredibly high taxes, of course.

Take a step back for a moment and  consider the big picture: Virtually every household in America drives at some point, and therefore pays gas taxes. Virtually every household in America works at some point, and therefore pays payroll taxes. The average man wakes up every day, has his breakfast, kisses his wife and kids goodbye, goes to work, does his thing, comes home, has dinner, goes to bed… and rinses and repeats for his entire adult life. Every two weeks he collects a paycheck and every month he pays his bills. Does he care if his paycheck is slightly higher and his credit card charges at Texaco are too, or if both are a bit lower? Not really; at the end of the month, all that matters is that the bills are paid and he has a little bit left for the vacation fund, so he can take the kids to Disney World over Christmas break. And, in a nutshell, this is how Canadians and Europeans survive gas prices that would bankrupt many ordinary Americans — savings elsewhere balances the expenditure out.

On the government side the point is largely the same. All this talk of gas taxes being earmarked for highway funds and payroll taxes being earmarked for social security is largely legerdemain. General revenues are now being added to the highway budget to provide for desired spending; historic social security surpluses were “invested” in government bonds and the funds used to pay for general programs. Money within a single entity is fungible, and the sprawling Federal government is one giant entity.

So if it’s all the same, why bother with such a plan?

Because on the margins this proposal will create good incentives in America at large. Over the course of a few years it will help promote beneficial changes for the average working American.

Cutting payroll taxes gives everyone a pay raise and rewards work. If you want to get a job, earn money and be a productive member of society it is virtually impossible to avoid these taxes — even the self-employed have to pay them. As a worker’s earnings and productivity grows there is very little he can do to avoid or minimize these taxes, short of getting lazy and working less, which is not something the government needs to promote. With more paycheck to take home, the average worker can spend more, save more, donate more, or do any number of useful things to help himself, his neighbors and the national economy. Aside from the fact that the government needs a certain amount of revenue to fund its programs, there is virtually no downside to cutting this tax. Cutting payroll tax gives everyone with a job a well-deserved raise and encourages work — you can sell this to the average Trump supporter.

Raising gas taxes has some superficial drawbacks: Virtually every household drives, and even those who don’t drive rely on other people driving to deliver the goods, get to work, and keep the wheels of commerce turning. So raising the gas tax makes it more expensive to get many things done. But the benefits of a higher gas taxes, especially when combined with the benefits of a lower payroll tax, should more than outweigh these drawbacks.

There will be many winners and some losers from such a shift, and understanding these wins and losses will help explain why the benefits outweigh the drawback in the long run. Every working American will win a little bit, with a 1% raise virtually across the board. The losses will be spread unevenly. The average commuter who makes no change in his habits will pay slightly more to drive, while the above-average commuter with a very long drive will pay a fair bit more. Taxi drivers, salesmen with large territories, long-haul truckers and bus line operators will pay a lot more, because they drive a lot more than average. Professional drivers especially will have to pass on their higher costs to their clients, which will slowly spread these burdens out across the population at large — but negotiating new rates with customers or the taxi board is not an effortless process.

So if there were no price elasticities anywhere in the system, my proposal would be a real waste of time — shuffling costs around the economy to no useful end. But happily, that’s not the case. While gas price fluctuations have a limited effect on demand for vehicle miles traveled, they have a significant effect on demand for gasoline: elasticities are -0.26 in the short term and -0.58 in the long term (that implies a 10% rise in prices leading to a short term decline in consumption of 2.6% and a long term decline in consumption of 5.8%, all else equal). The magic sauce is efficiency: people keep driving, often the same number of miles, but they do so on fewer gallons. In the short term they inflate their tires, take the sedan instead of the minivan on longer drives, remove excess weight out of the trunk, and in the longer term they buy more efficient cars… in short, a price rise doesn’t just mean a lot of busywork spreading costs around, it promotes efficiency quite strongly.

This is an unalloyed good. Environmentalists will talk about climate change and the need to reduce greenhouse gas emissions, so you can sell this plan to a few Democrats and call it bipartisan. Lower demand means less upward price pressure on oil, which is good for geopolitical reasons: plenty of unpleasant foreign despots rely heavily on oil revenues to fund their adventures. While U.S. shale production has risen to become the fast-acting shock absorber on the world oil market, helping keep prices in the reasonable $50 per barrel range, this only works as long as demand does not outstrip the ability of that sector to ramp production up and down to match. We’ve seen before what happens when you bust the upper limit of your shock absorber, such as when pricing power passed from the Railroad Commission of Texas to OPEC in the late 1960s and early 1970s due to declining U.S. production and growing demand. Reducing demand in the world’s largest oil consumer should keep this shock absorber functional, checking prices and curbing the ambitions of our wilder geopolitical rivals by pinching their incomes. This will help sell the plan to foreign policy hawks inside the establishment wing of the Republican party.

This policy will have dynamic effects, of course. As drivers strive for efficiency over time and oil consumption decreases, revenues from this tax will start to go down. Given the elasticities involved, the cut-back should be partial, leaving the government with more revenues that before, just not the entire $70 billion per year. And mind you, this kind of price rise is better for America than a market price rise, since 100% of the additional price paid across the country stays within the U.S. economy and is widely distributed through the payroll tax reduction. A market price rise, by contrast, would go 25% abroad (given current import levels), and even the 75% that remained onshore would flow mainly to a few regions in the country, leaving plenty of Americans worse off.

The elasticity estimates quoted before ignore advancements in technology, which may eventually reduce oil consumption dramatically and largely wipe out this revenue stream; but in the span of the next few years, before technology shifts become too great, a set of gas and payroll tax rate changes which are revenue neutral in the first year may become a bit revenue negative in subsequent years. The answer is to enact a law with dynamic adjustment mechanics built in: the newly increased gas tax should be indexed for inflation, which should give it some headroom for revenue growth (until electric cars finally conquer the market, if they ever do), while the payroll tax rate reduction should be mathematically adjustable yearly in light of the gas tax revenues available. This payroll tax holiday might eventually taper off or end entirely, much like the 2011/2012 payroll tax reduction (passed as part of a stimulus program) finally ended in January 2013, but I would guess this would not happen for a long time.

But by the time there is no money at all to be gained from gas taxes, we will have put a fair bit of money back into every working American’s pocket, inevitably bankrupted the oil sheikhs of Saudi Arabia, promoted home-grown regime change in Venezuela, put Putin’s Russia back in its place, and denied the Ayatollahs of Iran the wherewithal to build atomic bombs, and, depending on who you listen to, saved the planet from environmental destruction to boot.

Implementing this plan promotes all these goals. Not bad for a couple of revenue-neutral tweaks to the tax code!

3 thoughts on “Gas and Payroll Taxes”

    1. A big adjustment, but not as overwhelming as you’d think. And worthwhile for the reasons set forth in my post.

      Diesel pump prices in the U.S. are about $2.50 on average. In Canada, they are about US$3.15 on average, which is pretty much equal to the price implied by my proposal. Yet Canada is as vast, sprawling and truck-dependent as the U.S. is, and people manage just fine. (Europe has much higher diesel prices, driven by eye-watering taxes, but it is geographically and economically quite different to North America, so the comparison is somewhat less fair.)

      The implementation matters to make sure the adjustment is smooth — rates should be announced well in advance, a phase-in period might be appropriate, etc., but those are details that can be worked out later.


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