More light reading on windfall profit tax economics

The more we know, the better we’ll understand. I think it’s important to start gathering facts. We still don’t know exactly how Obama wants to take this money; we just know he wants it.

Here’s a 37 page report by the Congressional Research Service. The Crude Oil Windfall Profit Tax of the 1980s: Implications for Current Energy Policy was given to Congress. Packed with information detailing the effects of taxing oil by the barrel during the 80’s, this report shows how expected revenues fell very short of the projections.

To make life easier, the summary is right after the table of contents. Since this is a public document, I’ll copy it below. I’ve made bold a few things that caught my eye.

In April 1980, the federal government enacted the crude oil windfall profit tax on the U.S. oil industry. The main purpose of the tax was to recoup for the federal government much of the revenue that would have otherwise gone to the oil industry as a result of the decontrol of oil prices. Supporters of the tax viewed this revenue as an unearned and unanticipated windfall caused by high oil prices, which were determined by the OPEC (Organization of Petroleum Exporting Countries) cartel.

Despite its name, the windfall profit tax (WPT) was actually an excise tax, not a profits tax, imposed on the difference between the market price of oil and an adjusted base price. While most domestically produced oil was subject to the tax (about 2/3 in 1985), the remaining 1/3 that was tax-exempt was significant (1.3 billion barrels in 1985, or 360,000 barrels per day). The $80 billion in gross revenues generated by the WPT between 1980 and 1988 was significantly less than the $393 billion projected. Due to the deductibility of the WPT against the income tax, cumulative net WPT revenues were about $38 billion, significantly less than the $175 billion projected. This report presents estimates of the amount of foregone oil production from 1980-1986 due to the WPT under three alternative supply price responses, reflecting three different assumptions about the price elasticity of the domestic oil supply function, a critical factor (statistic) in estimating lost oil output and increased import dependence. From 1980 to 1988, the WPT may have reduced domestic oil production anywhere from 1.2% to 8.0% (320 to 1,269 million barrels). Dependence on imported oil grew from between 3% and 13%. The tax was repealed in 1988 because (1) it was an administrative burden to the Internal Revenue Service (IRS), (2) it was a compliance burden to the oil industry, (3) due to low oil prices, the tax was generating little or no revenues in 1987 and 1988, and (4) it made the United States more dependent on foreign oil. The depressed state of the U.S. oil industry after 1986 also contributed to the repeal decision.

Reinstating the windfall profit tax would reduce recent oil industry windfalls due to high crude and petroleum prices but could have several adverse economic effects. If imposed as an excise tax, the WPT would increase marginal production costs and be expected to reduce domestic oil production and increase the level of oil imports, which today is at nearly 60% of demand. Crude prices would not tend to increase. Some have proposed an excise tax on both domestically produced and imported oil as a way of mitigating the negative effects on petroleum import dependence. Such a broad-based WPT would tend to reduce import dependence, but it would lead to higher crude oil prices and likely to oil industry profits, potentially undermining its original goals. Because the pure corporate profits tax is relatively neutral in the short run — few, if any, price and output effects occur because marginal production costs are unchanged in the short run — a possible option would be a corporate income surtax on the upstream operations of crude oil producers. Such a tax that would recoup any recent windfalls with less adverse economic effects; imports would not increase because domestic production would remain unchanged. In the long run, such a tax is a tax on capital; it reduces the rate of return, thus reducing the supply of capital to the oil industry.

Be sure to read that last paragraph of if/then statements again. This shows what would happen if Obama’s plan was implemented as another excise tax (increase costs and reduce domestic oil supply, then increase foreign oil dependence), or taxing both domestic and imported oil (lead to higher crude prices and oil industry profits!), leaving the only viable option as taxing the capital and thereby reducing the rate of return for investors.

The report doesn’t say, but I would speculate that move would depress stock prices for oil companies. Less capital would mean less research and development, which would eventually reduce production and either raise prices or raise foreign oil imports. Also consider all of the engineering and equipment manufacturing jobs attached to the oil patch, and it’s easy to see the entire sector taking a dive, leading to more unemployment.

Just like America blew it with credit for everyone that created a housing bubble, our government could easily manipulate an opposite effect by suppressing an industry capable of standing alone. The outcome of both mistakes means less economic security for Americans.

Why does Obama think this tax is important? That’s next.