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Removal of the Tax on a Fixed Supply will not reduce the Price
By Byron A. Ellis-May 01, 2008
It is often difficult for non-economists to understand economics. Thus, Hillary and McCain’s proposal of a holiday gas tax reflects their lack of economic understanding. Alchian and Allen noted that the important implication of demand and supply analysis is that no matter what happens, if the demand and supply schedule are unchanged, the price is unchanged. In other words, if gas taxes were reduced it would not reduce the price at the pump as long as the supply and demand schedules are unchanged.
A lower tax rate will not shift the demand or supply curves. Lets follow Hillary and McCain’s logic, and reduce the gasoline tax by $0.18 per gallon. Now, we ask what will happen to the demand and supply schedules. Lets assume that the supply was fixed at 1,000 gallons, so the supply schedule is vertical line at 1,000 gallons. Thus, the tax does not affect the supply schedule. Hence, the only way that the price of gasoline would fall is if the demand schedule shifted downward from D0 to D1; but the demand schedule is not contingent on the tax, so it is unaffected by the tax.
As we can see from the graph, consumers would not benefit from the Clinton-McCain holiday tax federal tax reduction proposal. Ironically, the beneficiaries of the tax decrease would be the energy suppliers. Instead of the tax going to the government, it would go to the sellers.
The confusion here is the inability of Hillary and McCain to distinguish between two related demand schedules: the one that accrues to the consumer and the other is that part of the consumer’s demand that affects the sellers’ wealth.
Given the demand and supply schedules D0 and S0, the consumer will always pay P0 whether the tax is present or not. The portion of the consumer demand that would accrue to the seller would be P0 less the tax. However, if the tax was not present the full P0 would go to the seller.
Therefore, it is erroneous to state that removing the tax would accrue savings to the consumers.
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