The Consequences of a Windfall Profits Tax

Oil company executives went before Congress yesterday in a hearing designed to give the American people an explanation for the recent run-up in energy prices. From Reuters:

Big oil companies defended their combined quarterly profits of more than $30 billion at a Senate hearing on Wednesday, warning lawmakers that proposals for a windfall profit tax could discourage investments and lead to higher prices.

It was unclear whether the hearing would lead to any new energy legislation, or simply be a vehicle for Republicans and Democrats to assure voters of their concern about high prices.

Lee Raymond, the gruff chief executive who is about to retire from Exxon Mobil Corp., told the Senate’s energy and commerce committees that proposals for a windfall profit tax on oil could hurt investment in domestic oil production. Exxon earned its biggest-ever profit, $9.9 billion, on revenue of more than $100 billion in the third quarter. (Full Story.)

It’s true that the oil industry is earning record profits thanks to higher oil and gas prices. But most causes of higher prices are beyond the control of oil companies, including increased energy demand from China and India, supply shocks from Hurricane Katrina, and falling output in Russia due to the Yukos scandal and in Venezuela and Iraq because of political uncertainty.

Unfortunately, even though these events are beyond the control of oil companies, the answer to rising prices from many in Washington has been a proposed windfall profits tax. Not only would such a tax create uncertainty that’s likely to reduce future output, it also would unfairly strip away profits from shareholders in an ex post facto manner.

A large portion of the shares of companies like Shell and Exxon Mobile are owned by mutual funds. Who owns mutual funds? Anyone with a well-diversified retirement portfolio. As a result, imposing a windfall profits tax may end up harming many Americans on the verge of retirement, without doing much to lower gas prices.