The result: The economic and political benefits Trump and the GOP hoped to reap from cutting tax rates could be swamped by higher pump prices that Americans face every time they hit the road. But the first clear impact of higher gas prices emerged in the latest retail sales figures, which showed a 0. Higher gas prices will lead to stronger profits for oil and gas companies, but less spending on everything else and potentially higher inflation.
President Donald Trump is hoping a wave of tax-cut-fueled economic euphoria will boost his approval ratings and his party’s political fortunes this fall. A sharp spike in gas prices could slam the brakes on all of that.
As Americans head out for traditional Memorial Day weekend road trips, they’ll confront gas prices of nearly $3 a gallon, the highest since 2014 and a 25 percent spike since last year.
The increased cost of fuel is already wiping out a big chunk of the benefit Americans received from the GOP tax cuts. And things could get worse as summer approaches following the administration’s standoff with Iran and a move by oil-producing nations to tighten supplies.
The result: The economic and political benefits Trump and the GOP hoped to reap from cutting tax rates could be swamped by higher pump prices that Americans face every time they hit the road.
“If you look at the benefits of what households are getting from lower rates, roughly one-third of that is wiped out if these higher gas prices are sustained,” said Ellen Zentner, chief U.S. economist at Morgan Stanley. “And when we drive down the street, every block we see glaring signs about how much gas costs that day and it’s all over the media. The tax cuts were a one-off. It’s a one-time level shift in your paycheck that you are not reminded of every day.”
The economic impact of higher gas prices is already stark.
Morgan Stanley estimated that if prices remain at current levels, they would cost U.S. households an additional $38 billion this year. Using Joint Committee on Taxation data, it estimated the tax-cut bill would reduce individual taxes by about $128 billion in 2018. And it gets even worse for Trump.
The increase in gas prices is felt most heavily by lower-income Americans – especially in the South where people drive the most – who received the smallest share of the tax-cut benefits. So the increase could hit Trump’s blue-collar Southern base the hardest while potentially eroding confidence in the economy and tamping down consumer spending, which accounts for 70 percent of economic output.
So far, consumer spending remains fairly strong as higher wages and lower taxes encourage people to open their wallets. But the first clear impact of higher gas prices emerged in the latest retail sales figures, which showed a 0.3 percent decline in spending at restaurants and bars. Typically, the first area households cut back when feeling pinched is going out to eat. Spending on travel, tourism and apparel, among other categories, could also wind up declining if fuel prices keep rising.
“Gas prices will reduce the benefits of the tax cut by at least one-third, but I think the impact may actually be much larger than that because the bulk of the tax cuts go to high-income households who aren’t going to spend much of it,” said Mark Zandi, chief economist at Moody’s Analytics. “Gas prices mean less today than they did 20 years ago, but they still mean a lot, especially to those folks living on the margins in lower and lower-middle income groups.”
Higher gas prices can trickle out to nearly every sector of the economy.
When prices fell in 2014 and 2015, they hit the profits of oil giants but left everyone else with more money to spend, helping lift everything from dining out to home sales – and contributing to a boost in overall gross domestic product.
The reverse may now also be true. Higher gas prices will lead to stronger profits for oil and gas companies, but less spending on everything else and potentially higher inflation.
If prices continue to rise, consumers will feel the pinch not just at the pump but in what they pay to heat their homes and for virtually any product that is delivered to their home or the store in cars and trucks.
“The price of oil and inflation are positively – and highly – correlated,” wrote Scott Anderson, chief economist at Bank of the West, in a recent note to clients. “In other words, as oil prices increase or decrease, inflation moves in the same direction.”
A spike in inflation could push the Federal Reserve to add another interest rate hike this year, further pushing up the cost of borrowing on everything from credit cards to home purchases. Mortgage rates are already rising, and a further increase could reduce home purchases and all the household formation spending that goes along with them.
None of the negative impacts from higher gas prices are guaranteed.
Many analysts view the price spikes as temporary, noting that a decline in political uncertainty in the Middle East could push prices lower. The U.S. is also far less dependent on imported oil than it was during the oil shock of the late 1970s. And Americans spend less now on gas given alternative energy sources and more efficient cars.
But such a sharp spike in prices still has real economic and psychological impacts that could easily blow away any benefits from a tax-cut bill Americans already have mixed feelings about.
A study released this week by the Federal Reserve Bank of New York showed that only 37 percent of households believe they will be better off a year from now because of the tax cuts, while 47 percent expect no change and 16 percent think they will be worse off.
Higher gas prices, meanwhile, act as an immediate tax on consumers and make people feel poorer.
“There’s still a positive impact from the tax cut, but it tells a little different story when the tax cuts are seen against the backdrop of higher gas prices,” Zentner said. “It changes the narrative a little bit.”
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