Does the Foolhardy McCain/Clinton Proposal for a "Gas Tax Holiday" Expose a More Fundamental Flaw in Democracy?

By MICHAEL C. DORF


Wednesday, May. 07, 2008

Presidential candidates John McCain and Hillary Clinton have both recently endorsed a "gas tax holiday" a temporary suspension of the federal 18.4 cents per gallon excise tax on gasoline and 24.4 cents per gallon on diesel fuel—during the summer months, as a means of affording working Americans some relief from high fuel costs. The proposals differ in one important respect: Clinton would couple the temporary suspension of the tax at the pump with a windfall-profits tax on oil companies.

Nevertheless, with or without an accompanying windfall-profits tax, the gas tax holiday is unjustifiable as a matter of policy, and to his credit, Senator Barack Obama has rejected it as a gimmick. Yet historically, candidates who have eschewed populist but misguided policies have not fared well, and it is thus quite possible that Obama's principled stand on this issue could cost him votes or even the Presidency.

More generally, the mere fact that Senator McCain would propose, and that Senator Clinton would then endorse, an idea that makes such poor policy sense raises a more fundamental question about democracy: Can rule by the people generate wise policy? In this column, I address the gas tax holiday proposal and then the broader question about democracy.

What's Wrong With the Gas Tax Holiday Proposal? Just About Everything

Taxes have two primary effects. First, they raise revenue for the government. Second, they increase the cost of the goods or services taxed, which, per the law of supply and demand, reduces demand for those taxed goods or services. In general, the greater the tax, the greater the reduction in demand, although at some point, taxes become so great that they may shift demand to black market alternatives. There is no evidence, however, that taxes on gasoline in the United States are anywhere near the level that would lead to a black market.

Accordingly, the temporary elimination of the federal gas tax will both decrease federal revenue—an impact that would be offset under the Clinton windfall-profits tax proposal—and increase demand for gasoline. Increasing demand for gasoline is utterly irresponsible. It will lead to greater CO2 emissions and other pollution as well as greater dependence on oil imported from unstable or hostile regimes. The gas tax holiday will not even lower prices at the pump by very much: The greater demand stimulated by lower prices (because of the temporary elimination of the tax) will in turn tighten supplies, leading suppliers to raise prices. A new equilibrium price will arise, and drivers will may pay nearly as much for gasoline without the tax as they did with the tax, except that the oil companies and their foreign suppliers will pocket much of the revenue that formerly went to the federal government as a tax.

Supporters of the gas tax holiday—and it is hard to find any economically-sophisticated supporters who are not also McCain or Clinton supporters—can respond that demand for gasoline is largely fixed. In economics jargon, they would say that gasoline demand exhibits price inelasticity. But this is false, as the recent increase in sales of hybrid, compact and sub-compact cars relative to sales of SUVs demonstrates. Most people make decisions about how much to drive, what sort of vehicles to drive, whether to carpool, and whether to use public transportation where it is available, in the same way they make other pocketbook-affecting decisions such as whether to buy lettuce, spinach, or broccoli: based on a combination of factors including price. Indeed, demand for gasoline should be especially responsive to price in the summer months, when many Americans make discretionary spending decisions about whether and how much to use their cars for vacation travel.

To be sure, some portion of fuel demand—for example, by truckers and others who have no ready alternative to automobile transport for their livelihood—is relatively insensitive to price. But if affording relief to these people were the goal of the McCain/Clinton proposal, it could be much better targeted so as not to have systemic demand-stimulating effects. Further, tying the tax holiday to the summer, rather than to the economic downturn, however long it lasts, would make little sense as a measure targeted to drivers with fixed fuel needs.

What about Senator Clinton's proposed windfall-profits tax on oil companies? On the revenue side, this may be sensible policy, but if so, there is no reason to couple it with the gasoline tax holiday. If it is possible to tax oil companies on profits already made without undue harmful impact on their future behavior, and if one thinks that doing so is not unfair to the companies or their shareholders, then one should favor a windfall profits tax, quite apart from one's views about the gas tax at the pump.

However, even windfall taxes—that is, taxes imposed after the activity giving rise to them has occurred—can affect behavior going forward. Economists talk about the "incidence" of a tax, namely, who feels it, and the incidence of a given tax may be very different from its nominal object. Even a tax called a "windfall" tax on oil companies can be felt by drivers, if the companies pass on the cost of the tax to their customers in the form of higher prices—much as they would pass on other costs, such as those associated with higher oil prices on world markets.

Granted, the fact that an oil company might pass on the cost of a tax to drivers is not necessarily a reason to oppose a tax on the company. However, if the cost is indeed passed on, then that undermines the claim that shifting the nominal incidence of federal taxes from drivers to oil companies saves drivers money. Thus, the best that can be said for coupling a windfall-profits tax on oil companies with the gas tax holiday is that it might have the effect of undoing the harmful effects of the gas tax holiday. In other words, the best that can be said for the Clinton proposal is that it might ultimately do nothing.

Implications for Democracy

The core insight underlying democracy is that the people know their own interests best and that in competing for the people's votes, politicians will strive to deliver policies that serve those interests. In most respects, that theory works. Historically, democratic regimes have outperformed undemocratic regimes on just about every possible measure. Undemocratic regimes that have succeeded along one dimension—as in the case of China's rapid economic growth in the last two decades—have probably achieved that success despite their undemocratic nature, not because of it.

Nor is it difficult to see why undemocratic regimes would serve the popular welfare less well than democratic ones. The rulers of an undemocratic regime answer only to themselves and thus tend to pursue policies that preserve their own power and serve their own interests. To be sure, these interests sometimes align with the interests of the people, and occasionally, enlightened despots rule undemocratic regimes. But as a structural matter, democracy ensures the alignment between the interests of the rulers and the ruled in a way that autocracy does not.

Nevertheless, democracy can misfire. On many issues, the people's interests are heterogeneous. Then, democracy can become a tool for deciding which private interest to serve rather than for simply serving the interest of the undifferentiated public.

Worse, in many of these circumstances, the distributional principle chosen is not simply the greatest good for the greatest number. Instead, political scientists have shown that where a policy creates concentrated benefits for a small but well-organized group, it will often be selected even though the net costs outweigh those benefits. Because the costs are distributed over a much larger group, the people who pay the costs do not have nearly as strong an incentive to organize and oppose the policy that the people who benefit from the policy have to exert political pressure in its favor.

Agricultural subsidies are a good example. They provide great benefits to a relatively small number of farmers at the cost of taxpayers generally, but the farm state Senators and Representatives are keenly sensitive to the interests of the farmers receiving the subsidies. Consequently, Senators and Representatives from other states will typically accede to their farm state colleagues' demands for agricultural subsidies in exchange for support on their own legislative projects. Beginning the Presidential selection process in Iowa only exacerbates the problem.

Political scientists call the process by which interest groups organize to extract benefits from government "rent-seeking" behavior. The costs of "rents" to the public as a whole typically outweigh the value of the rents to their beneficiaries, but the logic of interest group politics nonetheless allows them.

Still, if rent-seeking is harmful to public policy as a whole, at least the behavior that leads to it is individually rational. Ideological movements and non-governmental organizations can and do arise that combat the impact of rent-seekers. When we hear politicians railing against "special interests," they are trying (or at least trying to appear) to organize and energize the great mass of the public who are harmed by rent-seeking.

Rent-seeking is not the only pathology that can afflict democracy. The proposed gas-tax holiday is not a response to rent-seeking but an exercise in demagoguery. It appeals to people's misunderstanding of their own self-interest. When faced with what appears to be a choice between paying more for gasoline or paying less for gasoline, people can naturally be expected to opt to pay less. Likewise for the Clinton variation, when faced with the apparent choice of a tax on individual drivers struggling to make ends meet, or a tax on the fat cats who run the oil companies, Senator Clinton assumes that people will choose to tax the fat cats.

As we saw above, these choices are false, but explaining why requires more than a sound bite. Moreover, it is easy to portray anyone who opposes a populist measure such as the gas tax holiday as doubly elitist: first, for the apparent failure to appreciate that even a few extra dollars can make a difference to a struggling family; and second, for suggesting (even if correctly) that the people do not understand what is best for them.

Accordingly, the great wonder of democracy is not that politicians frequently pander to popular sentiment, but that sometimes they don't. At bottom, Winston Churchill expressed a hopeful view when he famously described democracy as the worst form of government, except for all the others.


Michael C. Dorf is the Isidor & Seville Sulzbacher Professor of Law at Columbia University. He is the author of No Litmus Test: Law Versus Politics in the Twenty-First Century and he blogs at michaeldorf.org.

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