Windfall Oil Tax

MONTANA, Jun 13 2008 (Neo Natura) - Montana Senator Jon Tester lashed out at Republicans on Tuesday, after the Consumer First Energy Act received only 51 votes, which was nine short of that needed to pass the legislation. The act was designed to roll back tax cuts for oil companies, impose a permanent windfall tax on those companies, and to help protect consumers from high gas prices caused by oil speculation.

"I remember when gas was a buck-46. It wasn't that long ago. It was before the Bush Administration took over. That was before the War in Iraq. Before speculators and market manipulators spiraled out of control. Before that $17 billion Bush tax cut for our nation's biggest oil companies." Tester said in a prepared statement.

Sen. Mitch McConnell (R-Ken.) said, "Hitting the gas companies might make for good campaign literature or evening news clips, but it won't address the problem. This bill isn't a serious response to gas prices. It is just a gimmick."

The purpose of the gas tax is simple: to raise revenue for building and maintaining roads and related infrastructure. This approach conforms to what economists call the "benefit principle" of taxation, which stipulates that consumers of government services should pay in proportion to the benefit they obtain from those services. It follows that the revenue raised from a tax that adheres to the benefit principle should be used solely to provide the good or service on which the tax is levied. Therefore, if gas taxes are paid by the individuals who benefit most from roads (drivers) and if the revenue is used solely for road building and maintenance, then the tax is a good one.

However, there is also the question of whether gas taxes should be used to decrease fuel consumption in order to protect the environment and reduce pollution. Pigouvian taxes, named after Arthur C. Pigou, a renowned English economist from the early 20th century, are taxes that attempt to make up for undesirable side effects of certain industries—what economists call "negative externalities." Pigouvian taxes are controversial and often difficult to calculate; they complicate the gas tax debate considerably.

Tax Foundation President Scott Hodge's Tax Gouging at the Pump and Record Taxes Paid before Record Oil Profits explain that oil companies actually pay more in taxes than they earn in profits, contrary to some people's notion that "greedy" oil companies are raking in huge profits without paying their fair share of taxes. The Tax Foundation Background Paper Paying at the Pump: Gasoline Taxes in America provides an in-depth look at the history and use of gas taxes. The Fiscal Fact Questions to Ask before Raising the Federal Gas Tax presents a concise discussion of the role of fuel taxes. The Distributional Impact of Windfall Profits Taxes and a Gas Tax Holiday shows how much money taxpayers in each income group stand to gain or lose under the gas tax proposals put forth by the presidential candidates.

The Democratic energy package would have imposed a 25 percent tax on any "unreasonable" profits of the five largest U.S. oil companies, which together made $36 billion during the first three months of the year. It also would have given the government more power to address oil market speculation, opened the way for antitrust actions against countries belonging to the OPEC oil cartel, and made energy price gouging a federal crime.

"Americans are furious about what's going on," declared Sen. Byron Dorgan, D-N.D. He said they want Congress to do something about oil company profits and the "orgy of speculation" on oil markets.

As with all tax initiatives instituted by governments, there is always a divide between those who are for and those who are against the tax. The benefits of a windfall tax include proceeds being directly used by governments to bolster funding for social programs. However, those against windfall taxes claim that they reduce companies' initiatives to seek out profits. They also believe that profits should be reinvested to promote innovation that will in turn benefit society as a whole.

There were arguments in the early 1980's about whether it made economic sense to tax away much of the gain from higher oil prices. But there was no question that the windfall tax was needed to ease the political sting of allowing the domestic price to rise to the level set by OPEC.

Congress hammered out a complicated formula for determining the revenue base liable for taxation and the tax rate. The criteria vary according to the date that oil was discovered, the difficulty of extraction and the size of the company. For some categories of oil, taxes phase out early in the 1990's. In all categories, the taxable base price is adjusted each year for inflation.

The tax raised a whopping $26 billion in 1981, 27 percent of domestic oil revenues. Thereafter, revenues sagged with the price of oil, running just $5.6 billion in 1985 and nothing in 1986. If the price inches above $20 a barrel, Washington may collect a few hundred million dollars this year from the owners of oil discovered before 1978. New discoveries won't be taxed again unless the price soars to $29.

Despite a number of government studies and congressional hearings, no evidence has been presented showing that the oil industry has colluded to keep retail gasoline prices high. For instance, the Energy Information Agency (EIA) in the U.S. Department of Energy found that approximately 85 percent of the changes in gasoline prices in the aftermath of Hurricane Katrina were due to changes in the market price of crude oil.

Global energy markets determine the price at which oil is bought and sold by even the largest oil corporations. For instance, ExxonMobil, the world's largest private oil company, accounts for only 3 percent of the market and the prices it pays for crude oil are set by trading on commodities exchanges in London, Hong Kong and Chicago.

What they won't get, however, is nearly as much money out of such a tax as they probably think. A windfall profits tax targeted at earnings far beyond the U.S. industrial average would return zero revenue to the Treasury because windfall profits in the oil sector are figments of the imagination.

While the raw earnings figures sound big, they are unexceptional when we take into account the size of those companies. Divide profits by sales, for instance, and you'll find that in the fourth quarter of 2005 (the last quarter for which data are available), profit margins were 6.8 percent at British Petroleum, 7 percent at ConocoPhilips, 7.1 percent at Shell, 7.7 percent at Chevron, and 10.7 percent at ExxonMobil. The 20 largest investor-owned oil companies earned a collective 8.8 cents on every dollar of sales for that quarter.

While tariffs provide an incentive to increase supply, taxes will decrease demand and therefore prices. With a sufficiently low price expensive domestic production may be crowded out. In the extreme, a halving of demand from 20 to 10 mbd would not eliminate imports, but instead raise their share to 100% with all domestic production becoming uneconomic.