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WebMemo #918 on Energy and Environment

November 15, 2005

Windfall Profits of Doom

By

Criticizing big oil companies and their big profits is very popular in Congress right now. Even some normally free-market Republicans have tried to outdo the Democrats in anti-industry rhetoric, and bills have been introduced proposing ways to punish the major oil companies. But experience has shown that hurting big oil is not the way to help consumers, and ideas like the windfall profits tax that have failed before should not be given a second chance.

 

The post-Katrina rise in already-high oil and gasoline prices sparked a number of new energy bills. Some take the right approach, looking for ways to remove federal restrictions on access to domestic oil production[1] or streamlining the regulations that have hampered refinery capacity expansions.[2] However, many other bills chose to target the oil industry by imposing price controls or instituting penalties for price gouging. And a bill from Sen. Byron Dorgan (D-ND), The Windfall Profits Rebate Act of 2005 (S. 1631), would resurrect the windfall profits tax (WPT). This tax was first imposed by President Carter in 1980 but was repealed by President Reagan in 1988. Such punitive bills have gained popularity after recent announcements of record high quarterly profits for many of the major oil companies.

 

The WPT is an excise tax on oil when its price exceeds some predetermined level. S. 1631 would impose a 50 percent tax on the price of oil above $40 per barrel. The market price of oil is currently near $60 per barrel. This tax would be imposed in addition to the 35 percent federal corporate income tax to which current industry profits are already subject. Under the Dorgan bill, the proceeds from the WPT would be rebated to the public.

 

The underlying assumption is that oil industry profits are excessive, especially in light of the Katrina tragedy, and that it would be fair to redistribute these gains.

 

WPT The Second Time Around

Of course, there is a considerable populist appeal to taking more in taxes from big oil at a time when they can most easily afford it and giving the proceeds to taxpayers when they are straining to pay high energy costs. But the last time it was tried, the WPT backfired badly. It discouraged expansion of domestic energy supplies and led to increased oil imports. According to a 1990 Congressional Research Service study, the WPT in place from 1980 to 1988 "reduced domestic oil production from between 3 and 6 percent, and increased oil imports from between 8 and 16 percent."[3] In effect, putting domestic oil producers at a disadvantage had the unintended effect of strengthening OPEC's hand. In the end, the WPT probably hurt consumers more through higher energy prices than the increased tax revenues helped them.

 

These unintended consequences were among the reasons why the WPT was repealed in 1988. In the time it was in effect, it probably served to stop some exploration and drilling projects that would still be producing today.

 

The impact on domestic production would be just as great or greater today if the WPT were imposed again. Since the 1980s, the cost of oil exploration and drilling has increased. These projects cost billions of dollars and last for decades, over which time the price of oil will fluctuate. Indeed, the price of oil was well under $20 per barrel for most of the 1990s, reaching a low near $10 per barrel as recently as 1998. Needless to say, oil industry profits were quite modest at the time, and many oil wells were operating at a loss. If producers have to endure periods of low oil prices but must forfeit extra proceeds to the government in times of high prices, they will not undertake as much exploration and drilling. OPEC and foreign oil companies would again be given a comparative advantage relative to U.S.-based firms.

 

Given the tightness in current supplies and predictions of strong future growth in demand for energy, anything that discourages additional oil production will inevitably hurt the energy-using public.

 

Conclusion

The goal of federal energy policy should not be to hurt the major oil companies per se, nor should it be to help them. The goal should be to help the American consumer, and any impact on the oil industry should be merely incidental. Experience has shown that the public interest is best served by a pro-market energy policy with a minimum of federal interference. At the very least, the government should avoid anything that discourages the growth of energy supplies. While vilifying big oil companies may be politically popular right now, measures like the WPT would reduce supplies and hurt energy consumers in the long run. Bills like S. 1631 are no solution to the nation's energy challenges and could even make things worse.

 

Ben Lieberman is Senior Policy Analyst in the Thomas A. Roe Institute for Economic Policy Studies at The Heritage Foundation.



[1] See Ben Lieberman, "More Domestic Energy: The Right Response to Katrina and Rita," Heritage Foundation Webmemo No. 868, September 29, 2005, at http://www.heritage.org/Research/
EnergyandEnvironment/wm868.cfm
.  

[2] See Ben Lieberman, "The Gas PRICE Act: A Modest Step Forward in the Post-Katrina Energy Debate," Heritage Foundation Webmemo No. 895, October 25, 2005, at http://www.heritage.org/Research/
EnergyandEnvironment/wm895.cfm
.  

[3] Salvatore Lazzari, "The Windfall Profit Tax On Crude Oil: Overview of The Issues," Congressional Research Service, Sept 12, 1990.

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