Tuesday, April 25, 2006

The Windfall Profits Tax is Bad for the Economy

Congress is currently deliberating the merits of what has been termed a “windfall” profits tax. According to the legislation (Senate Bill 1631), the federal government would impose a 50 percent excise tax on the excessive profits earned by U.S. oil companies. The tax, net of administrative expenses, would be returned to taxpayers in the form of rebates. The difficulties and the problems of such a tax are beyond the scope of this blog, but let me list just few of the negative outcomes and problems with this bill.


First, the tax is a 50 percent tax on the price of a barrel of oil in excess of $40. Historically, empirically, and theoretically, this will only reduce oil production thus creating shortages. It will also result in a higher price. Certainly the price will not rise by the full extent of the tax, but it will increase. Thus, oil companies and consumers are sharing the burden of the tax and the consumer is more likely to encounter gasoline outages and long queues at petroleum (I’m going to Europe this week) stations.

Second, it increases the size of the federal bureaucracy. In order for the tax to be something less than disastrous, the federal government will have to hire a fleet of accountants and economists to insure the proper administration and disposition of the tax. Just another “no economist left behind” law.

Third, it discourages firms in the oil industry from undertaking the investment necessary to produce more oil in years to come. Of course, there is a tax break for oil from new wells. But investors weary and wary of government involvement in this industry and others will provide diminished funds for ventures in which the government is likely to confiscate a portion of the profits.

Fourth, it politicizes the marketplace placing a drag on investment activities in the U.S. That is, investors will place a higher probability that the federal government will intervene in other industries. Is the pharmaceutical industry next?

Fifth, it is inconsistent with our notions of fair play. If we are going to tax an industry’s success, then we must stand ready to subsidize an industry’s failures. I assert that federal, state and local governments should do neither.


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