Price Gouging Is Easy to Outlaw, Hard to Police

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On May 3, 2006, the U.S. House of Representatives passed H.R. 5253, legislation that would make “price gouging” in the oil industry a crime. Wholesalers who engage in price gouging would be subject to criminal fines of up to $150 million and imprisonment for not more than two years. Retailers would be subject to fines of up to $2 million and jail terms of up to two years. Both wholesalers and retailers also would be subject to treble civil damages. The legislation contains no definition of price gouging, nor does it describe what conduct would be criminal in nature. Instead, the bill passes the question of defining this new criminal behavior to the Federal Trade Commission.

In other circumstances, House passage of this bill might be regarded as mere political pandering. After all, how seriously should the public regard knee-jerk passage of a bill that says something is illegal but does not say what that something is? But this is an election year, and the electorate is agitated about gasoline prices. These circumstances create some risk that this legislation might pass the Senate and be signed into law, which raises the questions of how the Federal Trade Commission would define price gouging if the bill is enacted and what effect, if any, the law would have on gasoline prices.

For starters, it should be noted that the Federal Trade Commission deals in economics. Price gouging is not an economic concept of any real meaning; price gouging is a political and social concept. It is the notion that it is somehow unfair, but only in certain circumstances, for a firm in an industry to charge more for the same product today than it did yesterday, even though the new, higher price is a competitive, free-market price. Although such an amorphous concept is difficult to codify, 27 states and the District of Columbia have laws that purport to prohibit price gouging. If the House-passed legislation becomes law, the Federal Trade Commission likely would turn to those statutes for guidance in defining this new criminal behavior. The specifics of the state statutes differ. However, they share several common characteristics. These characteristics suggest that the House passed legislation likely would not lead to many discoveries of actionable gasoline price gouging or have any appreciable effect on gasoline prices.

Most state price-gouging statutes are limited to certain products and are triggered by a declared state of emergency, such as the one declared for Hurricane Katrina. California, for example, defines a declared “state of emergency” as “a natural or manmade disaster or emergency resulting from an earthquake, flood, fire, riot, or storm for which a state of emergency has been declared by the President of the United States or the governor of California.” Cal. Penal Code § 396(h)(1). The states have recognized that in our economy, on a day-to-day basis, sellers are free to charge whatever the market will bear. It is only in emergency circumstances that the laws of supply and demand are to be ignored and prices artificially restrained. The implications of this limitation on price-gouging enforcement to current gasoline prices should be obvious. There is no declared state of emergency, and thus existing state price-gouging statutes are not in effect. A similarly limited federal statute also would not be in effect.

The states have struggled to come up with meaningful and workable means of describing when a price increase actually constitutes price gouging. Florida, for example, makes it unlawful to charge an “unconscionable price” during a declared state of emergency. Fla. Stat. § 501.160(2). “Unconscionable price” is, in turn, defined as a price that “grossly exceeds” the average price during the 30 days before to the declaration of an emergency. Fla. Stat. § 501.160(1). “Grossly exceeds” is undefined. “Unconscionable” and “grossly exceeds” are powerful rhetoric, but such rhetoric provides precious little guidance to firms or law enforcement as to what price gouging is.

Some states have sought to remedy that ambiguity by creating a presumption of price gouging when a price increase exceeds a certain percentage. For example, in Alabama, a price increase of 25 percent or more raises a presumption of price gouging. Ala. Code § 8-31-4. Whether such presumptions make the law more effective is unclear. Assume a summer drought causes the price of corn to increase from $2.00 a bushel to $2.60 a bushel―a 30 percent increase. If a farmer in Alabama who is fortunate enough to have a crop pulls into the local elevator and sells for $2.60 a bushel, is he guilty of price gouging? In order to avoid being branded a criminal, should he insist that the buyer pay no more than $2.49 a bushel for his crop? Most people would answer those questions, “Of course not.” The farmer is merely receiving the market price; he is not a criminal. Fair enough, but how does that differ from a noncolluding seller of gasoline that seeks out and charges the market price, just as the corn farmer?

California goes even further. Rather than raising a presumption of price gouging, which might be easily rebutted as in the example above, Penal Code section 396 makes it unlawful for a seller of certain goods, including gasoline, to charge a price more than 10 percent higher than the price charged by that seller immediately before the declaration of a state of emergency, unless the price increase is attributable to an increase in costs. The California statute is a naked price control, which brings with it the threat of harmful economic disruption, shortages, and consumer suffering. Accordingly, the California statute is limited to a 30-day period immediately following the declaration of a state of emergency. After the 30-day period expires, prices may lawfully go to the market level.

Seemingly every state statute recognizes that when costs increase, price must follow. Thus price increases attributable to an increase in costs are typically excused from price-gouging condemnation. That only makes sense. The government cannot, or at least should not, compel firms to absorb increased costs. In the long run, that would hurt everyone, particularly consumers. Prices increase when there is a shortage. The ultimate solution is to increase supply, reduce demand, or both. Squeezing margins and forcing suppliers to absorb increased costs provides a disincentive to increase supply. As a result, consumers lose.

In the case of gasoline, the necessary “increased cost” exception to price gouging would be the exception that swallowed the rule. According to data published by the California Energy Commission, the average price per gallon for branded gasoline in the last week of April 2006 was 50 cents more than in April 2005. Of that 50 cents per gallon increase, the data show 48 cents is attributable to the increased cost of crude oil. In other words, all but two cents of that increase would be excused under current state efforts to prohibit price gouging.

As the foregoing discussion demonstrates, if the Federal Trade Commission follows the states in defining “price gouging,” a federal prohibition is unlikely to discover any actual price gouging or have any meaningful effect on gasoline prices.

This article appeared in The Daily Journal’s Forum Column on July 5, 2006. © 2006 The Daily Journal Corporation. Reprinted with permission.

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Edward C. Duckers
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