High Oil Prices Could Wipe Out the Tax Cut
Life + Money

High Oil Prices Could Wipe Out the Tax Cut

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While President Obama and Republicans on Capitol Hill joust over how to pay for next year’s payroll tax cut, it’s worth looking at where this year’s extra money went.  For most Americans, a substantial portion went to pay for higher gas prices.

Oil industry analysts say the same thing could happen next year. With oil prices in recent weeks rising to well above $100 a barrel (the benchmark price for Brent crude trading at $107.84 late Thursday), the outlook for the coming year is that prices at the pump will continue to fluctuate around $3.50 a gallon. While that’s a half dollar less than the peak reached last April, it is still about a half dollar more than prices in late 2010 when the 2 percent payroll tax break was initially passed.

That translates into Americans shelling out about $75 billion more a year, or about 65 percent of the $115 billion payroll tax break that was given wage earners. Nationwide, gasoline prices averaged about $3.58 a gallon (including local taxes) during 2011, according to data available from the Energy Information Agency, compared to an average cost in December 2010 of $3.01 a gallon.

“Job growth would have been much, much weaker had people spent $75 billion more on gas without the payroll tax cut,” said Gus Faucher, chief macroeconomist for Moody’s Analytics.

True enough, but that is scant consolation to average wage earners and consumers who did everything they could to stretch their newfound payroll tax cut dollars into something more tangible than merely paying for gas.
There was some good news, too. Despite the growing economy, and perhaps because of the 16 percent rise in prices during 2011, gasoline consumption in the U.S. fell 3.5. To use economists’ argot, the demand for gasoline is inelastic. Most people in our car-bound culture (those who do not live in large cities) have to drive to work because they have no other options.

Yet some people did switch to mass transit, analysts said, while others turned to smaller cars with better fuel efficiency. “A good portion of the decline was either because we’re not driving to work or the person driving the farthest to work in the family started using the most fuel efficient vehicle they own,” said James Williams an energy economist in Arkansas-based WTRG Economics, which tracks oil industry trends closely.

Why the Price Hike?
A variety of factors drove oil prices higher during 2011 and will likely keep them above historic norms for most of 2012. The Arab Spring and subsequent disruption to Libyan supplies sent oil soaring above $120 a barrel last spring. In that volatile environment, some politicians and analysts accused major investment banks of manipulating markets to benefit their proprietary trading desks, which remain unchecked.

“History has shown that these people are able to move markets,” Fadel Gheit, an oil and gas analyst for Oppenheimer & Co.  Last April, when oil prices were spiking and some were predicting prices of $150-per-barrel, he told Bloomberg TV, “It’s not an Exxon or Mobil or Shell that moves the oil market. It’s the large financial players – the Goldman Sachs and Morgan Stanleys. Shame on them, and shame on the government that allows them to get away with that.”

A group of Democratic Senators led by Bill Nelson (D-Neb.) and Maria Cantwell (D-Wash.) last March pressed the Commodity Futures Trading Commission to investigate possible manipulation of the oil market. They urged the agency “to restore integrity to our energy markets by exercising the CFTC’s authority to require higher margin levels for speculative oil futures contracts.”

However, curbs on commodity speculators contained in the Dodd-Frank financial reform legislation remain bogged down in the rule-making process amid repeated objections by the U.S. Chamber of Commerce and the Financial Services Roundtable. Republicans on Capitol Hill, who are also opposed to the rules and are pushing to slash the CFTC’s budget next year, believe the path to lower oil prices lies in opening more off-shore areas to drilling and through building the controversial Keystone pipeline to import more Canadian oil, which is vehemently opposed by environmentalists.

While those debates rage, higher gasoline prices continue to have their great impact on lower wage workers, who often have to drive long distances to get to their jobs. People earning $30,000 a year received $600 from this year’s payroll tax break. But if they drove 15,000 miles per year in cars that averaged 30 miles per gallon, they spent an additional $250 on higher gasoline prices.

Given that gasoline price increases lag the increase in oil prices by a few weeks, the current spike in oil prices is likely to lead to higher prices at the pump over the next few weeks. In addition, petroleum inventories around the world are well below where they were a year ago, Williams of WRTG Economics said.

However, there are a few hopeful signs that prices will eventually fall back, at least to current levels or even lower. Libyan production is coming back on line; and the Saudi Arabians, who are still the largest producers in the world, are signaling they may push for greater production at the December 14th Organization of Petroleum Exporting Countries (OPEC) meeting in Vienna.

“The Saudis are very concerned that oil at $110 a barrel is eating into economies worldwide and it will trigger a recession,” Williams said.