It’s Unwise To Tax ‘Well-Earned’ Profits

Investor’s Business Daily | There are certain laws you can break without serious repercussions, but the laws of economics are far less forgiving. And history shows that we will all pay a hefty fine if lawmakers choose to enact a “windfall” profits tax as House Speaker Nancy Pelosi has just proposed and Democrat presidential candidate Barack Obama supports.

Talk of a “windfall” profits tax turns up, like a bad penny, when politicians catch on that Americans have become frustrated by high gas prices. The concept is simple: Politicians, who are no more popular than high energy prices right now, see an easy scapegoat. So they slap an extra tax on the “bad guy” and take a bow.

The concept’s proponents must be credited for their shrewdness.

Indeed, even calling it a “windfall” tax implies that people or firms have not rightly earned that money.

In a bill earlier this year, 51 senators voted to impose a massive new special tax on energy companies whose profits grew by more than 10% — hardly a “windfall” by most definitions.

As columnist Jonah Goldberg argues, “If we were honest with the people having their profits yanked away, we’d call it the ‘well-earned and richly deserved profits tax.’ “ Many are not so forthcoming.

In this rags-to-riches story, it seems like no party has profited more from the recent high energy prices than the federal purse. The Wall Street Journal recently reported that one oil “giant” paid nearly $65 billion in U.S. taxes from 2003 to 2007, “exceeding its after-tax U.S. earnings by more than $19 billion.”

Unfortunately for proponents of sound policy, windfall profits are more satisfying emotionally than they are economically.

American households and business are rightly frustrated by the high cost of energy, but will punishing the oil industry with higher taxes do anything to make prices fall? Most experts believe that is not likely for a number of reasons.

First, America’s oil-producing firms are price takers, not price makers, in a global market. They are not members of the price-fixing body, OPEC, whose oil production decisions influence the world market supply.

The price of a barrel of oil, like most commodities, is set on the international markets by traders making sales between willing buyers and willing sellers.

Second, we tried a windfall profits tax from 1980 to 1988. A report by the nonpartisan Congressional Research Service concluded that this tax reduced domestic oil production by 3% to 6% and increased oil imports in the range of 8% to 16%. History has shown that a windfall profits tax increased U.S. dependence on foreign oil. It would do so again if repeated.

This real-life history proves the economic theory for why windfall profits negatively impact progress toward cheaper gas and increased supply of alternative fuels.

Rising oil prices encourage companies to invest more in finding new reserves and to increase production from existing fields. Increasing taxes on oil company revenue will only reduce the desire and ability of firms to find and produce more oil.

One of the axioms of scholars of the public finances is that if you tax something, you get less of it.

A windfall profits tax, by reducing capital available for investment in future energy production, will lower future energy production and therefore lower government revenues into the foreseeable future.

Reinstituting the windfall profits tax on oil companies will only reduce the amount of money companies can plow back into finding more oil and reduce the return to shareholders.

A more serious and useful approach for bringing down high energy prices would consist of several steps:

  • Free up more locations — offshore and onshore — for domestic exploration and development to help increase supply.
  • Revise the federal tax code to increase the speed of capital cost recovery for new investment.
  • Reduce the corporate tax rate to give companies more funds for capital expenditures.
  • Fund the provisions in the 2005 Energy Policy Act aimed at increasing energy supplies, encouraging conservation and promoting renewable energy sources.
  • Work with developing and emerging economies to promote economic freedom, the rule of law and the sanctity of contracts.

In the long run, these steps would gradually enhance energy supplies, reduce demand for energy, and relieve the global pressure on energy prices.

That’s a real plan for reducing American’s high energy cost frustrations.