Gas Taxes and Price Divergence

Rising gasoline prices got my attention pretty forcefully this weekend when I filled up our rental car in South San Francisco, at the end of a short holiday trip to California. I expected to pay a bit more than usual near the SFO airport, but $4.439 per gallon for unleaded regular was a jolt, because prices in Northern Virginia, where I live, have been hovering at or under the $4 mark. This served as a reminder that while I have tended to focus in my writing on the average US gasoline price, local and regional variations can be significant, and their effect can amplify the economic impact of high oil prices in markets like California, where the unemployment rate is still in double digits. Most of these differences in gas prices can be attributed to taxes, which some would like to see increased further, to promote energy security.

As in so many other aspects of life, California provides a laboratory for testing the effect of higher gasoline taxes, for which I've been seeing a growing number of calls, lately. As of January 2011, the Golden State's gas tax was 18 ¢/gal. higher than the national average and 28 ¢/gal. higher than I pay in Virginia. However, that's not the whole story, because California effectively taxes gasoline twice: once by means of the state and local taxes collected at the pump and again via regulations that make it difficult for refiners to blend gasoline to the state's strict fuel specifications, and even harder for local refiners to expand output. The combination of these explicit and implicit taxes cost Californians on average an extra 29 ¢/gal., compared to the national average gas price over the last five years. That works out to about an additional $140 a year per car based on typical usage and fuel economy. That's not enough to provide a big incentive to buy hybrid or electric vehicles, but it surely puts a dent in the purchasing power of low-to-middle income residents.

Nor have alternative fuels been of much assistance in reducing this premium. If anything, the economics of ethanol have contributed to higher gas prices in California. That's because the state's few ethanol plants are capable of producing only about 16% of the roughly 1.5 billion gallons of ethanol blended into California's gasoline annually, based on 10% of sales. The rest must be shipped in by rail, mainly from the Midwest, with significant freight costs.

The key question in terms of supporting a higher national gasoline tax is whether California's higher existing gas tax has actually reduced fuel consumption, compared to the rest of the country. Based on Energy Information Agency statistics, 2010 gasoline sales in the state were 7% lower than in the peak year of 2006. That's more than twice the 3.3% reduction the entire US experienced in the same interval. Of course there are many other factors at work in that comparison besides gas taxes, including the large difference in unemployment cited above, the disproportionate exposure of California consumers to falling home prices, as well as variations in population growth and other demographic factors. Teasing apart all those influences is beyond the scope of this blog. But even if we attributed half of the additional reduction to fuel taxes, I question whether the result is large enough to justify the resulting drag on the economy, if conservation were the only goal.

Based on this simple analysis, California's higher gasoline taxes appear to have at least contributed to reducing gasoline consumption, although they also increase the financial burden on the state's consumers, especially at times of high gas prices such as we are currently experiencing. That was noticeable even from a single fill-up of my relatively thrifty rental car. What they don't seem to have done, despite raising billions of dollars for state and local government, is to have had a discernable impact on the state's financial health or the condition of its roads, compared to other states with lower gas taxes.