Pump prices fail to fall by full amount of gas tax cuts, MIT Sloan expert says

Consumers reap only partial benefits of gas tax moratoria; gas stations stand to gain

Cambridge, Mass. — Price-pained drivers hoping that proposals to suspend state gasoline taxes will mean at least limited relief at the pump will likely be disappointed to see that gas prices fall by significantly less than the full amount of the actual tax cut, according to an MIT Sloan professor who adds that gas station owners stand to benefit from the tax cut as much if not more than consumers.

“There is a common misperception that if a state tax of 5 percent per gallon is eliminated, then the price at the pump will fall by 5 percent,” says Joseph Doyle, Jon D. Gruber Assistant Professor of Applied Economics at MIT Sloan. “In fact, our research suggests that retail gas prices drop by as little as 3 percent following the elimination of a 5 percent sales tax.”

Doyle, who is also a faculty research fellow at the National Bureau of Economic Research, and his fellow researchers based their findings on a unique dataset of daily, gas station-level data collected during temporary suspensions of state gasoline taxes put into effect by Illinois and Indiana during the summer and fall of 2000 in the wake of gasoline price spikes the previous spring.

“We were able to determine that suspending the 5 percent sales tax led to a decrease in retail prices of just 3 percent compared to neighboring states,” Doyle says. “When the tax was reinstated, retail prices rose by roughly 4 percent.”

The reason consumers don't reap a gas tax cut's full benefits is the basic economic law of supply and demand, he explains. Lower prices lead to increased demand for gas by drivers, which in turn reduces the competitive pressures on retail gas stations to reduce their pump prices by the full amount of the gas tax cut.

“We found that suspension of the gasoline tax benefited gas station owners two ways,” said Doyle. “The quantity of gas they are selling is likely to go up, and their profit margin increases as well.”

On the other hand, service stations immediately across the border from states where gas taxes were suspended took some financial hit, Doyle added — they often had to reduce prices to stay competitive with stations across the state line.

Even if gas stations passed through the full amount of a state gas tax cut to drivers, the actual pocketbook effect would still be rather limited, Doyle notes.

“Suspending state sales taxes on gasoline means about $10 a month extra in consumers' pockets,” he says. “These proposals would have the effect of lowering as prices, but not by very much.”

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