on windfall profits tax

Windfall taxes are not new, but they have surfaced in recent news. What is a windfall tax? A windfall tax is a tax placed upon a business, usually in the commodities industry, by a government during times when economic conditions allow said business to reap larger than normal profits.

Lately, the US Congress has been battling over the issue of levying a windfall tax on oil companies in the wake of Exxon-Mobil’s record-breaking profits, with an eye on a record high $140 per barrel oil price.

Some Democrats in Congress think this is a great idea. They believe that such a tax will cause the price at the pump to go down because the oil companies will pull back on the pricing they charge out for the oil they’re producing/distributing. Indeed, the windfall tax will most likely result in lower prices at the pump. For now, anyway.

The fundamental problem with the windfall tax on petroleum is the burden it places on the oil company itself. The exorbitant profits the oil industry is now gaining isn’t “just because they want more profit,” but because these companies’ speculators suspect that future mining, extraction, refinement, and distribution of future oil findings will come at a much greater cost than before (hence talk of "peak oil"). In essence, they’re hedging their profits in lieu of the coming shift in energy sources and also due to increased global demand. What this tax will do will hurt the pump price in the long run. Here is why:

Companies exist to make money, and for no other reason (unless they are non-profit organizations). What a company does with its profits vary by industry, but for the most part, companies pay their bills (which includes salaries/wages, taxes, insurance, etc.), and anything left over they keep in order to develop better processes, systems, products, advertising, etc. A windfall tax on the oil companies is extremely myopic. It may lower prices for the consumer in the short run, but with one of two (or both) outcomes.

One outcome is that the oil industry will not be able to re-invest in itself. The extraction, refinement, and distribution of oil is not cheap – the only reason a gallon of oil costs less than a gallon of soda pop is because millions upon millions of barrels of oil are produced and consumed each day. But the idea that a windfall tax will keep the pricing down is false. It will keep them down in the short-term, but in the long run it will only drive pricing up more dramatically. This is due to the fact that the company is hindered from investing in itself due the additional tax levied on its profit margins. Procurement would decrease, refinement would decrease, and distribution costs would increase. This all ads up to artificial expense increases that only become deferred through time until the windfall tax is lifted, at which time the company spikes its prices to make up for the lost profits during the tax years. Not a good scenario.

Another problem with the windfall tax is that it is not capitalistic in any way, it is anti-freedom, and the profit/pricing controls it implies are the very thing that caused the USSR to have so many economic problems through the decades leading up to the 1990s. A company should be able to charge what it wants. If people pay for it, great. If they don’t, then pricing adjustments need to be made. In a free market, the consumer IS the market, and ultimately dictates the price through supply & demand. When government officials (who are generally NOT economists) intervene with mechanisms such as a windfall tax, they are disrupting the natural state of the marketplace/economy, which may create wealth in the short-term, but in the long run the bubble will burst.

In this sense, I am glad that the Republicans have stopped any attempts to tax windfall profits on oil companies.