Nobel Laureate Thomas Schelling on Windfall Profit Taxes

April 25, 2006

With new proposals to tax “windfall” profits of oil companies in the news, it’s easy to forget how old the notion of taxing “windfalls” is, let alone how thoroughly discredited it’s been by economists.

Here’s a gem from our archives that sheds some light on the issue. It’s a statement from Nobel Laureate economist Thomas Schelling before the Joint Economic Committee on June 27, 1979—during the time of America’s last windfall profits tax—noting the counter-productive nature of the policy:

“Any windfall profits tax, or excess profits tax, that applies to future discoveries and developments of fuel is very much like the IRS treatment of casino gains and losses. The government proposes to capture only the ‘excessive profits’ of the lucky strikes that lead to profits in excess of cost. If you gamble in the casino, or on the horses, and win handsomely, the IRS will share your winnings with you, and indeed the bigger you win, the higher the share the IRS takes. If you lose, you lose alone; the IRS neither commiserates nor shares in your loss. The scheme is asymmetrical; it exists largely because people believe that this is a way to discourage gambling.

“This is a sure way to discourage risky enterprises. It is built into our income tax policy because it does.

“To apply it to natural resource development is therefore misguided. We want people to invest risk capital in the search for new petroleum, and in the development of new technologies for liquid fuel. If we promise them that we’ll share their happy investments, taking a cut for the Treasury as windfall profits, but if they lose, they lose alone, we are simply applying to liquid fuel development the philosophy that has historically been found attractive and effective in discouraging risky enterprise.

“I wish it were possible to tax away today’s and yesterday’s windfall profits without causing any anticipation that we may do the same thing next year, and the year after, and ten years from now. But you cannot forever treat bygones as bygones without people anticipating that you’ll do it again.”

Source: Prof. Thomas Schelling quoted in Prof. David I. Meiselman, “The Oil Excise Tax: Another Government Windfall,” Tax Foundation Tax Review (October 1979).


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