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November 12, 2005
Windfall Profits Taxes: Take 2
In my post on this topic yesterday, I made note of pgl's endorsement of a windfall profit tax in his comments at Angry Bear. This morning, pgl takes exception with my characterization of his position:
Incidentally, I hope I was clear that I’m opposed to price controls and do not buy into this price gouging spin. Spencer does not buy into the spin either. I’m not sure why David associated my advocacy for a gasoline tax with the gouging spinmeisters.
My bad. It was certainly not my intention to associate pgl with either price controls or "the tax gouging spinmeisters," which I probably did by combining commentary on the tax issue with commentary related to critics who accuse the oil companies of price gouging. I am a great fan of the boys at Angry Bear, not least because I don't expect anything less than a thoughtful analysis on whatever the issue of the moment might be. Consider this an apology.
So, let me try again. I take pgl's comment to be that, as long as we are searching about for ways to close the fiscal financing gap, why not take the opportunity to collect some revenue via the windfall profit tax? My interpretation of Andrew Chamberlain's evidence from the Carter/Reagan era windfall profit tax is that this is not a very durable source of revenue. In the comment section of my earlier post, Spencer writes this:
Technically, the windfall profits tax was signed into law in April 1980 and remained on the books until 1988.
But the tax only collected revenues when the price of crude was above $30 and April 1983 was the last month oil was above $30. So for all practical purposes the effective end of the tax was April 1983 -- because no one had to pay the tax after that point.
But the data the CBO study uses to claim the tax caused oil production to fall has to go out to 1986 to find lower oil production, about 3 years after the tax effectively ended although it was sill legally on the books..
That's a good critique of the CBO study, but doesn't change the essential point I was trying make:
Things change, and profits and prices in the energy sector are notoriously volatile. To my mind, this fact significantly diminishes the attractiveness of a windfall profit tax as a way to finance government expenditures.
There is another, potentially more serious, criticism which I neglected to emphasize in my first post. A windfall profit tax is essentially an after-the-fact tax on fixed capital. As such, it is prime candidate for the time inconsistency critique. In brief, because "windfall profits" represent returns on economic activity that has already taken place, it may seem like a free lunch to generate revenue from these profits because there is not a whole lot that the taxed companies can do to to avoid paying the tax today. But if the impacted businesses anticipate that the tax will persist or be levied again in comparable future circumstances -- and why wouldn't they? -- the end result will be a less than socially optimal level of investment. That's a bad thing.
For sure, I endorse pgl's refrain that it is a good thing to get serious about reducing the magnitude of the federal deficit relative to GDP. I am more agnostic than he about whether that should be through higher taxes or lower expenditures -- the devil is always in the details, so you need to tell me which taxes you intend to raise and which expenditures you intend to cut before I am willing to come to any conclusions. Based on his past positions, I'm willing to bet that pgl would prefer the reversal of the previous reductions in income tax rates. That's fine. If we collectively decide that fiscal financing gap is best closed by higher taxes, let the debate proceed to the recommendations of the Federal Advisory Panel on Federal Tax Reform, and how those proposals might be amended to raise the requisite revenues. I'd forget the windfall profit tax.
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