To be sure, higher fuel prices produce economic suffering. The unfortunate reality, however, is that when the price of an imported resource rises in the world market, buyers must take a hit. Subsidizing fuel does nothing to reduce the inevitable suffering, and actually makes it worse.

The problem is that when the price of a good is below its cost, people use it wastefully. In the case of a gallon of gasoline, the cost to a country is the value of every additional sacrifice that its use entails. That includes not just the price of buying the gallon in the world market  say, $4  but also external costs, like dirtier air and increased congestion. The external costs are often hard to measure but are nonetheless substantial. With reasonable estimates factored in for them, the true cost of using a gallon is clearly greater than $4. By contrast, the price of gasoline to users is simply the amount they pay at the pump. With a $2-a-gallon subsidy in effect, gasoline bought in the world market at $4 would sell for $2, or more than $2 less than its true economic cost.

Image Credit... David G. Klein

Consider how this difference might affect a trucker’s decision about whether to accept a hauling job. A rational trucker will apply the basic cost-benefit test, which says that something is worth doing if, and only if, its benefit is at least as great as its cost. Suppose the job in question requires 1,000 gallons of fuel, available at the subsidized price of $2 a gallon, for a total fuel outlay of $2,000. If the cost of the trucker’s time and equipment are, say, $1,000 for the trip, his narrow interests dictate accepting the job if the shipper is willing to pay at least $3,000. Suppose the shipper is willing to pay that amount but not more.

The problem is that if the trucker accepts the job at that price, the country as a whole will be worse off by more than $2,000. Although the $3,000 fee would cover his own costs, the government would end up paying $2,000 in additional subsidies for the 1,000 gallons consumed. On top of that, the trip would generate additional pollution and congestion costs. So the fact that the subsidy encouraged him to accept the job means that its net effect is equivalent to throwing more than $2,000 onto a bonfire.