ALL BUSINESS: Don't count on gas tax cut lowering prices

By RACHEL BECK AP Business Writer

NEW YORK (AP) - Sure, a gas-tax holiday seems like a good idea, at first. According to the presidential candidates touting it, it would yield cheaper gas, which in turn would produce less expensive packaging, food, etc.

It's trickle down at its best ... until you drive over one of those super-sized potholes that jolts your car and rattles your teeth.

That's because the idea proposed by presidential candidates John McCain and Hillary Clinton to ease the federal gas tax would strip the U.S. government of about $10 billion for roadway and transportation projects.

And the plan doesn't even guarantee that lower taxes will lead to lower gas prices. Just the opposite might happen if the tax holiday spurs more demand for gas at a time when supply is already constricted.

It's basic economics. But it gets muddled when mixed with politics.

McCain and Clinton are trying to capitalize on motorists' dismay over gas prices topping $3.60 a gallon nationally. That's more than 20 percent higher than a year ago and it's hurting average Americans as they face mounting economic stress due to soaring food costs, fewer jobs, declining home prices and volatile financial markets.

McCain, the likely Republican presidential nominee, recommended the gas-tax moratorium during an April 15 speech where he laid out his economic plan. He called for cuts in the federal gas tax - 18.4 cents a gallon for gas and 24.4 cents for diesel - from Memorial Day to Labor Day - the peak summer driving season. He also wants the United States to stop adding its emergency stockpile known as the Strategic Petroleum Reserve, a move that would lower the worldwide demand for oil.

Combined, he said, the two proposals would reduce gas prices, which would have a trickle-down effect. "Because the cost of gas affects the price of food, packaging, and just about everything else, these immediate steps will help to spread relief across the American economy," McCain said in the speech.

Clinton, who is still battling with Barack Obama for the Democratic Party nomination, announced her support of the tax holiday on Monday, and said she would make up for that lost revenue by imposing a windfall profit tax on oil companies. "I understand the American people need some relief," she said in an April 28 speech.

Before anyone starts counting on the potential savings, it's important to know that a gas tax moratorium might not give them much.

As economists explain it, gas prices typically rise in the summer months because demand is higher. Now, refineries are already running near capacity. If lifting the federal tax reduces gas prices, that could boost demand even more. Supply can't grow - in economics terms it is known as being inelastic - so it could drive prices back up.

That means the economy wouldn't get the intended stimulus, and consumers would see no benefit or could even be worse off.

"If the supply is really fixed, then no cut in the federal gas tax will change gas prices," said Jerry Taylor, senior fellow at the libertarian Cato Institute.

Meanwhile, the oil and gas companies - which already have been tallying massive profits thanks to higher gas prices - could see another boon to their bottom line if prices rise and they don't have to deduct any tax from their prices, notes Len Burman, director of the nonpartisan Tax Policy Center.

"As if Exxon Mobil doesn't have enough," Burman said, referring to the Houston-based oil giant that on Thursday reported first-quarter earnings of $10.9 billion, a 17 percent year-over-year gain.

There is also more to this issue than just the quick fix for the economy. As noted above, it would strip the government of funds for highway and transportation needsaccording to the Tax Policy Center, a tax issues analysis think tank. Besides, this effort would encourage more gas consumption when the world is trying to lower it to reduce global warming.

Obama's rivals have attacked him for not supporting the gas-tax relief - but he might have some insight into this issue that the others do not. Back in 2000 when Obama was in the Illinois Senate, he supported suspending gas taxes in his home state, a moratorium that didn't turn out to be much of an economic boon at all.

A study by the National Bureau of Economic Research of the short-term tax breaks in Illinois, and Indiana during the same period, found that gas prices - which were around $2 a gallon then - fell by an average of 3 percent, not the full 5 percent of the tax cut. That means about two-thirds of the tax holiday was passed along to consumers.

The relief was short-lived. After the moratorium ended, prices rose 4 percent. And the tax cut cost Illinois an estimated $157 million in funds and $46 million was lost from Indiana, according to the study.

That shows the real cost of putting pennies back in consumers' wallets.

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Rachel Beck is the national business columnist for The Associated Press. Write to her at rbeck(at)ap.org