Wednesday, November 9

"Windfall" taxes

A Supremely Horrible Idea

The results of this kind of measure are easy to predict (and are observable in the aftermath of similar taxes being levied during the Carter administration):

  • Decreased domestic oil production
  • Increased reliance on foreign oil
  • Higher oil prices

High energy prices are in large part due to limited refinery capacity, but how can we expect rational companies to build additional refineries if we raid their profits? Anyone who's kept up at night by oil companies making "windfall" profits is welcome to open an online brokerage account and buy a few shares. Their perspective should change markedly.

If you listen to your friendly television newsperson you'll see almost universal approval of the proposal to seize oil company profits. If you asked one of these people what "inventory profits" were, and why inventory profits rise and fall quickly, they wouldn't have a clue. I doubt that 10% of them could correctly state the difference between profits and profit margins, nor could they come within a few points of telling you what Exxon-Mobile's profit margin was for the last quarter. These news readers shouldn't feel bad though, they're right in step with the vast majority of the American public. Ignorance of basic economic matters is rampant (thanks to government schools) and politicians will always exploit ignorance to expand their power.
Political Dogs are more technical, but still convincing. They run the numbers and conclude such taxes would be counter-productive:
Oil lives in an environment in which prices can fall as quickly as they rise. Yet oil companies need to hold inventory on hand - they don't buy product today and deliver it into your gas tank tomorrow. That means there is significant inventory risk associated with the business. Inventory risk is the risk of loss when the price for a commodity such as oil drops. We have seen a drop of more than 20% in retail oil prices over the past two months. If you buy something for a buck, planning to sell it for two bucks and the retail price falls to $1.60 after you bought inventory, you lose a full 20% of your bottom line. Generally this inventory risk on the downside is compensated for via the upside potential when prices are increasing. But we've eliminated that by taxing the upside potential. That means oil companies still would not have incentive to buy product at this 25% windfall profits rate. The net effect of this approach is oil companies would be compelled to keep prices high and not permit them to drop, if they had that sort of control.

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