Is a Windfall Profits Tax Justified by Ability to Pay?

April 30, 2008

Yesterday, Democratic presidential candidate Hillary Clinton made the following statement in support of her windfall profits tax on oil companies to finance a temporary gas tax holiday:

“We will pay for it by imposing a windfall profits tax on the big oil companies. They sure can afford it.”

They can afford it? What does that even mean? A windfall profits tax will be borne almost entirely by the shareholders of the oil companies. Companies really have no “ability to pay” as their taxes are borne by individuals, which is where the true “ability to pay” lies.

Clinton fails to understand that the current value of the oil stocks that shareholders are holding represents expectations about future profits (even if those profits are from economic rents due to some barriers to entry, etc.) and those accrued profits that have yet to be distributed (either via stock buyback or dividend payments). However, the shareholders of Exxon-Mobile, Shell, BP, etc. change everyday. So if I go buy a share of Exxon today at its high price expecting higher future payments, but then Clinton’s windfall profits tax kicks in, I would be the one to lose, an individual who has not benefited a dime from the higher profits that Exxon has reaped.

On the other hand, many stockholders of Exxon are stable, mostly pension funds and those who merely hold onto the stock for a long period of time. If one truly feels that the current profits Exxon (and others) have made are excessive and unfair, then really the only fair tax would be to somehow tax those shareholders past and present that have truly benefited from those “excess” profits. And that will not necessarily be the same person who holds the stock at the time of the profits being earned due to expectations being factored into the stock price. In lay men’s terms, you would ideally be taxing those who bought low and sold high (or currently hold the stock). Otherwise, there is no justification from a “they sure can afford it” argument for imposing a windfall profits tax because the party that bore the windfall profits tax may not necessarily be the same party that reaped the gains from the profits. It would actually be more justifiable under the “they can afford it” criterion to merely raise capital gains taxes and dividends taxes at the individual level, although doing so would some adverse economic consequences (no free lunch).

Overall, Clinton fails, like most politicians on both sides of the aisle who know little about tax incidence, to realize that corporations’ tax burdens (and profits) are borne by individuals.

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