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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.

November 12, 2005 in Energy, Taxes | Permalink


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» Windfall profits tax from Econbrowser
Here's a summary of some of the recent discussion about the proposal of a tax on the windfall profits of oil producers. [Read More]

Tracked on Nov 21, 2005 6:14:44 PM


The reason I came down so hard on the tax foundation study is that it was just another example of a biased study that you see so much of these days.

It is like the claim you see so often that Carter imposed price controls. But Carter did not impose price controls. Nixon imposed price controls. Carter actually lifted price controls. No he did not lift them 100% -- it was a phased deconrol. But, on a percentage basis Carter actually did more to lift price controls then Reagan did. But time after time I see this claim given uncritical acceptance -- even by Nobel prize winning economist -- when it is completely untrue.

There were no gas lines under Carter either -- they were all under Nixon.

But I constantly see claims that the windfall profits tax did massive damage. But the fact was that the time of the windfall profits tax was the era of the most masive investment by the oil industry.

I am opposed to a windfall profits tax.

But I am more opposed to dishonesty in economic analysis.

I am not accusing you of dishonest, just of uncritically accepting a study you know is from a source that is well known for its bias.

But maybe this is the biggest problem with blogs. Such claims that would never be published in a peer review article get widely circulated and become part of the generally accepted thinking.

Posted by: spencer | November 12, 2005 at 11:22 AM

If you want to impose a tax on energy my own personal preference is an import tariff.

A tax on the final product would act to reduce demand, but it does nothing to increase supply.

But an import tariff would raise the price to domestic producers --
assuming that imports are the marginal product that set the domestic price --and make some oil available that is not available at lower prices.
For example, at $60 oil the ammount of oil that could be extracted from ANWAR is some two to three times that that can be extracted at $30.

Posted by: spencer | November 12, 2005 at 11:36 AM

There were no gas lines under Carter

Now who is revising history? Under the second oil price shock, gas supplies were allocated toward the countryside and shortages developed in the cities. I know. I waited in those lines. Fortunately it only lasted a few weeks.

Posted by: Lord | November 13, 2005 at 01:26 PM

It is fairly easy for me to remember. In the first oil shock I lived in the washington burbs and commuted into DC and remember the lines and shortages. In the second oil shock I lived near Boston and have no memory of lines or shortages. Because they are two distinct locations it easy for me to differentiate between the two.

Posted by: spencer | November 14, 2005 at 02:52 PM

spencer -- I'm not quite sure where the dishonesty is. The point was that the windfall profit tax did not raise the revenues it was expected too. Your cogent comments on my earlier post clearly demonstrated why that was so -- the price assumptions just did not hold up. On the issue I was highlighting, I don't think the piece I was referencing said much more.

Posted by: David Altig | November 14, 2005 at 11:11 PM

LA had lines. August 79 is about right. Not being able to get gas in the cities, few left them for the country and they had a surplus as a result. Didn't drive under Nixon so I didn't have to wait in those lines.

Posted by: Lord | November 15, 2005 at 11:45 AM

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