Windfall Profits Taxes: Still a Bad Idea

Yesterday, the Wall Street Journal‘s editorial page took another much-deserved thwack at Barack Obama’s execrable “windfall profits tax” proposal. (Unfortunately, between this idea and John McCain’s gas tax holiday plan, we know that stupid energy tax gimmicks are de rigueur for today’s presidential candidates.) The WSJ correctly notes that oil companies’ profit margins are not outsized, and that companies like Google look a lot more “unreasonably” profitable than Exxon.

High oil prices are a signal of strong demand and scarce supply, and they provide an incentive for increased production. Taxes discourage production because they drive a wedge between the price paid by the consumer and received by the supplier. Windfall profits taxes also drive up oil imports because they discriminate against domestic oil producers to the benefit of the Saudis and the Venezuelans—even Barack Obama lacks the power to impose production taxes on foreign oil producers.

It’s almost a cliché to invoke Jimmy Carter when discussing Barack Obama, but I’m going to do it anyway, because it’s so appropriate here. Back in 1980, then-President Carter signed into law the Crude Oil Windfall Profits Tax Act, which imposed a 70% excise tax on the amount of an oil sale price exceeding $12.81 per barrel ($36.14 in 2007 dollars). The terms of the new windfall tax are undefined, but Obama says the government would take “a reasonable share” of oil company profits—whatever that means—by imposing a tax on oil sold over the arbitrary price of $80 per barrel.

As we discussed a few years ago, Carter’s windfall profits tax fell far short of its projected revenues, partly because it discouraged domestic production and partly because worldwide economic events caused oil prices to fall sharply during the early 1980s. According to the Congressional Research Service, the Carter-era windfall profits tax:

• Reduced domestic oil production by 3-6%; and
• Increased foreign oil imports by 8-16%.

If foreign producers have the capacity to offset all the lost domestic production, then the windfall profits tax will simply shift domestic consumption from domestic to foreign oil with no effect on pump prices at all. On the other hand, if foreign producers can’t turn up the taps to offset reduced U.S. production—Saudi Arabia in particular may not be able to meet its ambitious production targets—then not only will we be more dependent on foreign oil, but pump prices will rise to bring demand in line with newly-reduced supply.

So there’s your windfall profits tax in a nutshell: reduced domestic production, increased dependence on foreign oil, and pump prices either unchanged (best case) or higher (worst case).

See more on windfall profits taxes.