Politics & Policy

Troublesome Tax Talk

Higher gas taxes are ill-advised. Payroll-tax replacement is unworkable.

Two tax issues seem to be getting a lot of discussion on the Internet these days. First is a big increase in the gasoline tax in order to discourage oil consumption and make the nation less vulnerable to the OPEC oil cartel. Second is the idea of replacing the Social Security payroll tax with a progressive consumption tax. Both have serious flaws.

The idea that a higher gasoline tax will help our energy situation is ludicrous. All European countries have far higher gasoline taxes and they are just as vulnerable to increases in the price of oil as we are. If a higher oil price translates into a 50-cent per gallon increase in gasoline prices (net of tax), then the Europeans and we are both going to pay 50 cents more per gallon.

The reason is that oil is an internationally traded commodity. Whether you are importing oil or exporting it, you are going to pay the world price one way or another when you use oil. If you are an oil exporter, you can hold the price of gasoline down for your citizens, but then the nation as a whole pays an opportunity cost equal the foregone profit. In the end, it is no different than an oil importing country using public funds to subsidize the price of gasoline.

From the point of view of the consumer, it makes no difference whether you live in a country that is self-sufficient in terms of oil or one that is not. When fundamental market forces cause the price of oil to rise, everyone pays. There is no way of insulating yourself except by shifting the cost to someone else.

Raising the gasoline tax may reduce domestic oil consumption, but this will only happen very slowly. It takes time for people to trade in their gas-guzzling SUVs for fuel-efficient Mini Coopers. Leaving aside the loss of welfare for those forced to drive in tiny little cars when they would rather be in something much bigger, let’s suppose that the lower demand reduces the world oil price. Unless it goes down by an amount equal to the tax, consumers are still worse off.

In the end, the only beneficiaries of a higher gasoline tax are the government and the road-building industry. Under current law, revenues from the federal gasoline tax go into the highway trust fund, which is used to build roads and bridges. Congress tends to treat uncommitted funds in this trust fund like free cash, useable for any stupid pork barrel project as long as it involves transportation.

As a consequence, increases in the gasoline tax don’t reduce the budget deficit. Of course, the law could be changed to put higher gasoline taxes into general revenues. But the road builders and others who benefit from increased transportation spending will strenuously oppose this. Hence, it is unlikely to occur.

The idea of replacing the payroll tax is similarly unworkable. This system of funding Social Security benefits was created for a specific reason which is still valid. By tying a worker’s contributions directly to his benefits, workers tend to view the payroll tax not so much as a tax, but rather as a payroll deduction for his 401(k) plan, life insurance, or medical benefits. To the extent that this is the case, the payroll tax is viewed as part of a worker’s pay and not a subtraction from it.

Of course, a worker loses the use of his payroll-tax deduction. But most get it all back with interest. Indeed, because of the highly progressive nature of the Social Security benefit system, low-income workers get a very high return on their payroll taxes. They get back benefits in retirement that are far greater than the money paid in. In this respect, the Social Security system reinforces work incentives, and is not a simplistic “tax on work” as it’s often portrayed.

Replacing the payroll tax with some other broad-based tax that is unconnected to a specific worker’s wages breaks the link between contributions and benefits. It will convert Social Security into a pure welfare program, rather than a government pension. The effect would be to reduce political support for the program and work incentives at the same time. Any disincentive effects from the replacement tax would come on top.

If we are going to replace a given tax with a progressive consumption tax, it should be the income tax, not the payroll tax. If done properly, this would increase incentives for work, saving, and investment — boosting real economic growth.

– Bruce Bartlett is senior fellow for the National Center for Policy Analysis. Write to him here.


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