Many in Congress
are looking to provide Americans with relief at the gas pump, but
raising taxes on the oil industry is not the way to do it. The
track record for punitive measures like the windfall profits tax
shows that they usually harm consumers along with the targeted
industry. Thus far, Congress has wisely resisted calls to impose a
windfall profits tax directly. However, the Senate is trying to
sneak such a measure into the tax reconciliation bill (The Tax
Relief Act of 2005, H.R. 4297) by changing rules on the way oil
inventories are valued. According to the Joint Committee on
Taxation, the proposed change would raise taxes by $4.33 billion.
For the sake of the driving public, Congress should reject this
A Bad Idea
gasoline prices-despite drops in recent weeks, they are still well
above $2.00 per gallon-along with announcements of record high
quarterly profits by most major oil companies have led to some
strange logic in Washington. If high oil industry profits coincide
with high pump prices, the logic goes, then reducing those profits
via confiscatory taxes will somehow lower prices at the pump. Based
on this reasoning, Sen. Byron Dorgan-sponsor of The Windfall
Profits Rebate Act of 2005, S. 1631-and others have tried to
resurrect the windfall profits tax, which would sharply raise taxes
profits tax is a tax levied on oil producers when the price of oil
exceeds some predetermined level. Dorgan's S. 1631 would impose a
50 percent tax on the price of oil above $40 per barrel. Thus, at
the current market price of about $60 per barrel, each barrel an
oil company sells or refines would be taxed an additional 50
percent on the $20 "windfall" above $40, or $10. This tax would be
imposed on top of the 35 percent federal corporate income tax and
other taxes on the industry. Under the bill, the government would
rebate the proceeds of the windfall tax to the public.
considerable populist appeal in raising taxes on "big oil" at a
time when the industry can most easily afford it and then giving
the proceeds to taxpayers. But the last time it was tried, the
windfall profits tax backfired badly. It discouraged the expansion
of domestic energy supplies and led to increased oil imports.
According to a 1990 Congressional Research Service study, the
windfall profits tax 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."
In effect, putting domestic oil producers at a disadvantage had the
unintended effect of strengthening OPEC's hand. In the end, the tax
hurt consumers more through higher energy prices than it helped
them through higher tax revenues, which turned out to be far lower
than originally predicted because the tax discouraged
consequences were among the reasons why the windfall profits tax
was repealed in 1988. Its effects, however, still linger; it likely
slowed exploration and drilling of sources that would be producing
If the windfall
profits tax were re-imposed, the impact on domestic production
would be just as great as or greater than it was in the 1980s.
Since then, the expense of oil exploration and drilling has
increased. These projects cost billions of dollars and take
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 modest at the time. Many
oil wells operated at a loss, and some shut down for good. If
American oil companies have to endure periods of low oil prices but
must forfeit extra proceeds to the government during times of high
prices, they would undertake much less exploration and drilling.
Furthermore, OPEC and foreign oil companies would again enjoy a
comparative advantage relative to U.S. based firms.
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.
Still a Bad Idea
While S. 1631 and
other attempts to directly impose a windfall profits tax have
faltered, the Senate is now trying to do so indirectly in H.R.
4297, the tax reconciliation bill. The Senate's version of this
bill includes a provision that amounts to a backdoor windfall
profits tax. It would change the manner in which oil companies
value their inventories so as to capture an additional $4.33
billion in tax revenues over the next two years. Though ostensibly
a minor accounting change, the purpose of this after-the-fact tax
code revision is the same as that of the windfall profits tax: to
make oil companies pay much more in taxes during times of high
The House and
Senate are beginning the process of reconciling their respective
versions of the tax reconciliation bill. Fortunately, the House has
thus far shown no interest in joining the Senate in its backdoor
windfall profits tax. And Secretary of the Treasury John Snow, in a
letter to House and Senate conferees, reiterated the President's
opposition to this tax change.
As it is, the tax
rates faced by the oil industry are already quite high; indeed,
they are higher than those faced by other American firms and most
Raising taxes further is unlikely to lower gas price and, over the
long term, may discourage the domestic energy sector from expanding
supplies. For these reasons, this provision should be left out of
the final version of the tax reconciliation bill.
not penalize-or subsidize-different industries through the tax
code. Rather than make the tax code more complex, politicians
should junk the existing system and replace it with a simple
cash-flow tax that logically defines taxable income as the
difference between total revenues and total costs. This is the
"flat tax" approach and it would eliminate the corrupting influence
of special-interest tax provisions while making American companies
more competitive in the global economy.
Lieberman is Senior Policy Analyst in the Thomas A. Roe
Institute for Economic Policy Studies at The Heritage