November 21, 2005
Windfall profits tax
Here's a summary of some of the recent discussion about the proposal of a tax on the windfall profits of oil producers.
it may seem like a free lunch to generate revenue from these profits because there is not a whole lot that the taxed companies can do to avoid paying the tax today. But if the impacted businesses anticipate that the tax will persist or be levied again in comparable future circumstances -- and why wouldn't they? -- the end result will be a less than socially optimal level of investment.
Energy Outlook notes that the specifics of the senate's proposal raise problems beyond these traditional concerns:
The proposed change would affect the way that oil companies account for the value of their inventories for tax purposes. Most companies use the Last-In/First-Out (LIFO) method of inventory accounting. Under this system, the cost of goods sold is determined by the most recent purchases, not by cheaper product already in inventory. If the Senate version of this bill passes, any oil company with more than $1 billion in sales would have to recognize 75% of the increased inventory value between year-end 2004 and year-end 2005. If that were done based on yesterday's closing price on the NY Mercantile Exchange, it would amount to about $10.00/barrel of additional taxable earnings for every barrel of inventory held by these companies. In aggregate, the Senate expects this to generate approximately $5 billion in extra taxes from the affected companies.
The arguments against this are different from those against a simple surtax on oil company profits, which would act as a general deterrent to investment in the industry. In some respects, this kind of back-door tax is even worse, because it increases the existing disincentives for holding commercial oil inventories, while taxing income that hasn't yet occurred and may never, if prices fall again. Lower inventories will increase oil market volatility and translate directly into reduced flexibility in operations. The less inventory a refinery carries, the less it is able to respond to sudden changes in the market or events that affect crude oil supplies, such as hurricanes or terrorist incidents. Hammering oil companies for the unrealized appreciation of their inventories--not unlike taxing you for the market appreciation of your house, even if you have no plans to sell it--sends a negative and unhelpful signal to an industry that has already seen its inventories decline from the equivalent of 27 days of average refinery throughput in 1990 to only 19 days in 2004.
Econlog argues that a simple gasoline tax or traffic congestion tax might make more sense.
Posted by James Hamilton at November 21, 2005 03:05 PMdigg this | reddit
Why can the govt just cut the subsidies.
THe US military spending so high relative to the rest of the universe,
is this in any way a susidy to oil producer
and services corporations. can this be quantified?
Posted by: halko at November 21, 2005 03:43 PM
sorry for the bad grammar
Posted by: Anonymous at November 21, 2005 03:44 PM
Posted by: nate at November 21, 2005 06:28 PM
I agree halko, and am dissapointed that the blogs tend to treat the tax as an isolated issue.
Posted by: odograph at November 22, 2005 06:00 AM
Parry & Small are suggesting a doubling of the gasoline tax. interesting.
Posted by: pgl at November 22, 2005 01:27 PM
This kind of discussion makes the US seem like some third world authoritarian country. Ad hoc special taxes are nothing for a stable economy and society. The concern of excessive untaxed profits might be legitimate, but this should be addressed by reconsidering the general corporate tax rules. But of course, all this is just talk.
Low gasoline prices in the US are a relic from the time when the US was self-sufficient in oil, even an oil exporter. Most oil producing countries do subsidize their domestic oil consumption and keep the domestic gasoline prices down. But the US is now an oil importer (over 50% of consumption) so it would be time to move to the European system of high gasoline taxes. Otherwise, don't complain about the dependence from imported oil.
Posted by: TI at November 23, 2005 12:40 AM
The proposed Dorgan-Dodd windfall profits tax would not have led to energy independence. By exempting from the tax any profits used for exploration, it might have influenced energy companies to drill in high-risk, low return regions. By exempting from the tax profits used for refinery expansion it might have led to further concentration of refining, as expansion by majors beyond equilibrium supply points would force out smaller refiners. The tax might have influenced energy investors to avoid the tax by transferring investment to non-U.S. energy firms. But the biggest impact of the tax would be not on the energy sector at all. Rather, it would be the reduction of investment in other industries that would follow from returning energy profits to shareholders.
Posted by: JohnDewey at November 23, 2005 03:23 AM
Those of us of a certain age remember when oil prices collapsed in the early 1980's after the runups in the 1970's. Countries, companies, banks, and others went bankrupt. I once had a taxi driver in Houston who was a PhD in petroleum geology. Hotel rates in Houston,once $150 a night, were down to $35.
My problem with a windfall profits tax is that it sets a precedent for granting a subsidy later if and when prices collapse. Look at the airline industry, and today Ford Motor Company is proposing a package of tax incentives for the auto producer.
If we go down the road of managing industries via tax surcharges in good times and tax subsidies in bad times,we're going to eventually do major damage to the U.S. economy which will cost even more for a very long time.
Rather than a tax surcharge I would prefer to see things such as a consumption tax (politically impossible), or a breakup of the major oil companies into smaller companies,thereby incresing competition.
Posted by: jim miller at November 23, 2005 06:39 AM
A consumption tax would make more sense--you would presumably reduce oil company profits in a less arbitrary fashion, while discouraging consumption rather than production. I agree it is a political impossibility. However there appears to be lots of competition in the oil industry already--I doubt breaking up the majors would accomplish much, and might well curtail expensive exploration projects.
Posted by: matt wilbert at November 24, 2005 04:41 AM
There is a common perception that the oil business is an oligopoly,which my graphs in college taught me was not a very efficient way to do business.
Oil companies form consortia/joint ventures all the time to explore, drill,develop,produce. It's a common way to share the risk and diversify one's portfolio. If XOM and CVX were broken up into peices each piece would be forced by circumstance to be more efficient and competitive. If 50 companies were competing to invest in a particular project rather than only 5, the project would be developed more efficiently.
Posted by: jim miller at November 24, 2005 05:06 AM
But the intereting thing is if you look at the record, the windfall profits tax of the 1980s had virtualy no impact. The period when it was in effect -- from 1980 until oil prices fell below $30 in 1983 was a period of massive over investment by the oil industry. The rig count, for example nearly doubled to 4,000 in 1982 before it collapsed to an average of under 1,000 since 1985.
In the early 1980s the oil industry was in such a boom of overinvestment that it has taken the industry almost 20 years to work out from the excess capacity created during that period. For example, the average age of petroleum engineers is now 48. Over the long run it is possible that we might have been better off if the tax had had more of a bite and dampened the boom so we would not have experienced such a boom and bust cycle.
Posted by: spencer at November 25, 2005 07:37 AM