Senate Rejects Oil Company Windfall Profits Tax Bill

June 11, 2008

Yesterday, the U.S. Senate voted 51 to 43 to reject a bill that would have imposed a windfall profits tax on oil companies. 6 Republicans joined 43 Democrats and 2 Independents in supporting the measure. (The six were Sens. Norm Coleman (MN), Susan Collins (ME), Chuck Grassley (IA), Gordon Smith (OR), Olympia Snowe (ME), and John Warner (VA); Sen. Mary Landrieu (D-LA) voted against the bill. Interestingly, Grassley had said he would oppose the proposal.)

Sen. Ben Cardin (D-MD) gives some of the ideas behind the bill:

The bill would provide for a windfall profits tax against the oil industry and would eliminate unnecessary tax breaks the companies receive. These companies are making record profits, and there’s no need for the government to subsidize even more. It also limits the impact of excessive speculation in the oil markets, which has driven up price.[… T]he Consumer-First Energy Act would take the revenues from the windfall profits and the repeal of tax breaks to the oil industry and use those funds to offer incentives for renewable energy.

I think three points need to be made.

First, the tax breaks to which Sen. Cardin refers are a combination of generic tax breaks made available to any business (such as the manufacturing tax deduction), and subsidies for “nuclear power, energy-efficient cars and buildings, and renewable fuels research.” quotes the Congressional Research Service as saying that these “tax breaks” resulted in a net increase in taxes for large oil companies. Now, it may well be that the manufacturing tax deduction or the renewable energy subsidies aren’t justified uses of our tax code, since it politically warps decisions that would have been made differently without the subsidies. But repealing them only for large oil companies makes our tax code even less neutral and more distorting.

Second, efforts to tax “windfall profits” will run into problems because the term can never be more than vaguely defined. The guts of the bill have a definition: profits arising from “a gross disparity” (gross as in the layperson term, not the IRS’s term) exceeding the price offered previously in the same geographic area, not justified by the costs of production. But prices are determined by supply and demand, not by comparable prices or the costs of production. No one has enough information to know the “right” price of oil or gasoline; its price depends on literally billions of individual decisions each day to buy or not and sell or not.

For example, many politicians host expensive fundraising dinners of $500 a plate or more. The price of those dinners is certainly a “gross disparity” from the price offered previously in the same geographic area, and not justified by the costs of production (usually a barely digestible rubberish chicken). But people still pay for them voluntarily, because of supply and demand. And, of course, price controls cause shortages, as in the gasoline price controls in the 1970’s, or after enforcement of anti-gouging laws in the wake of natural disasters. And again, singling out one type of company for a windfall profits tax makes our tax code less neutral. Lots of other businesses earn large profits or have large margins (such as the real estate speculators and investment houses now the subject of bailout proposals).

Third, the bill was unlikely to result in lower gas prices or significantly increase government revenue. The windfall profits tax passed in 1980 brought in $80 billion in revenue, well short of the $393 billion projected, and it lowered domestic oil production. Taxes matter, and if a company must pay more in taxes, it has to pay for it by cutting costs (such as payroll), or decreasing investment and research (a very heavy cost in the oil industry, that only sometimes pans out), or reducing payments to shareholders (essentially anyone with a mutual fund or retirement plan), or increasing prices (difficult due to world competition). Congress cannot mandate this choice, and even company executives have only limited control over many of these things. If windfall profits tax revenue comes from decreased research and development investment, it essentially will be used for R&D in either case; the latter will just involve a wasteful roundtrip to Washington, and success will be driven by politics and not profitable outcomes.

Finally, as we have noted, big oil companies already pay nearly half their profits in taxes; how high need it go until we can say that the tax is excessive and unfair?



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