Nothing stirs up populist fury like large profits. Specifically, the tremendous profits recently enjoyed by the major oil companies has got much of the public in a tizzy. Oil companies, or so the thinking goes, are exploiting natural disasters and unfairly raising prices in ways that have nothing to do with supply and demand and everything to do with generating huge profits through price gouging. Congress is getting in on the action for the cameras and demanding an explanation.
But kudos (hat tip: Cafe Hayek)to the Washington Post for getting it right:
A tax on windfall profits is less counterproductive but still bad. For one thing, it's not as though the profits are socially useless. Even in the absence of a special tax, they generate regular tax revenue for both federal and state governments as well as dividends for retirement plans. For another, the profits are a spur to new investment; taxing them reduces the return that companies will expect to make on new oil finds or refineries, with the result that there will be less oil and gas available in the future and hence higher prices.
Moreover, taxes on windfall profits tend to exacerbate dependence on imports, because companies generally make windfall profits only from their U.S. drilling operations; contracts for drilling foreign oil are usually structured so that the windfall from high prices is captured by the foreign government. As a result, windfall taxes penalize oil drilled in the United States. A study by the Congressional Research Service found that the last such tax imposed on the oil industry, between 1980 and 1988, reduced domestic production 3 to 6 percent and increased imports between 8 and 16 percent.
As I've argued before, profits - even large ones- are not necessarily a sign of price gouging. Higher prices are simply the market's way to allocate a scarce resource, a reduced supply. Typically higher prices function as a natural incentive to conserve. The record profits the oil companies earned in the third quarter of this year, in fact, most likely indicate that price gouging did not really occur at all: for the most part, consumers kept buying gas and oil at about the same rate. Higher prices were not enough to keep them away from the pumps. Consumer spending slowed in some areas, but not enough to reduce economic growth, which - against many economist's predictions - kept growing through the third quarter.
Besides, as the Post argued, heavy taxation on profits will only increase our dependence on foreign sources of oil, a dependence we are supposed to be trying to reduce. Here's Charles Krauthammer on our shameful dependence:
For decades we've been dithering over drilling in a tiny part of the Arctic National Wildlife Refuge. Look, I too love the caribou. They are sweet, picturesque and reputedly harmless. But dire predictions about the devastation that Prudhoe Bay oil development would visit upon the caribou proved false. They have thrived. Let's get serious. We live at the edge of oil shortages and in perpetual vulnerability to oil blackmail. We have soldiers dying in the oil fields of the Middle East, yet we leave untouched the largest untapped oil field in North America so that Lower-48ers can enjoy an image of pristine Arctic purity. This is an indulgence bordering on decadence.
As is our refusal to drill on the continental shelf. Offshore drilling technology is far safer and more efficient than it was decades ago when this prohibition was passed. We're starving ourselves.
If the Senators want to have an inquisition perhaps it should be on why we've been promising to reduce foreign dependence on oil for all these years, and are still yet shackled to the many countries that pray for our destruction.
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