"Windfall" Profits

I'd say that John Cole is right and a "windfall profits" tax on oil companies is a pretty bad idea -- it doesn't really make sense to say that we're going to try to pass laws explaining exactly how profitable different kinds of companies should be. Now, "windfall profits tax to raise revenue" (Obama) is a better idea than "windfall profits tax to finance gas tax cut" (Clinton) or "gas tax cut paid for by magic" (McCain) but if you're really willing to hurt the oil companies in the name of the public interest what you really should be doing is raising the gas tax and rebating about half of the revenues to taxpayers.

Half is about the consumer share of the gas tax burden. Some folks will plow all of their rebated cash back into gasoline purchases (thus leaving things about where they were) but others will reduce consumption and use some of that money in other ways ways. Meanwhile, the remaining revenue raised can be spent on alternative modes of transportation. With that done, how profitable oil companies are will just be a question of how cleverly their executives adapt to a new policy environment. Something like BP's claim to be "beyond petroleum" is largely greenwashing, but in principle there's no reason why hugely profitable oil companies couldn't turn themselves into hugely profitably energy companies of another sort. The problem is the oil not the profit.

Comments

I wonder if Krugman will write on this again. It's turning out to be the defining issue in Indiana, and Clinton's misquoting him (note the pregnant ellipsis):

From Clinton's Fact Hub (http://facts.hillaryhub.com/archive/?id=7493):

Krugman adds: "Just to be clear: I don’t regard this as a major issue. It’s a one-time thing, not a matter of principle…Health care reform, on the other hand, could happen, and is very much a long-term issue — so poisoning the well by in effect running against universality, as Obama has, is a much more serious breach."

What's inside that ellipsis? From Krugman:

Just to be clear: I don’t regard this as a major issue. It’s a one-time thing, not a matter of principle, especially because everyone knows the gas-tax holiday isn’t actually going to happen. Health care reform, on the other hand, could happen, and is very much a long-term issue — so poisoning the well by in effect running against universality, as Obama has, is a much more serious breach.

Posted by Zach | May 5, 2008 8:55 AM

Meanwhile:

http://www.energyrisk.com/public/showPage.html?page=328626

http://emagazine.credit-suisse.com/app/article/index.cfm?fuseaction=OpenArticle&aoid=203622&lang=EN
~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~

We'll just transistion from paying them for oil to paying them for viable alternative energy resources and technology.

Posted by steve duncan | May 5, 2008 9:01 AM

it doesn't really make sense to say that we're going to try to pass laws explaining exactly how profitable different kinds of companies should be

Err.. but we do this all the time. Public utilities, certain telecom providers, and various other regulated industries are subject to rate-setting, wherein regulators do exactly that. It's not as if the federal government is not already deeply entwined with the oil business.

Posted by J.B. | May 5, 2008 9:04 AM

Also, we'll gladly take BP's "greenwashing" here in MD where they're spending hundreds of millions of dollars on solar research and manufacturing and have something like 500 green-collar (or whatever we're calling them) jobs there. It's a drop in the bucket, and pretty obviously a bit of a PR move given its proximity to DC, but it's great for Frederick, MD.

Posted by Zach | May 5, 2008 9:04 AM

or we could stop giving the oil companies billions in subsidies every year.

Posted by cleek | May 5, 2008 9:07 AM

J.B., though there are some regulated industries whose profit levels are fixed (typically by fixing debt levels and ROE), the key difference between them and the oil companies is that they are all "natural monopolies". Infrastructure companies like local telecoms or power grid companies have such huge network effects that they're likely to end up as monopolies, capable of setting nearly any price they wish. That's why the government just grants the monopoly in return for a regulated profit level.

Oil companies are actually a minority of their market. Even a huge player like ExxonMobil is probably pumping less than 10% of the daily oil volume going onto the market. Due to OPEC's power, oil companies are price takers, not price setters, which is why their profits are extremely cyclical. If the government really wants to regulate them and set profit levels, it would need to give them effective price-setting power in lean times, i.e. promise to give the oil companies money if oil suddenly plummets to $15 per barrel and they're only making a 5% ROE instead of the guaranteed 11%.

Much better to follow cleek and Matt's suggestions, slap on a carbon tax and cut existing subsidies to the companies for oil exploration, etc.

Posted by Po-Mo Polymath | May 5, 2008 9:30 AM

One problem with this suggestion is that we currently have a system in which government rebates do not go to the poor because they don't file tax returns or meet some minimal income level. This is justified on the somewhat silly grounds that this is a rebate of taxes overpaid, when in fact it is a middle class buyoff justified by a need to stimulate the economy.

But the people who are too poor to qualify for these government rebates still get hit by higher gas prices. So unless a new system is put in place for this rebating, the effect would be to charge the poor more to benefit the lower middle class and above.

Obviously this depends on the details of how the rebating is done. But is there any reason to think it would be done better than it has been in the past?

Posted by Lon | May 5, 2008 9:59 AM

Whenever people talk about oil and policy, they get two or three totally different things all mixed together. One is the issue that oil, a thing that we need to have a functioning civilization (at least in the near to medium term) is expensive and that hurts our economy. Second is that oil frequently comes from unstable or otherwise unpleasant countries. And third, oil adds to the greenhouses gasses in the atmosphere, which will have medium to long term negative consequences.

The windfall profit tax doesn't really address any of these, except 3 (and only indirectly). Oil companies could up their R&D expenses in reducing greenhouse gasses and thus reduce their profits and windfall profits taxes.

If all we were concerned with was 1, we'd cut taxes on oil companies and oil services and oil tools companies (we tend to forget that there are lots of big companies in the oil industry that don't produce oil--like Haliburton, Schlumberger and Baker-Hughes).

If 2 was all we were concerned with, we'd slap a tariff on oil. I still think this is a good idea. It would encourage exploration and production in the U.S., but it would also make consuming oil in the U.S. more expensive, which would in turn encourage conservation and alternative energy initiatives.

If 3 was all we were concerned with, we'd initiate a carbon tax. But a carbon tax would also help us with 2 by presumably pushing down consumption overall.

So if I were to use tax policy to push the U.S. into a better place oil-wise, I'd combine an oil tariff and a carbon tax. I certainly would not institute a windfall profits tax.

Posted by RWB | May 5, 2008 9:59 AM

As for a Gas Tax Holiday, John McCain or Hillary will not be President this summer so how can John McCain or Hillary really Implement this idea into FACT.. they can't! It is a gimmick that they cannot produce on... That is so sad, and another example of Politicians trying to fool people for a vote on an idea or Gift they can't deliver on or produce. It's basically dishonest and a lie! Barack will not make a Phony Promise to the American people!

Media is disingenuous and complicit in this gas-tax holiday lie and myth! First because they know a President would have to sign off on this and, second because they fail to enquire of Hillary or John, just how they plan to sign this into Law when they in fact will not be President this summer! So,once again the Republican-controlled media fail the people by pointing out the obvious! Failed us as they did with Iraq.

As for the obliteration of Iran remark, we should recall what Franklin Roosevelt and Winston Churchill wrote in position 8 after World War II in The Atlantic Charter, both who knew and were familiar with the horrors of war....

Position "Eighth, they believe that all of the nations of the world, for realistic as well as spiritual reasons must come to the abandonment of the use of force. Since no future peace can be maintained if land, sea or air armaments continue to be employed by nations which threaten, or may threaten, aggression outside of their frontiers, they believe, pending the establishment of a wider and permanent system of general security, that the disarmament of such nations is essential. They will likewise aid and encourage all other practicable measures which will lighten for peace-loving peoples the crushing burden of armaments."

Frankllin D. Roosevelt
Winston S. Churchill

Less we forget!

P.S. On Morning Joe, Joe said as they watched a clip today of Hillary speaking in Indianna and commented on how Inspirational she had become. What they did not say is that the speech sounded an awful lot like a Barack Obama Speech!

Posted by Angellight | May 5, 2008 10:03 AM

As for a Gas Tax Holiday, John McCain or Hillary will not be President this summer so how can John McCain or Hillary really Implement this idea into FACT.. they can't! It is a gimmick that they cannot produce on... That is so sad, and another example of Politicians trying to fool people for a vote on an idea or Gift they can't deliver on or produce. It's basically dishonest and a lie! Barack will not make a Phony Promise to the American people!

Media is disingenuous and complicit in this gas-tax holiday lie and myth! First because they know a President would have to sign off on this and, second because they fail to enquire of Hillary or John, just how they plan to sign this into Law when they in fact will not be President this summer! So,once again the Republican-controlled media fail the people by pointing out the obvious! Failed us as they did with Iraq.

As for the obliteration of Iran remark, we should recall what Franklin Roosevelt and Winston Churchill wrote in position 8 after World War II in The Atlantic Charter, both who knew and were familiar with the horrors of war....

Position "Eighth, they believe that all of the nations of the world, for realistic as well as spiritual reasons must come to the abandonment of the use of force. Since no future peace can be maintained if land, sea or air armaments continue to be employed by nations which threaten, or may threaten, aggression outside of their frontiers, they believe, pending the establishment of a wider and permanent system of general security, that the disarmament of such nations is essential. They will likewise aid and encourage all other practicable measures which will lighten for peace-loving peoples the crushing burden of armaments."

Frankllin D. Roosevelt
Winston S. Churchill

Less we forget!

P.S. On Morning Joe, Joe said as they watched a clip today of Hillary speaking in Indianna and commented on how Inspirational she had become. What they did not say is that the speech sounded an awful lot like a Barack Obama Speech!

Posted by Angellight | May 5, 2008 10:04 AM

J.B., though there are some regulated industries whose profit levels are fixed (typically by fixing debt levels and ROE), the key difference between them and the oil companies is that they are all "natural monopolies". Infrastructure companies like local telecoms or power grid companies have such huge network effects that they're likely to end up as monopolies, capable of setting nearly any price they wish.

That's all well and good, and I'm not personally convinced that the oil market is defective to the extent it is in need of rate regulation. But the objection that we shouldn't regulate, just because, isn't exactly an argument. Regulation, including rate regulation, can be good, and it can be bad, depending on the circumstances.

Certainly people have gone after oil companies and gas stations on antitrust grounds before and failed, but then again antitrust law in the US isn't worth the paper it's written on. You could put together a case that, despite the lack of a monopoly, there is implicit price fixing in the industry, and oil being the critical commodity it is (not dissimilar to the products of traditionally rate-regulated industries), government intervention is warranted.

Ultimately, I'm dubious that oil company profit margins are actually high enough to justify rate-setting right now. But I don't think the option should be dismissed out of hand on the basis of knee-jerk anti-regulatory sentiment as MY did above. This is a mature market populated by a small number of massive companies providing an absolutely critical product. It's true it is not a monopoly, but in most other respects it fits the general model of a regulated industry.

If the government really wants to regulate them and set profit levels, it would need to give them effective price-setting power in lean times, i.e. promise to give the oil companies money if oil suddenly plummets to $15 per barrel and they're only making a 5% ROE instead of the guaranteed 11%.

Because I'm sure the oil companies are losing sleep over the likelihood of oil prices plummeting... And in any case, oil companies collectively have obvious price-setting capability, and ROR regulations would set an equally obvious price floor for implicit industry coordination. This wouldn't even be an issue.

Posted by J.B. | May 5, 2008 10:07 AM

"it doesn't really make sense to say that we're going to try to pass laws explaining exactly how profitable different kinds of companies should be."

fyi, we do it for other industries (telecom/utilities); but you wouldn't know that because, well, your fancy-pantsy parents never told you...

Posted by Israel | May 5, 2008 10:10 AM

Some amount of the profits of the major oil companies is due to the rapid appreciation of the reserves they control, beyond their expectations and beyond what was necessary to encourage development of the reserves. That is the windfall nature of it. Calculating how to get at that number sounds extremely difficult to me, but lopping off the excess windfall profits and the tops of the cycle does not mean you have to regulate prices all the time.

All that said, there are probably easier and more structurally sound ways to get some marginal tax revenue out of the run up in oil prices.

Posted by Doug | May 5, 2008 10:10 AM

"it doesn't really make sense to say that we're going to try to pass laws explaining exactly how profitable different kinds of companies should be."

fyi, we do it for other industries (telecom/utilities); but you wouldn't know that because, well, your fancy-pantsy parents never told you...

Posted by Israel | May 5, 2008 10:13 AM

You could put together a case that, despite the lack of a monopoly, there is implicit price fixing in the industry

Every time oil prices go up, Congress launches an investigation into nefarious oil company price fixing. Every time, they wind up concluding that there is none.

Posted by right | May 5, 2008 10:24 AM

How about we make the oil companies actually pay the royalties they owe the government for being able to pump oil out of federally owned lands?

Posted by dantonj | May 5, 2008 10:31 AM

It's not as if the federal government is not already deeply entwined with the oil business.

At this point, a more accurate statement would be that the oil business is deeply enter twined with government.

Posted by justinb | May 5, 2008 10:34 AM

One of the major hurdles in applying free market priciples to the oil industry is that the oil industry doesn't really resemble a free market.

Oil reserves are nationalized in most countries. Many of these countries collude in order to set production and price.

Oil extraction, shipping, and refining are controlled by very few, very powerful companies. Yet it's a cartel as well; there is now way a start-up could get into the oil business because the oil companies would destroy any entrepreneur that tried.

Given the profitability of oil extraction and delivery the last few years, we should have seen dozens of companies flocking to make some money for themselves. Instead, the few companies that exists have actually decreased in number in recent years due to mergers and acquisition.

The oil industry is set up as a distributed monopoly that controls a strategic resource for the proper functioning of society. And even though I don't necessarily think a windfall tax is the proper course to take, it's silly to assume that big oil is just like any other ma-and-pop business.

Posted by afferent input | May 5, 2008 10:38 AM

Rebating half of the gas tax to the consumer is essentially providing a subsidy. Won't the price at the pump evenutally rise by an amount roughly equivalent to the subsidy, much as the subsidy provided by mortgage deductibility eventually gets built into the market price of a house?

Posted by Natasha October | May 5, 2008 10:43 AM

Ordinarily, we shouldn't want the government to decide when profits become "excess." But the case of huge profits from the run-up in oil prices is different for two reasons. First, it is unusually clear that these profits have nothing to do with productivity. Diverting them to the U.S. Treasury would have no effect on the incentive to extract more oil from American ground. Second, some or all of these profits are directly related to a situation that is imposing huge sacrifices—financial and otherwise—from others; that is, the Iraq war.

Because of the war, the government is adding hundreds of billions of dollars to the burden of debt that all taxpayers, including other businesses, will have to pay off. Because of the war, American soldiers by the hundreds, and Iraqis by the thousands, are paying the ultimate tax of death by government policy. And because of the war, American oil companies are raking in extra billions of dollars of profits. -Michael Kinsley, April 28, 2006

http://www.washingtonpost.com/wp-dyn/content/article/2006/04/27/AR2006042702122.html

Posted by Gary Sugar | May 5, 2008 10:48 AM

Details, details.

The problem with consumption tax rebates and even more with so called pre-bates is that we do not in fact know where everyone is living, and the farther you go down the socio-economic scale the more likely that is going to be. People living out of their cars with no fixed address or who simply rent a room in someone's basement are from the government's point of view often invisible.

As an intellectual exercise a combination of consumption tax offset by rebates for some or all customers is interesting, but I suspect the operational costs would be horrific and the amount of government data collection needed would amount to a soviet style internal passport system. For example any actual rebate program would have drivers having to record when and possibly where and in what quantities they purchase gas.

Handy for the FBI, not so good for civil rights. If me and ten friends like to take a monthly road trip to a remote cabin to talk politics and all have to gas up on our way back at the same station do we really want that fact to be available for data mining? Talk about Total Information Awareness.

These heavy handed attempts to change mass behavior via the market using a tax instrument focused on the end-consumer is just command and control with a gentle bow somewhere towards the Chicago GSB.

Posted by Bruce Webb | May 5, 2008 12:51 PM

A couple of questions I have about the Democrats' proposals for windfall profits taxes on oil companies:

1) Would these taxes apply to Aramco, Petrobras, PDVSPA, Canadian Natural Resources, and other foreign oil companies, or just to domestic bogeymen such as Exxon that collectively control about 10% of the world's proven oil reserves?

2) Would pure-play oil refiners such as Frontier Oil Co. be exempt from these windfall profits taxes, because their profits have been getting squeezed as high crude prices have squeezed their crack spreads?

Posted by Fred | May 5, 2008 1:05 PM

"Oil extraction, shipping, and refining are controlled by very few, very powerful companies. Yet it's a cartel as well; there is now way a start-up could get into the oil business because the oil companies would destroy any entrepreneur that tried."

Good thing I didn't believe that when I bought some of tiny Vaalco Energy at $4 per share last August.

Posted by Fred | May 5, 2008 2:35 PM

i heard someone on npr say that if we did go for a windfall profit tax, rather than basing it on the price of oil, go back, say four years or so, check out what profits looked like then and use that as your base line.

Posted by dj spellchecka | May 5, 2008 4:25 PM