California’s Prop. 87 Fails Economics 101

November 3, 2006

While gasoline prices have fallen by nearly 25 percent since August, some politicians and pundits are still on the oil-bashing bandwagon that began rolling over a year ago.

Gasoline prices will always be determined by supply and demand for oil in the world market, and while talking about supply and demand will earn you an “A” in economics class, it usually gets you an “F” in the world of politics. An unfortunate example of this is taking place in California, where proponents of Proposition 87 are urging voters to approve a new $4 billion dollar tax on the Golden State’s oil industry – one of the nation’s largest.

Supporters of Prop. 87 argue this new tax is needed to ensure greedy oil companies will pay the price for giving us high gas prices this year. While some politicians might see four billion reasons to support the new levy, the government already collects a windfall of tax revenue from oil companies.

According to the Department of Energy, from 1977 to 2004, federal and state governments extracted $397 billion by taxing the profits of “Big Oil” and an additional $1.1 trillion in taxes at the pump. That’s $2.2 trillion in today’s dollars and equals three times what the companies earned over the same period.

Oil companies pay billions more to governments in off-shore royalties, severance taxes, property taxes, and payroll taxes —the list goes on and reads like the Yellow Pages.

At the same time, Prop. 87 “guarantees” the tax will not be passed on to consumers, but basic economics suggests this is pure folly. Corporations don’t pay taxes, people do. No one should kid themselves about who will ultimately bear the burden of Prop 87: We all will.

Californians will really pay those new taxes, either through higher prices at the gas pump or through lower returns in 401(k)s. Smaller profits for companies means smaller returns for retirement funds.

Promising consumers they won’t pay the new tax is like a realtor promising new homeowners they will never have to mow their lawn.

This nation’s experiment with windfall profits taxes in the 1980s proved to be economically devastating. When we last tried a windfall profits tax, it failed to raise a fraction of the revenue forecasted and crippled the production of the domestic oil industry. Let’s hope that experience can teach voters in California a valuable lesson.

Despite its blatant disregard for economics 101, California’s Proposition 87 has once again ignited the windfall profits tax debate. While Big Oil continues to be everyone’s favorite whipping boy for high energy prices, it is clear that governments are the real profiteers.


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