Lower gas prices are equal to a $125bn tax cut, Goldman Sachs says

Goldman Sachs predicted yesterday that lower gas prices this season will amount to a $125bn “tax cut” for middle-class Americans.

That sounds like a pretty good deal. But is it real? And will we really spend that money?

Gas is already at $2.67 a gallon, the lowest levels in five years. And those who rely on cars to get to work, to ferry kids to and from school and to run errands, may get a very nice holiday gift: still lower gasoline prices.

How does $2.50 a gallon sound? That’s the price that AAA expects gasoline to touch by Christmas. If it manages to slide another 17 cents or so to that level, it would bring the magnitude of gasoline’s price plunge to a whopping 32% so far this year, from its April peak of $3.70 a barrel.

In the eyes of many pundits, the market’s decision to slash gasoline prices back to 2009 levels is the equivalent of a giant tax break for consumers – and it is poised to have a blockbuster follow-on impact on the economy as a whole.

Goldman Sachs is far from alone in its faith in lower gas prices to drive the economy. Economists argue that every penny that gasoline prices decline is equal to $1bn billion dollars in savings on energy costs on the part of American consumers, annually.

There’s a buzz phrase familiar to anyone who has ever studied economics that kicks in here: “all things being equal”.

In this case, all things being equal means that Americans are poised to save at least $100bn over the coming year, assuming the low prices stick around. That number could be even larger.

That means an extra $100bn-plus a year in our collective wallets to spend on other stuff – from the newest electronic gadgets to an extra bag of groceries. That kicks off the stimulus effect through a kind of virtuous cycle: each of those dollars fuels more economic activity as Costco, Walgreen’s or the Gap beef up their own spending in response.

Of course, not everything is equal. While undoubtedly there will be some kind of economic benefit from lower gasoline prices, it’s far from clear just where the balance will be struck.

Because it’s far from certain that there will be a big windfall; that it will prove lasting; or that consumers will choose to rush and spend it all, as economists confidently expect.

Meanwhile, there’s a flip side to the slumping oil and gasoline prices. Until recently, it was high energy prices that powered economic growth, creating jobs – many of them paying significantly more than the lower wages that anyone applying for a new position created in the service sector might expect to earn.

Now, oil and gas production companies are already slashing their spending. The first places to feel the hit will be those industries, and the regions that have been most dependent on the recent boom, from Texas to North Dakota, and from the exploration companies to the businesses that lease and service drilling rigs – even the coffee shops in the small towns that cater heavily to the oil patch.

And just as consumer spending sends positive ripples through the economy, the sudden curtailment of corporate spending will have some kind of broader negative consequences.

It will affect financial institutions that have loaned money to the energy companies and real estate in the regions that had been most significantly hit. It could even show up in your retirement savings plan, if you have a bond fund that owns junk bonds.

Energy companies dominate this corner of the bond market – and given the love that investors have shown junk bonds in recent years, that could end up being bad news for 401(k) plans and other portfolios.

Nor is a $100bn-plus annual windfall guaranteed to help the economy or generate more jobs. One Reuters/Ipsos survey released last month showed that nearly 60% of respondents don’t spend their savings. No spending, no buying, no new jobs.

One wrinkle in the scenario is the growing pressure in some quarters to raise gas prices again – with a tax on gasoline to fund much-needed infrastructure improvements.

Multiple states are already pondering boosting gas prices on their own, independently of whatever the federal government chooses to do. The tax increase may take away only a fraction of the gains that otherwise would have flowed to consumers, but it still will put a dent in the magnitude of the economic impact.

Then there’s the weather. The decline in oil prices means that heating oil, like gasoline, has seen its price decline significantly in recent weeks. Even so, if temperatures are bitterly cold, and the winter is prolonged, some of what we save on price we may end up paying out to keep those heating oil tanks full.

But nationwide, only 5% of households rely on heating oil these days; far more depend on natural gas, whose price is expected to see only very small declines.

My own gas bill soared in November, thanks to the need to keep the heating turned up as the mercury plunged. In some corners of the country, constrained pipeline capacity could actually make natural gas more pricey if demand outstrips supply.

What to do? Well, don’t worry about the economy. If you start seeing a benefit from lower gasoline prices in the form of more cash in your bank account or wallet, you’re really not under some patriotic obligation to spend it.

In fact, if you’ve been under-saving in recent years, a better bet might be to take any “free” money that you hadn’t been expecting and don’t really need and sock it into your 401(k) plan or an IRA or some other form of tax-deferred savings account.

Meanwhile, if you want to do your cash flow an additional favor, you can call your local utility and ask how you can get an energy audit of your home.

Some fixes may be easy to do – and the savings can be big, regardless of what happens to energy prices. The same is true of your car: for the first time in four years, the average fuel economy of new automobiles dipped slightly in November on a year-over-year basis.

Just because gasoline is cheaper doesn’t mean that if you’re buying a new car you should succumb to the temptation to disregard fuel economy and buy that relative gas guzzler.

And that champagne you bought to celebrate the sudden economic boom that cheaper gasoline will bring about? You may want to hang on to it to celebrate New Year’s Eve. That has the benefit of being certain to arrive as promised, on schedule.