With fuel prices staying high, the federal government has announced a halving of the fuel excise for three months. This will cost the federal budget A$2.55 billion, according to Treasurer Jim Chalmers.

This will cut the cost of fuel by 26.3 cents a litre. At the same time, the government said it will temporarily cut the 32.4-cent-a-litre heavy vehicle road user charge to zero.

Cutting fuel excise is politically deft. It is highly visible, easy to implement and provides quick relief to motorists.

But that does not make it the right response to the kind of crisis Australia now faces.

Australians are not experiencing a conventional cost-of-living squeeze. Global energy supply has tightened, and oil prices have surged. This is a direct hit to national income.

Rather than lifting supply, a temporary cut in fuel excise seeks to cushion the price hit for fuel users, by shifting part of the national burden to the federal budget. From there, the burden will be shifted to other groups via cuts in spending or higher taxes – or shifted to the future if the excise cut is funded through government debt.

A poor answer for the problem

From a political perspective, the excise cut is skilful. Subsidising fuel for everyone might seem like a simple way to lower prices at the petrol bowser, and is easy to understand.

But it misses the mark on several counts when it comes to the fiscal response Australia really needs. The fuel excise cut is costly at a time when state and federal budgets across the country are already strained, it is narrowly focused on fuel, it heads off fuel-saving strategies and it is poorly targeted in who it helps.

First, it is fiscally costly and unsustainable. Our research suggests that the effect of a cut to temporarily soften a hit comes at significant cost to the budget. If debt-financed, such relief comes with higher public debt. Depending on the scale, this may create a debt overhang, where higher interest bills become a drag on growth long after the crisis has ended.

The Morrison government’s fuel excise cut in 2022 to address cost-of-living pressures cost about $1 billion a month, a cost that is hard to sustain in long-term crises.

Second, it is too narrow in what it covers. A fuel excise cut only lowers the cost of fuel, even though the shock is hitting Australian households and businesses more broadly with higher prices for other goods that are reliant on energy, transport, and hydrocarbon-dependent products.

Third, it is too broad in who it helps. Relief is spread across all fuel users, not those who need it most. This is poorly targeted and makes the excise cut a blunt tool that benefits wealthy households, as well as low-income ones.

When fuel is scarce, higher prices serve an important role. They signal that economic adjustment is needed, encouraging businesses and households who can cut back to do so. This helps ensure that limited supply goes to essential uses – farming, food transport and other industries, and households under the greatest pressure from rising fuel costs.

A fuel excise cut works against this price signal. When higher prices can’t do the rationing, we tend to fall back on queues, spending limits or formal rationing, increasing the administrative cost.

Additionally, a broad fuel tax cut creates a wider macroeconomic tension. If it is not offset elsewhere in the budget, it can leave overall spending higher than is helpful when inflation is still a concern and the Reserve Bank is working to dampen demand.

That does not make a fuel excise cut inherently inflationary, but it does sit uncomfortably alongside the RBA’s efforts to slow growth.

Economists have voiced similar warnings about the inflation risk of broad fuel tax relief.

What better-designed relief could look like

If governments want to help households through an oil shock, support should be targeted and fiscally sustainable. The aim should be to direct help to the people under the greatest pressure, rather than simply subsidising all fuel users.

In the near term, that points to more targeted responses, such as direct payments to vulnerable, low-income households and support for essential fuel-using activities.

To fund that relief, a temporary tax on the windfall profits earned by the largely foreign-owned gas exporters from the energy shock is worth considering. Alongside these policies, the excise cut would reconcile public demands for action within a sound and broader economic policy package.

Over the longer term, policymakers could also focus on reducing Australia’s exposure to future energy supply shocks. That means strengthening energy security and exploring policies that support the transition to lower fuel dependence.

Read more: Amid a surge in energy prices, a windfall tax on gas profits could be the best way to protect households