Minimum-Markup Laws Gouge Gasoline Buyers

by Larissa Price

Larissa Price is FEE's director of seminars.

Wisconsin Governor Jim Doyle recently authorized gas stations to sell ethanol below the state’s mandated minimum price after a station owner in Monroe defied the law and sold it for a dollar less than the required $3.10 per gallon. Good move, but the minimum-markup law should be repealed.

Not surprisingly, the Unfair Sales Act was first passed in the 1930s, when many forms of market regulation (especially state mandated price-fixing) were regarded as acceptable economic policy. Under the law gasoline wholesalers are required to charge 3 percent above what they pay, and retailers are required to charge at least 9.18 percent above the wholesale price.

When a gas station sells below the minimum markup with the intent or effect of diverting trade from a competitor, he is subject to treble damages and a $2,000 fine.

The proclaimed goal of the law is to prevent predatory pricing. The theory of predatory pricing is that large firms (e.g., Wal-Mart) could charge prices well below cost and drive smaller firms out of business. Then the large firms could raise their prices to monopoly levels and hurt consumers. Thus preventing predatory pricing facilitates competition. Or that's the rationalization.

In reality there has not been a documented, clear-cut example of a monopoly created through predatory pricing. The reason is straightforward: it would be extremely costly for a company to engage in that strategy. The predator could never know in advance how long the price war will last and when he will be able to recoup his losses by charging monopoly prices. Simply put, the strategy is risky. (See Thomas DiLorenzo's The Myth of Predatory Pricing.)

Price-cutting is a perfectly normal activity in competitive markets, even when prices fall below cost. When a firm (or group of firms) earns high profits, it entices new competitors into the market. Through the dynamic process of competition sellers compete for the business of consumers, finding new and better ways of doing things in order to offer lower prices and gain customers.

Thus cutting prices, even if occasionally below money costs, is an essential part of the competitive process. (In truth, real costs are subjective opportunity costs.) When the state prevents competitors from lowering prices, it essentially stops the competitive process in its tracks. So much for the law's ensuring competition!

Who Gains?

Who gains from Wisconsin’s minimum-markup law? When one looks more closely it becomes clear that the law benefits gas-station owners who are able to sell their gas at higher prices than they could in the absence of the law. The losers are the consumers who must pay unnecessarily higher prices and other, more efficient gas stations that are able to offer lower prices and gain new customers, such as the station in Monroe.

One study found that in 1998, when the penalty for violating the Unfair Sales Act increased to $2,000, gas prices in Wisconsin rose two-to-three cents per gallon. (See James Brannon and Frank Kelly's Pumping Up Gas Prices in Wisconsin: The Effects of the Unfair Sales Act on Retail Gasoline Prices in Wisconsin, [pdf]). The authors estimate that if the law were repealed, Wisconsin gas prices (both ethanol and non-ethanol blended fuel) would drop 20-to-25 cents immediately. Gas prices are noticeably lower in neighboring states Minnesota and Iowa.

The likelihood of the law's being abolished soon is small. But recent reports from the governor's office indicate that an exception will be made for ethanol-blended fuels, such as E-10 and E-85, which contain 10 percent and 85 percent ethanol respectively.

In the United States much ethanol is created from corn, an important crop in Wisconsin, and Gov. Doyle is a staunch ethanol advocate. Thus he wants to subsidize the ethanol industry further (it already receives considerable federal subsidies) by pushing the legislature to consider $175,000 in grants for local gas stations to install pumps for E-85, in addition to exempting ethanol-blended fuels from the minimum-markup law, which would stimulate demand. It is worthwhile to note that E-85 can only be used by cars specially equipped to run on high-ethanol blends; these cars are not common.

So rather than remove distortions, Gov. Doyle is proposing to distort the energy market further. He has given no hint that he will advise the legislature to repeal the minimum-markup law, primarily because the law serves the interests of most gas-station owners. The well-connected Wisconsin Petroleum Marketers and Convenience Store Association loudly oppose repeal as well as the special exemption for ethanol.

Many states, including Michigan, Maryland, and New York, have similar laws. However, none are as extreme as the one in Wisconsin, where fuel taxes are also among the highest in the nation. It is unfortunate that all the state government can think to do is further regulate an industry that is already vastly overregulated.