Gasoline Price Controls Will Lead to Shortages

As summer approaches, Michigan motorists are beginning to eye the cost of gasoline more closely.  Traveling plans rely heavily on gas prices, and the complaining has already begun about the possibility of higher prices at the pump.  In Hawaii, the state government is doing more than complaining: Gov. Ben Cayetano is expected to sign a recently passed bill to cap both retail and wholesale gas prices.

Before jumping on the price cap bandwagon, however, Michigan (and other states) need to keep in mind what happened when another state recently limited energy prices.  Recall that Gov. Gray Davis capped retail electricity prices in California, and the result was massive shortages and frequent blackouts.  Disastrous results also can be expected in Hawaii and any other state that similarly restricts gas prices. 

As anyone with a basic grasp of economics knows, there are two main effects when prices are held below the level that would prevail in a free market.  First, consumers buy more of the price-capped good or product than they otherwise would.  Second, the artificially lowered prices send a signal to the producers of the good or product to supply less of it.  These two effects work together to simultaneously inflate demand and restrict supply, leading inevitably to shortages—as in California last year and in the 1970s when price controls created long lines at the gas pump.

So why would any legislator vote to pass a bill will inevitably cause shortages?  There is no economic reason, but there are short-term political reasons.  It is an election year in Hawaii and the state legislators (as well as gubernatorial candidates) latched onto gasoline price controls as a way to generate political support among the unfortunately numerous voters who lack an understanding of economics.  These controls do not go into effect until 2004, well after this fall's election.  Politicians have touted price-fixing as a way to "help consumers" in Hawaii by making gas more "affordable."

Nevertheless, there are sound economic reasons why gasoline prices are high in Hawaii, and they don't involve "gouging."  First of all, it costs more to ship fuel to Hawaii because it is a smaller market and cannot take advantage of large-scale production cost savings.  Second, in addition to the taxes imposed on gasoline in all other states, counties in Hawaii can impose additional taxes.  In Honolulu, a 16.5 cents per gallon county tax is piled onto all the other state and federal surcharges.

Indeed, if federal or state governments truly want to make gas cheaper, there is a much simpler and safer solution available to them: lower those gasoline taxes.  For example, in Michigan the average price for a gallon of gasoline during the month of February was $1.14 (across all grades).  However, 42 cents of this price goes to pay excise taxes, so that the pre-tax price is only $0.72 per gallon. 

The 42 cents in taxes comes from three different sources: first, the federal government imposes a tax of 18.4 cents per gallon on all gasoline; second, the Michigan state sales tax of 6 percent is the levied on top of the federal tax (yes, motorists even pay sales tax on the federal tax!); and, finally, Michigan adds its own 19 cent per gallon state gasoline tax on the top of all of this.  In the end, about a third of the price paid at the pump goes to taxes. 

Hawaiian policy-makers' "solution" to voters' concerns over rising gas prices is misguided and harmful.  Price caps on gasoline will simply distort fuel markets and cause shortages for consumers, as they always have in the past.  Michigan and other states should steer far away from foolish policies that substitute political snake oil for the valuable black stuff that comes out of the ground.