With OPEC Down, U.S. Can Profit : Only the Deficit Would Feel Impact of a Gas Tax Increase

<i> Martin Feldstein is former chairman of President Reagan's Council of Economic Advisers. His wife, Kathleen Feldstein, is also an economist. </i>

If the Gramm-Rudman legislation stays on the books, the President will have to accept a proposal for additional tax revenue by summer. The legislation requires that the deficit be reduced by about $50 billion in the l987 fiscal year, which begins next October, as a step toward a fully balanced budget in 1991. Although spending cuts must be a substantial part of deficit reduction, it will be impossible to reach the required deficit target without additional tax revenue.

The political exigencies of 1986 and the President’s own aversion to any talk of tax increases may dictate a preliminary period of posturing. The Administration will call for drastic cuts in domestic spending. Congress will counter with threats of across-the-board spending cuts that would reverse the President’s defense buildup.

But after all the grandstanding, there will almost certainly be a 1986 will to raise taxes, unless the prospect of a 1987 recession causes Congress to change the deficit target for that year.

The recent meeting of the Organization of Petroleum Exporting Countries provided an obvious choice for that tax increase. The meeting made it clear that the cartel has broken down, at least temporarily, and that a price war to maintain market shares has begun.


Oil prices already are falling and are expected to continue to fall in the coming months. The price is now about $27 a barrel, down from a peak of more than $30. The futures market indicates that experts now anticipate a further fall to less than $24 a barrel by the end of 1986.. In real terms--that is, relative to the prices of other goods--the price of oil is lower now than it has been at any time since 1974, just after the first oil crisis.

The cartel disintegrated largely because consumers are sensitive to the price of oil. In the last several years, oil consumption declined significantly in response to rising prices, but that decline in consumption required changes in life styles that did not come easily. Consider the switch toward smaller, more fuel-efficient cars. The consumer was ready to change consumption long before American industry could make the adjustment. We will be feeling the reverberations of that lag in response to the oil price rise for years to come.

If consumers are as sensitive to the present decrease in oil prices as they were to the earlier rise, we might find a cycle repeating itself. Lower prices could lead to increased consumption and greater dependence on OPEC oil until the cartel is again in a position to restrict output and push up the price.

A tax on gasoline or oil products more generally would limit the increase in consumer demand as well as contributing much needed revenue. Since each one-cent-per-gallon tax on gasoline would raise about $1 billion of revenue, an additional tax of 15 cents a gallon would yield a very substantial $15 billion. The effect on someone who drives 10,000 miles a year and gets 20 miles to the gallon would be an increase of only about $75 in gas costs for the year. A gallon of regular gasoline would sell for about $1.20, essentially the same as it was in relation to the price of all other goods and services back in 1974 when the price at the pump was 55 cents.


An alternative to a gasoline tax would be a tax on imported oil. Such a tax would have some advantages that a gasoline tax does not. By raising the price paid to U.S. producers, an oil import tariff would encourage more domestic exploration and production. This would further reduce America’s demand for OPEC oil, thereby causing a greater decline in the price we pay for imported oil.

At the same time, the higher price received by U.S. producers would make it easier for them to service their bank loans, thus maintaining the solvency of many banks that are currently in deep trouble. And a special arrangement to allow our distressed neighbor, Mexico, to sell oil to the United States without paying the import tax would provide a healthy boost to Mexico’s faltering economy.

But such an oil import tax would fall unevenly on those regions that depend most heavily on oil for heating and electricity generation and would be a serious burden to our nation’s petrochemical industries. The rise in the price of oil in the United States would also increase U.S. imports of foreign manufactured oil products and of products such as chemicals that are produced from oil.

Although there are pluses and minuses to both the gasoline tax and the more general tax on imported oil, the case for the gasoline tax is probably the stronger one. Moreover, since the government already collects a gasoline tax, an increase in that tax rate could be put into effect quickly and with no additional administrative costs.

While all taxes have adverse economic effects, some taxes are less harmful than others. The current decline in world oil prices makes an increased tax on gasoline more attractive than the feasible alternatives. The President and Congress should jump at this new opportunity to make a significant dent in the future budget deficit.